With a painful credit crunch, a growing regulatory burden, and a worryingly unstable geopolitical climate, business leaders have got plenty of issues to worry about, never mind what’s going on inside their own organisations. So what are the risks keeping leading business people awake at night? A new survey from Ernst & Young and think tank Oxford Analytica lists the top 10.
Global financial shocks and ‘radical greening’ are among some of the biggest risks for international businesses in 2008 and beyond, according to the report, ‘Strategic Business Risk: 2008: the top ten risks for global business.’ The risk of a global financial shock is now a critical issue not just for the financial markets, but for the real estate, biotechnology, oil and gas and utilities sectors, the report says. As one respondent put it, “A crisis in structured finance markets could lead to potential systematic problems. Sustainability of financial sector growth is more fragile than markets realise. There is the potential for dramatic fall out from excessive leverage.” Not a cheery thought.
Few sectors would escape such a shock, the report says. Biotech and utilities companies would have trouble raising capital; banking, asset management, and insurance companies would be likely to suffer direct losses from market movements; and after making high-cost exploration investments – oil and gas companies might suddenly find themselves facing low prices if the global economy moves into sudden recession.
The research for the report started back in April, before the sub-prime crisis provided a real-life demonstration of how highly contagious such shocks can be across sectors – and indeed – globally. The report quotes Rory MacLeod, the former head of global fixed income at Baring Asset Management, who predicted in April that if there was a “worldwide credit crunch – spread widening would not lead to bank collapses, as in the past, but would be spread throughout the financial system.
“There will be unexpected pockets of vulnerability. Disintermediation has replaced international banking as a finance source with a range of specialised credit instruments held widely, with risk exposures that regulators find it difficult to assess. A credit shock could lead to a temporary closing of the market for new credits, while traditional lenders such as banks have moved away from the area.” He wasn’t wrong.
‘Radical greening’ – the growth in environmental concerns – also made its way into the top 10 risks list, although it was considered a very low risk for the pharmaceutical, biotechnology, banking, telecoms and media and entertainment sectors. Gerard Gallagher, head of business risk services at Ernst & Young, was surprised by this finding. These sectors do not consider radical greening a major risk to their business, because they aren’t heavy energy users and their business is not dominated by carbon use or emissions, he said, “but they are wrong to think it does not touch their business.
“The carbon agenda is starting to cut across all sectors and affect consumer demand. These sectors could therefore be exposed if they view this as an operational risk rather than a strategic risk,” said Mr Gallagher. “For pharmaceutical companies, climate change affects disease and how disease is spread. This could have significant impact on pharmaceutical product distribution and future product development.”
The ever-present daily risk of global rules, regulations and compliance unsurprisingly featured in the top three threats to business. Regulator intervention was seen as a threat to a healthy competitive environment, which fundamentally changes business models.
The compliance challenges are particularly strong in highly regulated industries such as banking, insurance, pharma, and biotech, where the regulatory burden is increasing fast, and where firms are feeling pressure to demonstrate a return on investment for long-term risk management initiatives.
“Banks are experiencing significant fatigue around managing the myriad of often redundant compliance and regulatory reporting activities, the cost of which is massive and burdensome,” said one banker quoted in the report. Similarly, a biotech analyst said, “A mounting regulatory compliance burden in areas such as privacy, post-marketing monitoring of drug safety and sales force compliance… poses a management and internal controls challenge to biotech companies.”
Increasingly, companies may seek risk convergence initiatives which allow them to co-ordinate the various risk and control processes, reduce redundancy, which drives down costs, and, perhaps most importantly, more comprehensive enterprise-wide risk reporting to senior management and the board, said Ernst & Young.
As companies become increasingly global, compliance becomes a greater challenge, forcing them to manage
diverse regulations in different markets. “Managing regulations in 10 jurisdictions is one thing,” said one executive quoted in the report. “What happens when a firm has significant markets in 30-40 countries at varying levels of development and with very different regulatory traditions? This is not to say that global regulatory diversity is necessarily increasing; but rather, that corporate exposure to existing diversity is increasing.”
The importance of understanding local regulations, as well as major global industry regulations, is crucial to those companies expanding their global reach, said Fiona Sheridan, head of risk advisory services at Ernst & Young. “Globalisation continues to cause a major compliance headache for many organisations, which are frequently being forced to manage diverse regulations as they expand into new markets. The response from business to these challenges has largely been either to back away from opportunities because of regulatory restrictions or to build up a ‘layer cake’ of internal risk activities that barely touch each other.”
