Wednesday, 24 August 2011

Strategic Risk management: Risk Reporting and Treatment (2)

In an earlier article, Tempering the Pursuit of Profits, I discussed about how profit and non-profit seeking organisations can manipulate the way they make profits. One central component in that piece was matching risk and reward. Organisations face a choice of taking higher risk ventures with higher reward and then effectively and efficiently manage those risks or taking a lower risk venture with low return. Taking on high risk activities involves a strategic risk management approach. In the last article on risk management, I discussed how taking risk involves an extensive risk management from assessment to evaluation. In this article I am looking risk reporting and communication as well as risk treatment.  

Risk Reporting and Communication
For internal reporting purposes different levels within the organisation need different information from the risk management process. For example while the board of directors would like to know about the most significant risks facing the organisation, business units within the organisation would be aware of risks which fall into their area of responsibility, and individuals would understand their accountability for individual risks.

External reporting enables a company to report to its stakeholders on a regular basis setting out its risk management policies and the effectiveness in achieving its objectives. Good corporate governance requires companies adopt a methodical approach to risk management.

Risk Treatment
The process of selecting and implementing measures to modify the risk is called risk treatment. This process includes risk control/mitigation and extends to risk avoidance, risk transfer, risk financing, etc. A system of treatment should have a threshold of efficient and effective operation of the organisation; effective internal controls; and compliance with laws and regulation.

Making a detailed risk analysis assists the effective and efficient operation of the organisation by identifying those risks which require attention by management. Risk control actions are prioritised in terms of their potential benefit to the organisation. Effectiveness of internal controls is the extent to which the risk will either be eliminated or reduced by the proposed control measure by a cost/benefit analysis. Compliance with laws and regulations is not an option. Understanding the applicable laws and implementing a system of controls to achieve compliance is a must.

Further reading:

Saturday, 13 August 2011

Strategic Risk management: Risk Assessment – Analysis and Evaluation (1)

Risk and Risk Management:

Risk can be defined as the combination of probability of an event and its consequences (ISO/IEC Guide 73). There are opportunities for benefit (upside) and threats to succeed (downside) in all types of undertaking which are the results of potential for events and consequences. Risk management is increasingly being considered from both positive and negative perspectives. In this first part of the article, we are going to look at the general background of risk, risk assessment which includes risk analysis and evaluation.

The central part of any organisation’s strategic management is risk management. It is the process of methodically addressing the risks attached to their activities with the goal of achieving sustained benefit within each activity and across the portfolio of all activities. Identification and treatment of these risks is the result of a good risk management. The goal is to add value (sustainable) to all activities the organisation undertakes. Risk management should also be a continuous and developing exercise running through the organisation’s strategy to the implementation of that strategy. It must also be embedded and integrated into the culture of the organisation through an effective policy and/or programme led by the most senior management. The risks facing an organisation and its operations can be categorised into factors both external and internal to the organisation.

Another method of classification is to reflect broad business functions, groupings risks relating to production, information technology, finance and so on. However, directors also have to ensure that there is effective management of both the few risks that are fundamental to the organisation’s continued existence and prosperity, and the many risks that impact on day-to-day activities, and have a shorter time frame compared with longer-term strategic risks. These two types of risk can be categorised as strategic and operational respectively.

Risk Assessment – Analysis and Evaluation

The risk management process itself starts with the organisation’s strategic objectives, and continues with risk assessment, analysis and evaluation. Risk reporting, decision, risk treatment, residual risk reporting, monitoring. Risk assessment is the overall process of risk analysis and risk evaluation (ISO/IEC Guide 73). Analysing risk starts with risk identification. This requires an intimate knowledge of the organisation, the market in which it operates, the legal, social, political and cultural environments in which it exist plus a sound understanding of its strategic and operational goals including factors critical to its success and the threats and opportunities related to the achievement of these goals.

Within risk identification is risk description which aim to display the identified risks in a structured format. The design of well structure would ensure a comprehensive risk identification, description and assessment. This includes consideration of the consequences and probabilities of each risk; and prioritising and categorising them according to business activity. Estimating risk can be quantitative, semi-quantitative or qualitative in terms of probability of occurrence and possible consequences. Risk is analysed using a range of techniques which are specific to upside or downside risk. The end results are a risk profile that gives a significant rating to each risk and provides a tool for prioritising risk treatment effort. A comparison of the estimated risk against the risk criteria which the organisation has established is risk evaluation. This criterion may include associated costs and benefits, legal requirements, socio-economic and environmental factors, concerns of stakeholders, etc. Risk evaluation is therefore used to make decisions about the significance of risks to the organisation and whether each specific risk should be accepted or treated.

