DOC

DEFINITION OF BUSINESS RISKS

By Esther Taylor,2014-04-30 00:39
30 views 0
DEFINITION OF BUSINESS RISKS

    ARTHUR ANDERSEN

    TMBUSINESS RISK MODEL

    DEFINITION OF BUSINESS RISKS

    (OBTAINED FROM THE “UNIVERSAL BUSINESS RISK MODEL” SECTION

    TM OF THE BUSINESS RISK MODELKNOWLEDGE BASE)

     Competitor Sensitivity Shareholder Relations Capital Availability Catastrophic Loss Sovereign/Political Legal Regulatory Industry Financial Markets

    OPERATIONS RISKFINANCIAL RISKEMPOWERMENT RISKCustomer SatisfactionLeadership Interest RatePriceHuman ResourcesAuthority/LimitCurrencyProduct DevelopmentOutsourcingEquityEfficiencyPerformance IncentivesCommodityCapacityChange ReadinessFinancial InstrumentPerformance GapCommunicationsCycle TimeCash FlowLiquiditySourcingINFORMATION PROCESSING/Opportunity CostObsolescence/ShrinkageTECHNOLOGY RISKConcentrationComplianceRelevanceBusiness InterruptionIntegrityDefaultProduct/Service FailureCreditAccessConcentrationEnvironmentalAvailabilitySettlementHealth and SafetyInfrastructureCollateralTrademark/Brand Name Erosion

    INTEGRITY RISKManagement Fraud Employee FraudIllegal ActsUnauthorized UseReputation

    STRATEGICFINANCIALEnvironmental ScanOPERATIONALBudget and PlanningBusiness PortfolioPricingAccounting InformationValuationContract CommitmentFinancial Reporting EvaluationPerformance MeasurementPerformance MeasurementTaxationOrganization StructureAlignmentPension FundResource AllocationRegulatory ReportingInvestment EvaluationPlanningRegulatory ReportingLife Cycle

    c:\convert\temp\52117992.doc Last modified on: 1/98?1999 Arthur Andersen. All rights reserved.

    Page 1 of 37

ENVIRONMENT RISK

    ENVIRONMENT RISK Competitor Sensitivity Shareholder Relations Capital Availability Catastrophic Loss Sovereign/Political Legal Regulatory Industry Financial Markets

Environment risk arises when there are external forces that could significantly change the

    fundamentals that drive a company’s overall objectives and strategies and, in the extreme,

    put a company out of business.

    Environment risk arises from failure to understand customer wants, failure to anticipate or

    react to actions of competitors, overdependence on vulnerable suppliers, etc. As competitive

    advantage and the ability to sustain it become increasingly temporary, management's

    assumptions about the business environment provide a critical starting point for formulating

    and evaluating business strategies. These assumptions include the strategic profile of major

    competitors, demographic and social trends, new technologies that provide opportunities for

    competitive advantage, and economic, political, and regulatory developments. If key

    managers do not have a common understanding of the key environment risks, the company's

    strategic objectives will not be focused. The consequences will be severe -- loss of market

    share and competitive advantage. Because the high stakes of strategic error, management

    must have assurance that the key environmental assumptions on which its strategy is based

    are consistent with reality.

    Competitor Risk

    Major competitors or new entrants to the market take actions to establish and sustain

    competitive advantage over the company or even threaten its ability to survive.

    These actions include issuance of new products to market, improving product quality,

    increasing productivity and reducing costs, and reconfiguring the value chain in the

    eyes of the customer. Superior competitor performance in the marketplace (e.g., in

    terms of superior quality, low cost provider capability, or faster response time) will

    also result in loss of competitive advantage.

    Sensitivity Risk

    Sensitivity risk results when management commits the company's resources and

    expected cash flows from future operations to such an extent that it reduces the

    company's tolerance for (or ability to withstand) changes in environmental forces that

    are totally beyond its control. For example:

    ? Unfavorable changes in competitor capabilities, interest rates, currency rates,

    inflation, capital markets, international trade and other economic conditions

    that are closely tied to the business cycle (e.g., housing starts, consumer

    demand for durables, etc.) can adversely affect and even threaten the very

    survival of a company that is highly leveraged or has no exploitable

    competitive advantage.

    c:\convert\temp\52117992.doc Last modified on: 1/98? A company's strategy to grow rapidly, expand geographically and invest in

    significant high risk ventures can increase its sensitivity exposure to

    unexpected economic, regulatory and market developments.

