Late in 2011, Lloyd’s published a survey of global risk that outlined the major risk concerns of business executives around the world. I found the #1 risk on the survey, “Loss of Customers,” quite interesting. The Lloyd’s report describes the problem this way:

From concern about the availability of credit, business leaders are now facing an even more fundamental risk; the evaporation of those wanting – or able – to buy.

There are multiple reasons for this concern about loss of consumers. Western governments are driving down their deficits by cutting back both on investments their spending on public services. At the same time, the high cost of raw materials and of energy has driven up inflation, making many products more expensive.

Consumers in North America and Europe are paying down their debts, buying less and buying more cheaply when they do. The debt crisis in the eurozone is affecting global stock markets and dramatically eroding the world’s wealth.

Emerging economies such as India and China are changing focus as they deal with the dual issues of reduced international demand and escalating domestic consumption.

Against a background of dwindling demand for goods and services, supply chain failures or reputational damage can mean the difference between business survival or collapse. As margins are increasingly squeezed, mitigating against these types of risks has become more important than ever.

(“Lloyds Risk Index 2011.” Lloyds.com. August, 2011.)

A look at the complete Top 10 shows some interesting groupings:

1 Loss of customers/Cancelled orders

2 Talent and skills shortages (including succession risk)

3 Reputational risk

4 Currency fluctuation

5 Changing legislation

6 Cost and availability of credit

7 Price of material inputs

8 Inflation

9 Corporate liability

10 Excessively strict regulation

On the one hand, there are specific types of risks for which the typical CEO can identify tangible actions to at least try to mitigate any negative potential impact. These include:

2 Talent and skills shortages (including succession risk)

4 Currency fluctuation

5 Changing legislation

6 Cost and availability of credit

7 Price of material inputs

8 Inflation

9 Corporate liability

10 Excessively strict regulation

The two remaining risks are harder to pin down. One can hardly go out and buy a hedge against a complete destruction of reputational (the full valuation of which would be almost impossible), and many executives I have spoken with would not even put in on this list. They see reputational risk as the secondary outcome of issues in the primary aspects of the business, and I tend to agree with this view. Decreased demand is an even more amorphous risk. How does a CEO or CFO hedge against governments that cut back spending (US, UK, etc) or reduced international demand as emerging economies favor domestic producers (China, India, Brazil, etc.)?

The answer to the question above is critical because, as I have argued in the past, most risk managers have too narrow a view of how risk affects their business. Indeed, the reality is that the great majority of operational risk managers are worried about physical risk: the loss of a plant, or shipment, or the appearance of a natural disaster. While these risks are important the reality is that they are rare. What will not be rare in 2012 is the very risk executives place at the top of the Lloyd’s survey. Indeed, when our team looks at operational risk we look at it in three dimensions:

Risk Dimension 1) Supply Risk: risk inherent in the purchase of goods and services

Risk Dimension 2) Network Risk: risk inherent in operations controlled directly or via contract

Risk Dimension 3) Market Risk: risk inherent in the places where products and services are delivered

The risk the Lloyds report is clearly in dimension three, but in our experience very few risk teams give these types of risks the full attention they deserve. Moreover, almost no risk brokers or underwriters offer products to deal with risks in this area either. This situation  needs to change, as the Lloyd’s report highlights. For the risk of demand decreases in 2012 should be at the top of the agendas of risk managers all over the world, even if today the reality is that most companies have neither the understanding of how this risk works nor the tools to address it.

 

 

Advertisements

Posted by Carlos Alvarenga

Carlos Alvarenga is the Executive Director of World 50 ThinkLabs and an Adjunct Professor at the University of Maryland's Smith School of Business.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s