November 2, 2019

Identify, Execute, Monitor, and Manage: A Continuous Four-Stage Risk Analysis Process

"In an increasingly interconnected and complex world, it is vital to understand the external risks to your business" The Economist Intelligence Unit (The EIU) correctly notes in a report on how to navigate corporate risk. "Whether a firm is looking to understand the possible impact of" the trade war between the United States and China on its international "investments; the likelihood of new environmental regulations being implemented; or the threat of social unrest disrupting supply chains, being able to identify and understand risks offers the chance to put in place mitigation strategies that could help avoid significant losses. Failure to do so can prove terminal for businesses."

The EIU advises that "[t]o prevent this, risk analysis can be broken down into a continuous four-stage process:"

1. Identify

"Before identifying the external risks they are facing, firms need to understand and quantify their financial exposure—an important dimension of this is geographical." Furthermore, "This type of mapping exercise has become increasingly important in recent years, as global supply chains have become stretched across a growing number of territories, including cyber space, and exacerbated by examples of growing trade protectionism and political risk more generally. A clear understanding of a firm's exposure should highlight key areas of weakness and dependency. This, in turn, allows the firm to start thinking about which risks will need to be prioritized, as there will be trade-offs required when allocating resources for mitigation.

"Once a firm's exposure has been mapped, detailed and understood, the next step is to assess what exactly could put investments and operations at risk. Some of this should already have been achieved by the exposure-mapping exercise. For example, if the majority of sales revenue is earned in a particular country, then difficulty in taking money out of that country would be an obvious primary concern. However, the likelihood of this becoming a problem has historically been much lower within the EU than in emerging markets in Asia, such as Indonesia and Vietnam."

I concur that "[a]pplying this kind of political and economic historical awareness, external country experts can help provide the contextual knowledge and experience to understand which scenarios are more or less likely to occur in particular countries, including scenarios that firms may not have previously considered. This last point is particularly important—thinking outside the box is necessary, as market consensus can severely limit risk analysis."

2. Evaluate

The report accurately explains: "Each possible risk needs to be quantified in order to compare and evaluate them." My colleagues and I have adopted The EIU's methodology by giving "each risk scenario a probability score, and also a score for the likely impact on businesses' profitability. Combined, this gives an overall intensity score . . . . This process allows for the creation of a moving intensity scale—the risk scenario watchlist—as the scoring for different risks changes over time."

3. Monitor

"Without a system in place to monitor key business risks, the assumptions and analysis made by firms can become out of date very quickly."

What is more, "Navigating such shifts requires a monitoring system that cuts through the noise. Firms need to stay in tune with exactly what is going on in a country and to stay on top of geopolitical relationships, by receiving regular country-level alerts and speaking with country experts."

I am fortunate to be surrounded by a network of talented individuals located in key economies around the world where each share information and insights on geopolitical or socioeconomic events they are observing.

The report importantly adds: "One further way in which firms can improve monitoring is through the ability to track specific triggers that are likely to set off identified risk scenarios. This can then act as a form of early-warning system. Some broad examples include: disputed elections or food price spikes as drivers of social unrest in less stable countries; currency devaluations as a precursor to the implementation of capital controls; or falling natural resource prices in commodity-export dependent countries, leading to a drop in government revenue and, consequently, cancellations or delays to government-led infrastructure projects. In addition, some other increasingly important triggers include environmental protests or tensions and major geopolitical disputes, both of which have, for differing reasons, preceded a rise in successful cyber-attacks against governments and associated companies.

"Although many political events are difficult to predict precisely, a combination of specifically selected triggers and the development of, or use of analytical firms with, on-the-ground contacts will go a long way to helping firms prepare for the worst."

4. Manage

"Once key risks have been identified and are being monitored, firms will have a better idea of how to manage them. The intensity scale allows for prioritization, which can be adjusted as events and policies change on the ground. But, to mitigate effectively, firms also need an understanding of the exact areas that will be impacted by a particular scenario, both within their business and also in the wider business environment."

Lastly, I appreciate the report's concluding paragraphs:
Certainly, the global trends towards governments introducing more active environmental and data protection policies, as well as growing trade protectionism, indicate that firms need to pay special attention to managing regulatory changes in coming years. Firms that are able to identify possible regulatory shifts and put in place contingency plans to adapt before such shifts are implemented will have a better chance of success. Whatever the best strategy for each business, the ability to identify, evaluate and monitor key external risks should dramatically improve risk-mitigation efforts.
In an age of increased unpredictability and event risk, firms and governments are more than ever seeking to insulate themselves from the consequences. Global businesses cannot avoid risk—and too much risk aversion can be bad for growth—but they can prepare for risk, just as they can for opportunity.

Does your business employ a continuous four-stage process of analyzing risks? Do you have an alternate solution to understanding the external risks to your business?

Aaron Rose is a board member, corporate advisor, and co-founder of great companies. He also serves as the editor of GT Perspectives, an online forum focused on turning perspective into opportunity.

No comments:

Post a Comment