    ? Systemic risk for financial institutions is a form of sensitivity risk. It is the risk

    that financial difficulties in one financial institution or a major market

    Page 2 of 37

    disruption will cause uncontrollable financial harm to other institutions or

    prevent the effective operation of the financial system generally. The result is

    financial loss for significant uninsured depositors and other companies that

    have a stake in financial institutions that fail as a result of an uncontrollable

    chain reaction in financial markets that basically thrives on the expectation of

    prompt payments.

    Sensitivity risk also results when an organization is too inflexible to change in

    response to changes in the environment. If a company's business processes cannot be

    aligned to satisfy customer wants and meet the challenges of changing technological

    advances, unexpected competitor actions or other external environmental changes, its

    ability to compete and survive will be significantly affected.

    Shareholder Relations Risk

    A decline in investor confidence which impairs a company's ability to efficiently raise

    capital. Current and prospective investors do not understand the company and its

    core messages and strategies. As a result, they do not have the necessary confidence

    in the company's potential to provide sufficient returns on their investment. The

    consequences can be severe -- the company will not have the same efficient access as

    competitors to the capital it needs to fuel its growth, execute its strategies, and

    generate future financial returns.

    Lower stock valuations can have several consequences:

    ? Higher cost of capital and lower shareholder wealth. ? Stock options will not provide adequate compensation to executives. ? Stock will not provide an attractive non-cash alternative for acquisitions. ? Increased dilution from stock acquisitions.

    ? Greater vulnerability to takeovers.

    Capital Availability Risk

    The company does not have efficient access to the capital it needs to fuel its growth,

    execute its strategies, and generate future financial returns. This can result in a

    competitive disadvantage if the company is highly leveraged or its major competitors

    have larger cash reserves, a lower cost structure, greater market share, or access to

    capital through strategic alliances.

    Catastrophic Loss Risk

    The inability to sustain operations, provide essential products and services, or recover

    operating costs as a result of a major disaster. The inability to recover from such

    events in a world class manner could damage the company’s reputation, ability to

    obtain capital, and investor relationships.

    There are two sources of catastrophic losses:

    ? Uncontrollable -- Disasters from war, terrorism, fire, earthquake, severe c:\convert\temp\52117992.doc Last modified on: 1/98

    weather and flooding and other similar events are completely beyond the

    control of the company. However, their effect on the company’s assets and

    operations can be managed.

    Page 3 of 37

    ? Controllable -- Environmental disasters, pervasive health and safety violations,

    spectacularly large underwater real estate deals, incredibly high litigation

    costs, huge losses from derivatives, massive business fraud, and significant

    losses in market share because of failure to abandon strategies that no longer

    work can be as catastrophic in their effects on a business as an uncontrollable

    disaster; however the business activities that contribute to these losses are

    within the control of the company.

    Catastrophic loss exposure means different things to different industries and

    businesses, depending on where the bulk of the exposure is. For example:

    ? For a fast-foods restaurant, the primary focus is on preventing injuries from

    the process of preparing and serving food, because that is where the primary

    costs of risk are.

    ? For an electric utility operating a nuclear power facility, compliance with all

    standard plant operating procedures and safety regulations is paramount. ? For an auto manufacturer, product liability claims from exploding fuel tanks,

    unpredictable transmissions, and inability to protect occupants from crashes

    are key concerns.

    ? For companies trading in derivatives for profit or to hedge financial risks, fears

    of an “Orange County” or “Barings” scenario can create considerable unrest

    unless driven out of the organization with effective policies and controls. ? For professional services providers, exposure to professional liability and

    “deep pocket” litigation under tort laws are of major concern.

    ? For health care firms, malpractice claims from pharmaceutical products and

    professional services are the primary focus.

    ? For airlines, aircraft maintenance and pilot competence are significant

    priorities because of the concern for passenger safety and the high publicity

    given to industry safety records.

    ? For chemical firms, fire prevention and environmental risks can keep

    management awake at night.

    Breakdowns in any of these areas can threaten the very survival of the business. The

    risk of catastrophic losses occurring overlaps with other business risks that relate

    more specifically to the potential for adverse events, i.e., product/service failure,

    environmental, health and safety, and derivative risks.

