IDENTIFYING STRATEGIC

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GROUP 1

CHAPTER
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• IDENTIFYING STRATEGIC
• RISK

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Sources of Risk Defined

• An unexpected event or set of conditions that
  can inhibit or interfere with a business
  managers ability to implement the intended
  business strategy of the firm.

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Operations Risk

• A breakdown in the core function of the operating
  process in a firm Either in their manufacturing,
  operations, or process capabilities.
• All firms that create value via any or all of the
  above capabilities are exposed to some varying
  degree of RISK.

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Instances of Operational Process Break Down

• Shipping of defective products
• Bank transactional errors
• Online trading delays in the actual executions
• A contaminant in a product formulation for one of
  Mercks top drug lines.
• AOLs inability to handle customer demand due to
  inadequate planning in their server capacity

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Sources of Risk
Franchise risk
Customers
Competitors
Business Strategy
Asset Impairment Risk
Competitive Risk
Suppliers
Regulators
Operations risk
Employee Error
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What Should Firms Do?

• Analyze the operational process according to the
  inputs gt process gt outputs model Define key
  processes that must be standardized tightly
  controlled.
• Identify points where systems errors could
  damage key operations and imperative assets
• Use TQM, benchmarking, various types of studies

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Asset Impairment Risk

• Asset impairment occurs when an asset loses a
  significant portion of its current value because
  of a reduction in the likelihood of receiving
  those future cash flows.
• It becomes a strategic risk if there is a
  deterioration in the financial value,
  intellectual property rights, or the physical
  condition of assets that are important for the
  implementation of strategy.

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Types of Asset Impairment Risks

• Financial Impairment
• Impairment of Intellectual Property
• Physical Impairment

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Financial Impairment

• Results from a decline in the market value of a
  significant balance sheet asset held for resale
  or as a collateral.
• An asset becomes impaired when the future cash
  flows accruing to the firm are no longer
  sufficient to support the assets balance sheet
  valuation.

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Categories of Financial Impairment Risk

• Credit Risk
• Sovereign Risk
• Counterparty Risk

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Impairment of Intellectual Property Rights

• Impairment due to unauthorized use of
  intellectual property by competitors,
  unauthorized disclosure of trade secrets to a
  competitor or third party and failure to reinvest
  in the intellectual capital as asset quality
  deteriorates over time.

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Physical Impairment

• Asset impairment due to the physical destruction
  of key processing or production facilities. This
  impairment may be due to fire, flood, terrorist
  action or other catastrophe.

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Competitive Risk

• Risks inherent to market competition
• Result from changes in the competitive
  environment that could impair the businesss
  ability to successfully create value and
  differentiate its products and services

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Competitive Risk

• Faced by all businesses that compete in dynamic
  markets
• Present as long as there are active competitors
  and demanding customers

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Competitive Risk

• Customers- What employee actions could drive
  customers away?
• Suppliers- What employee actions could cause
  suppliers to stop supplying?
• Substitute Products- What employee actions could
  drive customers to competing products/services?
• New Entrants-What employee actions could cause
  new competitors to enter the market?

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Franchise Risk

• Problems, or set of problems, that threaten the
  viability of the entire enterprise
• Unlike Operations, Asset Impairment, and
  Competitive Risk, not a source of risk but a
  consequence of excessive risks from other sources

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Franchise Risk

• Also known as reputation risk, most easily
  exampled by a lack of confidence in a brand or
  entire corporation
• Operations -ValuJet and Florida Keys
• - Pan Am and Lockerbee
• Asset impairment -Savings and Loans Crisis
• -Music Industry and file sharing
• Competitive -Apple Computer
• -K-mart

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Franchise Risk

• Reputation is an important and critical
  competitive resource in maintaining customers
  demand for the firms product or service
• Public accounting firms
• Defense contractors
• Pharmaceutical firms
• Food processors, distributors and retailers
• Hospitals and medical personnel

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Common Risk IndicatorsOperations Risk

• System downtimes
• Number of errors
• Unexplained variances
• Unreconciled accounts
• Defect rates relative to quality standards
• Customer complains

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Common Risk IndicatorsAsset Impairment Risk

• Unhedged derivatives on balance sheet
• Unrealized holding gains or losses
• Concentration of credit or counterparty
• exposure
• Default history
• Drop off in product sales