Wednesday, 10 August 2011

Strategic Make or Buy Decisions (1)

Outsourcing or ‘contracting out’ traditional known as ‘make or buy’ decisions refers to the process of procuring a good or service from a third party, rather than generating such offering internally, in accordance with terms which are legally enforceable, or contractual. Outsourcing is a decision to move internal functions to an external supplier. Traditional make or buy decisions were confined to manufacturing operation. Toady such decisions are extended to the service industries. This articles reviews outsourcing as a strategic exercise, potential benefits and problems, and considers a new management skill, supply chain management. In another article I will be looking at how the finance function can be contracted out, a case study of outsourcing the finance department and review of internal outsourcing.
Strategic Decision
Outsourcing has been part of revolution of strategic thinking; the aim is develop a competitive organisation, where investment and management attention is to focus on narrower set of activities, mainly core capabilities to obtain competitive advantages. An organisation using a cost leadership strategy will adopt cost reduction decisions including a consideration to outsource. Others follow a differentiation or focus strategy will be aiming to improving core competencies to create value for their customers.

Cost Reduction
In a fiercely competitive business environment, organisations strive to deliver greater value at reduced cost. Pressure to reduce indirect or overhead costs necessitates contracting out some functions. The cost of the finance function is one such cost. Outsourcing aspects of the finance function may, therefore secure cost savings.

Focus on Core Competencies to Add Value
In assigning responsibility for activities to third parties, organisations are afforded the opportunity to focus on core competencies integral to the creation or addition to value. Where a core activity has high profit margin, the internal provision of financial services to support this operation erodes this profit unnecessarily if a similar service can be purchased for fewer resources from an external source.

Potential Benefits and Problems
An organisation’s core capabilities form a chain of activities that managers integrate to create a distinct type of value for its customers, thereby achieving competitive advantage. The organisation has to question performance for each activity in the value creation system. What level of performance is good or better than any organisation in the commercial world?  Could improvement be achieved through outsourcing or some other form of external supply?

Outsourcing improvements are strategic in nature: in terms of cost, quality, flexibility, reduced overheads, costs becoming variable, access to economies of scale and to advanced technologies; increased leverage of core knowledge and skill; improved focus on development of core abilities and a more compact organisation.

However outsourcing failures are not uncommon. Failure to achieve anticipated cost savings often occurs. A large proportion of outsourcing clients only break even, or sometimes find costs increase. These may arise due to low vendor estimates, misunderstanding of the contract, and the costs of establishing and monitoring supply. Similarly, outsourcing can results in reduced quality, especially, where service levels are poorly specified and monitored. More seriously, outsourcing has been accused of helping create the ‘hollow corporation’. This is the cumulative effect of outsourcing decisions which were not made to provide leverage for a firm’s skills and knowledge, but to incrementally undermine those core capabilities on which the organisation relies for its competitive ability.
Outsourcing requires skills to identify, evaluate, and compare the relevant costs of using an external or internal source of supply. As outsourcing decisions has become of increasing strategic importance, so the skills required of managers had to develop to ensure they are fully able to contribute to the development and implementation of an organisation’s outsourcing strategy. These include assessing strategic decisions in preparation for evaluating available strategic choices, followed by implementation, change management and supply chain management.

The outsourcing decision has, in many instances, become more strategic requiring recognition of other strategic factors and their longer-term development, in particular supply market conditions and effective management of the supply chain. In addition, managers need to constantly bear in mind that outsourcing decisions must be consistent with achieving increased strategic effectiveness, particularly by helping to develop the organisation’s particular form of competitive advantage.
Supply Chain Management
The development of a new management skill is the results of external supply. Managers need to develop skills in identifying potential suppliers and evaluating their reliability. Contracts will need to be specified and negotiated to deliver standards of performance which the buying organisation may not have explicitly recognised before. Change management is required to address changes in employment required by outsourcing, and to deal with the possible loss of motivation experienced by in-house staff. In addition managers have to learn how to work with supply organisations and its different culture, and to effectively monitor supplier performance.

Making Outsourcing Decisions
Each industry and business is, in some respect, unique. Consequently, the factors that should be considered when making an outsourcing decision will differ between each organisation and its specific context. Standard analytical tools are useful when considering the context of outsourcing decisions, while the value model helps maintain an overview of the sourcing decisions being made by an organisation. Organisations often develop a comprehensive analysis of variable and overhead cost including all of the activities associated with the operation of the activity, its supporting assets and its development. Others include opportunity costs associated with those resources that would be made available through outsourcing, such as an alternative revenue stream that could be established by in-house staff, or alternative use of office space.