    Sovereign/Political Risk

    The risk of adverse consequences through political actions in a country in which a

    company has made significant investments, is dependent on a significant volume of

    business or has entered into an agreement with a counterparty subject to the laws of

    that country. For example, possible nationalization, expropriation of assets without

    compensation, currency blockage or other restrictions could result in significant losses c:\convert\temp\52117992.doc Last modified on: 1/98

    to the company.

    Sovereign risk is a reflection of a country's financial standing in the world community

    and, to some degree, a function of the country's political stability and historic

    performance in meeting its international financial obligations. The greater the

    probability a government may impose foreign exchange controls, thus making it

    Page 4 of 37

impossible for a counterparty or foreign subsidiary to honor its commitments, the

    greater is the sovereign risk. For example;

    ? An issuer may be barred by its government from making interest and

    principal payments on its debt.

    ? A counterparty to a derivatives contract (i.e., a swap) is barred by its

    government from fulfilling its swap obligations. Legal Risk

    The risk that a company's transactions, contractual agreements and specific strategies

    and activities are not enforceable under applicable law. Changes in laws and

    litigation claims and assessments can also result in increased competitive pressures

    and significantly affect a company's ability to efficiently conduct business. For

    example, uncontrolled litigation and punitive damages can cause tremendous

    uncertainty in decision making and create potentially unacceptable liabilities for

    businesses.

    Regulatory Risk Changes in regulations and actions by national or local regulators can result in

    increased competitive pressures and significantly affect a company's ability to

    efficiently conduct business. For example, regulators can significantly change the

    rules of the marketplace and thrust entire industries into a vastly different

    competitive environment (e.g., deregulation).

    Industry Risk

    Industry risk is the risk that the industry will lose its attractiveness due to changes in

    the:

    ? Key factors for competitive success within the industry, including significant

    opportunities and threats.

    ? Capabilities of existing and potential competitors. ? Company's strengths and weaknesses relative to present and future

    competitors.

    There are also other risks that can be broadly categorized under "industry risk"

    because they tend to affect different industries in different ways:

    ? Demographic Risk -- The risks that demographic trends will affect the

    industry's customer base and work force.

    ? Social/Cultural Risk -- The way people live, work and behave as consumers

    can affect the industry's products and services. For example, more women in

    the workplace, concerns about drug abuse, increasing crime rate, increased

    health consciousness, etc.

    ? Ecological Risk -- Concerns about acid rain, global warming, recycling, waste

    c:\convert\temp\52117992.doc Last modified on: 1/98management, and energy conservation can lead to substantial changes in the

    way businesses within an industry operate.

    ? Natural Disaster Risk -- Severe weather, flooding, earthquakes and other

    natural disasters affect most industries, some more directly than others. For

    Page 5 of 37

    example, weather affects market demand for gas and electricity. Inclemental

    weather that is out-of-season also adversely affects the citrus industry.

    Financial Markets Risk

    Financial markets risk is defined as exposure to changes in the earnings capacity or

    economic value of the firm as a result of changes in financial market variables (e.g.,

    currency rates) which affect income, expense or balance sheet values. These variables

    include:

    (1) The market price of financial instruments (e.g., investment securities, foreign

    currency debt instruments, or commodities)

    (2) Market rates which influence income and expenses (e.g., interest rates); or

    (3) An index (e.g., a stock market index) which can affect either the price of a

    financial instrument or the value of a commercial transaction such as export

    sales.

    Financial market exposures can result in substantial losses if the exposures are

    unhedged or imperfectly hedged. Financial markets risk can be incurred in a number

    of different ways:

    ? Yield Risk -- Exposure to changes in earnings as a result of fluctuations of

    market factors (e.g., interest rate changes, currency fluctuations, etc.) which

    affect income from unhedged assets or the cost of unhedged liabilities

    (including executory contracts and other contingent exposures).

    ? Price Risk -- Exposure to changes in earnings or net worth as a result of price

    level changes, including:

    ? Adverse movements in revenues or expenses due to the impact of

    financial market factors on prices (e.g., the impact of currency

    fluctuations on export sales);

    ? Adverse changes in competitive position due to changes in financial

    market indices (e.g., an uncompetitive cost structure due to high cost

    fixed rate debt in a low interest rate environment); and

    ? Adverse changes in asset or liability values as a result of financial

    market fluctuations (e.g., revaluation of overseas subsidiaries). ? Credit Risk -- The exposure to actual loss or opportunity losses as a result of

    deterioration in a counterparty’s ability to honor its obligations. Credit risk

    includes:

    ? The default (or the failure to perform) by an economic or legal entity

    with which the company does business;

    ? The loss or opportunity cost as a result of the failure of a counterparty

    or customer to honor its obligations in a timely manner; and

    c:\convert\temp\52117992.doc Last modified on: 1/98? A change in the risk premium on securities issued by an entity due to a

    change in the market’s perception of that entity’s creditworthiness.