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Common Risk IndicatorsCompetitive Risk

• Recent competitor product introduction
• Recent regulatory changes
• Changes in consumer buying habits reported
• in trade publications
• Changes in distribution system

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Common Risk IndicatorsFranchise Risk

• Customer or bids lost to competitors
• Unfavorable news coverage
• Pending lawsuits or legal actions
• System downtimes
• Competitor business failure

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Assessing Internal Risk Pressures

• Understanding how strategic risks are exacerbated
  by the organizations operating context
• A variety of pressure points in a business cause
  strategic risk in a crisis situation
• Some of these pressures are due to
• Growth
• Culture
• Information Management

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Assessing Internal Risk Pressures Contd

• These internal forces can surprise managers in
  the form of
• Operating errors
• Impairment of assets
• Crises of customer confidence
• The Risk Exposure Calculator is a diagnostic tool
  can estimate the internal pressures they are
  additive and build upon each other.

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Risk Exposure Calculator
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Risk Pressures Due to Growth

• High pressure for continuation of high growth can
  lead to growth at all costs mentality
• Rapid expansion can make control difficult as the
  infrastructure design need changes and the
  infrastructure does not
• Rapid growth also necessitates hiring large
  numbers of new (unknown and untrained) employees,
  increasing the potential for error

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Risk Pressures Due to Culture

• Lack of consistent values employees and managers
• Risk taking attitudes
• Willingness (or lack of) to pass on bad news as
  well as good
• Internal competition rather than cooperation

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Risk Pressures Due to Information Management
Issues

• Transaction velocity high volume and processing
  speed increase the risk of problems
• Transaction complexity increases the risk of
  errors through lack of understanding and
  knowledge of control needs
• Missing performance measures ones that should
  be used but are not
• Decentralized decision making lack of
  centralized knowledge of what is going on

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Misrepresentation Fraud

• Managers and/or employees may knowingly subject
  the firm to unacceptable levels of risk.
• Employees may misrepresent their performance or
  misappropriate company assets.
• Bad decisions can be covered up and expose the
  firm to loss of valuable assets.
• Although most are small amounts, sometimes these
  actions severely damage the businesses in which
  these people work.
• Joseph Jett / Kidder, Peabody Company

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Misrepresentation Fraud Contd.

• Contrary to the inherent nature of people
  assumptions. --- Organizational blocks can
  overturn these tendencies and lead to
  dysfunctional behavior.
• Confusion about how to contribute
• Temptation and pressures
• Conflicting demands with too few resources
• Fear of failure

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The Dangerous Triad

• Pressure
• Employees are often under pressure to meet
  difficult performance goals through incentives.
• Salary Increases, Bonuses, Promotions
• Personal Problems bring pressure to misuse
  resources.
• Debts, Addictions, Crises
• Opportunity
• Employees can only engage in wrongful acts if the
  opportunity presents itself.
• Coupled with Pressure is dangerous TEMPTATION!
• Rationalization
• Employees are unlikely to succumb and engage in
  wrongful acts unless they can rationalize their
  behavior.

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The Dangerous Triad
Pressure
Opportunity
Temptation
Rationalization
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Lessons Learned

• Companies like Enron have hopefully learned about
  the consequences of material misrepresentation.
• Vicarious learning - Will hopefully deter other
  companies from suffering similar mishaps and
  failures they may witness in other firms.
• Ex. Kidder Peabody was damaged due to the
  questionable trading practices of Jett.
  Management by exception obviously was not
  successful in this instance.

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Lessons Learned Contd

• Review your companies operations and try to
  pinpoint the cause/effect for downturns in
  revenues and identify questionable business
  practices.
• Remain true to the companys core competencies.
• Do not set unrealistic performance measures for
  your employees as this may set the stage for
  unscrupulous activities and inaccurate benchmarks
  for the company.

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Quick Review

• Sources of Risk
• Operations Risk - in business processes
• Asset Impairment
• Financial Impairment
• Intellectual Property
• Physical Impairment
• Competitive Risk - Competition can be fierce
• Franchise Risk - Loss of consumer confidence
• Internal Risks - Growth, information management,
  culture
• Misrepresentation Fraud - The Dangerous Triad
• Managers must learn to control these risks
  to ensure the viability of the business

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