An increasing strategic risk for the majority of industries is the threat posed by workforce and consumer aging, the report says. Sectors such as asset management and insurance are experiencing dramatic shifts in demand and competitive battles are being fought for savings products that will appeal to the growing group of older consumers.
Other firms, for example, those in the auto sector, are facing severe competitive challenges because of their aging workforces, the report said. “A number of industries are experiencing dramatic shifts in demand – often dramatic growth – as a result of the rising average age in, for example, Europe, North America, and Japan.” Sectors most affected by these shifts include pharma, biotech, consumer products, insurance, and asset management companies, which could lose their competitive edge if they cannot effectively respond to these new opportunities.
“People reaching retirement age have very different financial needs,” said an insurance expert quoted in the report. As a result, a struggle is now emerging between insurance and asset management firms to deliver the innovative products that will meet these needs, such as income maintenance and health care spending. “To be competitive, companies will need to gain an understanding of the specific needs of these new consumers, and many will need to have an aggressive approach to key competitors that may increasingly come from outside their sector,” the report said.
Next five risk
The other strategic challenge posed by an aging population is workforce aging, a risk issue that figures highly in oil and gas and is perceived to be a ‘next five risk’ for sectors such as banking (see figure 2). These sectors are already experiencing a significant human resource challenge, the report said, adding that the most extensive example of this threat can be seen in the US auto industry, which is particularly weighed down by pensions and health care costs. “There remains a possibility of insolvency in the US auto industry, and a long line of dependent component companies have yet to construct a path to safety,” it said.
With regard to emerging markets, the report said that, while many companies have been in these markets for some time, emerging markets remain dynamic for developed market (DM) companies. Over 60 percent of DM companies have been in these countries for less than 10 years, and almost 20 percent less than two years. In most cases, global firms are competing with other global players for opportunities in these markets, although in several sectors, emerging markets firms are themselves entering the global stage.
Often companies are being driven to these markets by the saturation of existing markets, said the report. It quoted one consumer products executive who said: “Over the next few years nearly all of the increase in world population will take place in the developing countries. In the meantime, other established markets will reach maturity.” Similarly, in real estate, “Intense competition for a limited pool of desirable assets, combined with yield compression in most global markets, has resulted in real estate funds needing to broaden their geographic search for opportunities. This has created an increased number of competitive variables in real estate markets,” said another executive.
For other sectors, such as biotech and consumer products, emerging markets offer supply chain advantages, the report said. It quoted one biotech executive who said, “The sources of biomedical innovation will become more diverse in a globalised marketplace. The implication is that while, in the past, the main source of competitive advantage for firms throughout the industry has been technology, in the future the supply chain will be important as well. Global companies will need to form networks with firms in many markets.”
What are the boardroom implications of the report? “The global heavyweights of tomorrow are already identifying these risks and developing strategies to use them as a point of competitive advantage in the race for increased market share,” said Ernst & Young’s Mr Gallagher. “Someone’s challenge is frequently someone else’s opportunity – and how an organisation exploits strategic risk will be what separates the winners from the losers.”
Ms Sheridan agreed. “This report is just a snapshot of the risks we see now,” she said. “Risks, and the business perception of them, will change over time. If we had done this exercise 10 years ago, it is unlikely that climate change would have placed so highly. That is why it is so important for global businesses to be looking at all risks, not just the critical risks of today, but also those sitting just below the horizon. They could rapidly become critical.
“CEOs need to be more open-minded about risk – they should look beyond financial and regulatory risks to the wider environment in which their organisation operates. It is important that all boards have strategic business risks on their radar – ignoring them is not an option as they can be the quickest and most permanent destroyers of stakeholder confidence and that’s not good news for CEOs.”
The emerging risks likely to make the top 10 in three years time:
1. The war for talent
2. Disease pandemic
3. The rise (and possible fall) of private equity
4. Inability to innovate
5. China setback
Source: Ernst & Young
The top 10 strategic business risks
1. Regulatory and compliance risk
2. Global financial shocks
3. Ageing consumers and workforce
4. Emerging markets
5. Industry consolidation/transition
6. Energy shocks
7. Execution of strategic transactions
8. Cost inflation
9. Radical greening
10.Consumer demand shifts