    ? Liquidity Risk -- Exposure to loss resulting from the inability to convert assets

    (e.g., investment securities, receivables, inventories) to an equivalent cash

    Page 6 of 37

    value, or to raise unsecured funding, in a timely and cost-effective manner. It

    may arise due to:

    ? An illiquid or thinly-traded market (e.g., the small size of a securities

    issue);

    ? Gaps in price information and/or market participation (e.g.,

    unexpected changes in market conditions due to the failure of a large

    financial institution); and/or

    ? Constraints on the organization’s ability to hold and carry an asset

    leading to conversion of an investment to cash, divestiture of an asset,

    exit from an investment position or execution of an offsetting hedge

    under unfavorable market conditions.

    ? Systemic Risk -- Exposure to loss as a result of a major market disruption

    which adversely affects all participants in that market (e.g., the inability to

    repatriate funds held in a foreign country due to the failure of its financial

    markets and/or banking system).

    ? Legislative / Regulatory Risk -- Exposure to actions by legislators and

    regulators which affect the market value of a financial instrument (e.g.,

    changes in tax or accounting treatment of financial instruments).

    ? Complexity Risk -- Exposure to loss resulting from entering into complex

    transactions, the structure and pricing of which are not completely

    understood.

    Financial market exposures are a major risk management concern for company’s with

    investment portfolios, such as insurance companies, financial institutions, investment

    companies and commercial enterprises with large portfolios.

    PROCESS RISK

    Process risk is the risk that business processes:

    ? Are not clearly defined, ? Are poorly aligned with business strategies,

    ? Do not perform effectively and efficiently in satisfying customer needs,

    ? Do not add to shareholder wealth or ? Expose significant financial, physical and intellectual assets to unacceptable losses,

    risk taking, misappropriation or misuse.

    Process risks include:

    ? Operations Risk -- The risk that operations are inefficient and ineffective in

    satisfying customers and achieving the company's quality, cost and time

    objectives.

    c:\convert\temp\52117992.doc Last modified on: 1/98? Empowerment Risk -- The risk that managers and employees:

    ? Are not properly lead,

    ? Do not know what to do (or how to do it) when they need to do it,

    ? Exceed the boundaries of their defined authorities,

    Page 7 of 37

    ? Do not have the resources, training and tools necessary to make

    effective decisions, or

    ? Are given incentives to do the wrong thing.

    ? Information Processing/Technology Risk -- The risk that the information

    technologies used in the business are not efficiently and effectively supporting

    the current and future needs of the business, are not operating as intended, are

    compromising the integrity and reliability of data and information, are

    exposing significant assets to potential loss or misuse, or threaten the

    company’s ability to sustain the operation of critical business processes.

    ? Integrity Risk -- The risk of management fraud, employee fraud, and illegal

    and unauthorized acts, any or all of which could lead to reputation

    degradation in the marketplace or even financial loss.

    ? Financial Risk -- The risk that cash flows and financial risks are not managed

    cost-effectively to:

    ? Provide adequate liquidity to meet the firm’s obligations,

    ? Manage currency, interest rate, credit and other financial risks in a

    manner that is consistent with the business objectives of the firm, and

    ? Move cash funds quickly and without loss of value to wherever they

    are needed most.

    The interdependencies of processes within a business and with customers and suppliers are a

    contributing factor to process risk. Deficient outputs from one business process are deficient

    inputs to another.

    OPERATIONS RISK

    PROCESS RISK

    OPERATIONS RISK Customer Satisfaction Human Resources Product Development Efficiency Capacity Performance Gap Cycle Time Sourcing Obsolescence/Shrinkage Compliance Business Interruption Product/Service Failure Environmental Health and Safety Trademark/Brand Name Erosion

     c:\convert\temp\52117992.doc Last modified on: 1/98

    Customer Satisfaction Risk

    The company's processes do not consistently meet or exceed customer expectations

    because a lack of focus on the customer. The consequences of dissatisfied customers

    are severe -- permanent loss of repeat business, declining revenues, and loss of market

    Page 8 of 37

share. Without a constant drive toward customer satisfaction and continuous

    improvement, the company will neither understand nor accept the product

    characteristics or service elements necessary to remain competitive and will fail to

    improve its products and processes. If a company does not focus on the root causes

    of customer dissatisfaction, long-term growth is impossible and survival doubtful.

    Human Resources Risk

    The personnel responsible for managing and controlling an organization or a business

    process do not possess the requisite knowledge, skills and experience needed to

    ensure that critical business objectives are achieved and significant business risks are

    reduced to an acceptable level.

    Product Development Risk

    The company's product development process creates products that:

    ? Customers do not want or need,

    ? Are priced at a level customers are not willing to pay, or ? Meet a need but are late in reaching the market that a competitor reached first.

    The productivity of the product development process is significantly less than more

    innovative competitors who are able to achieve higher productivity through a

    stronger customer focus, concentrating focused resources and faster cycle time.

    Efficiency Risk

    The process is inefficient in satisfying valid customer requirements resulting in higher

    than competitive costs, e.g., significant gaps are identified when the cost of process

    activities is compared with costs incurred by world class performers.

    Capacity Risk

    Capacity risk has several dimensions:

    ? The effective productive capacity of the plant is not fully utilized, resulting in

    spreading fixed costs over fewer units and creating higher unit costs and lower

    unit margins.

    ? The effective productive capacity of the plant is not adequate to fulfill

    customer needs and demands, resulting in lost business. Performance Gap Risk

    A business process does not perform at a world class level because the practices

    designed into the process are inferior. When compared to competitors or best of class

    performers, there is an unfavorable performance gap because of lower quality, higher

    costs, or longer cycle times. When customers discover the alternatives provided by

    superior performing competitors, they cease to purchase the company's products.

    c:\convert\temp\52117992.doc Last modified on: 1/98

    Page 9 of 37

Cycle Time Risk

    Elapsed time between the start and completion of a business process (or activity

    within a process) is too long because of redundant, unnecessary and irrelevant steps.

    Cycle time can be measured for all operations, e.g., order entry, production, delivery,

    product design, etc.

    Cycle time risk has many forms. For example:

    ? If competitors using time as a strategic weapon can pose a formidable threat if

    they significantly alter the cost structure of the value chain to the end user.

    Total cycle time reduces the need to tie up cash, liberating funds for growth

    opportunities. For example:

    ? Cutting the cycle time of product design and development by half or

    better will double the productivity of research and development

    investments and open larger windows of opportunity in the market.

    ? A company moving to larger machines and facilities to achieve cost

    economies may not be able to compete with time-based competitors

    that shorten their manufacturing cycle times by using smaller machines

    and smaller run sizes that are optimized to fulfill the demands of the

    marketplace rather than to achieve full capacity utilization. ? The use of Just-in-Time (JIT) reduces inventory and liquidity risk, e.g., the

    amount of cash tied up in procuring, storing, handling and financing raw

    materials, work-in-process and finished goods at any point in time.

    Compressing the cycle time of ordering, receiving, handling, converting and

    shipping inventory reduces liquidity risk.

    ? Contrary to conventional thinking, time-based competitors believe there is a

    link between reducing the number of steps in a process to get the same or

    better result with total quality because it reduces the number of things that can

    go wrong. The result is elimination of unnecessary and redundant steps,

    unneeded precision, excessive materials handling, needless delays and the

    automation of as much as possible of what is left. The drive to compress the

    time it takes to perform a process or an activity can create a formidable

    competitive environment for companies that choose to not focus on time.

    Sourcing Risk

    The fewer the alternative sources of the energy, metals and other key commodities

    and raw materials used in a company's operations, the greater the risks of shortages

    and higher costs. These risks can significantly affect the company's capability to

    provide competitively priced products and services to customers at the time they are

    wanted. For example:

    ? If the decision is made to source from foreign suppliers, the company will

    either assume foreign currency risk if the seller prices in its home currency or

    pay a substantial premium if the seller prices in the company's currency. c:\convert\temp\52117992.doc Last modified on: 1/98

    ? When engineers specify a component that can be sourced from only one

    supplier from a foreign country, they expose the company to sourcing risk.

    ? Fewer suppliers can mean higher costs.

    Page 10 of 37

Report this document

For any questions or suggestions please email
cust-service@docsford.com