In principle, cost analysis should also be extended to include the cost of potential supplier. To avoid the familiar disappointing cost performance of outsourced activities, any claim for lower cost of supply must be confirmed by identifying such cost drivers as economies of scale, superior learning leading to cost reduction, and labour agreements that provide a lower cost base.

Many industries face conditions that include increasing competitive pressure, the need to achieve developments more rapidly, and variable demand and the consequent threat of periodic excess or insufficient in-house capacity.
A closer examination of the outsourcing option is called for each of these factors. The manager, through developing cost comparisons, has always had a key role to play when making outsourcing decisions. The outsourcing decision has, in many instances, become more strategic requiring recognition of other strategic factors and their longer-term development, in particular supply market conditions and the effective management of the supply chain. In addition, the manager needs to constantly bear in mind that outsourcing decisions must be consistent with achieving increased strategic effectiveness, in particular by helping to develop the organisation’s particular form of competitive advantage.

Making outsourcing decisions and managing supply relationships requires wide-ranging expertise. This requires a team approach in which all members – including the manager – seek to develop a full understanding of what can often be a complex strategic decision.

Monday, 8 August 2011

Strategic Pricing (1)

In an earlier article, Tempering The Pursuit of Profits, I described how pertinent it is for profit and not- for-profit organisations to manipulate the profit equation. One component of that equation is price of outputs that determines revenue. Pricing can be the effect of the marketing mix of product, promotion, price, place, people, processes and physical evidence. Establishing a price is also a strategic exercise recognising both economic and non-economic factors.  Additionally, altering the price of a product will usually allow much faster changes to organisational performance than developing products or designing and running promotional campaigns. I will be looking at influences on prices and then in another article specific approaches to pricing.
The influences on prices can be summarised in the diagram above. These influences are likely to be iterative and interwoven as in all strategic planning processes. For example a marketing objective could be established but could not be achieved because of cost or competition issues, so the objective has to be revised. Certainly, pricing is a dynamic process since nothing remains constant. Influences like the economic environment, the taste of consumers, the innovative processes including competitor actions and reactions will continually change, often forcing prices to be revised.

Mission and Marketing Objectives
An organisation’s primary purpose of existence, its self perception, its position in the market and its culture and ethics cannot be separate from pricing of its goods and services. A not-for-profit organisation might have a zero price for its goods and services or heavily subsidised. Some organisations might see itself to be ‘up-market’ and charge high prices to project quality and exclusivity. Other organisations in specialised industries like pharmaceuticals face ethical issues when pricing their products both for the rich and poor markets. In rich markets the intention might be to make profits but for poor markets ethical and social responsibilities take centre stage.
Pricing Objectives
The variety of pricing objectives tends to be short term, whereas missions and marketing objectives are long term. A profit organisations have to at least break even so prices are set to allow for this. There is no point to enforce the impression of upmarket by having high prices and realising sales volumes are very low. At times, the need for survival and increase cash flows quickly will influence massive price cuts. At times, organisations might hope of forcing competitors to withdraw from the market by lowering prices and sustaining losses for a while.
To make a profit, revenue must exceed all costs. Variable costs, fixed costs and period cost are for the short term pricing decisions. The sales and production volumes are used to determine how much contribution a product or service makes to profits in the short term. This also determines the breakeven price and sales volumes. In strategic management, opportunity costs and exit cost are important for the long term decisions.
 A forgone revenue as a results of a decision is the opportunity cost of that decision. If a piece of land is used for dwelling, it cannot be used for cultivation. The sale price forgone is an opportunity cost of the decision to build. Exit costs arise when the decision is to abandon a strategy. Examples of exit cost include liabilities as a result of redundant employees, clean-up or reparation costs. It might be cheaper to carry on provided the marginal revenue just exceeds marginal costs. The organisation is likely to suffer great pressure from competitors if they are in this position.
There are four types of markets, perfect competition, oligopoly, monopoly and monopolistic competition, each giving rise to a particular type of competition. The descriptions of these are highly technical and beyond the scope of this article. Very often organisations that uses a cost leadership strategy adopts price competition where consumers are motivated primarily by price and the suppliers will have to lower prices to succeed.  Because costs are very low, prices can be low as well. Most laptop producers are using price competition because they all do the same things, with the same operating systems, run the same application software and have similar reliabilities.
In non-price competition consumers are attracted not only by the price of the goods or services but also influences by the other marketing mix variables like the quality, brand and features; promotion activities; place ( where the goods or services are obtained). Ideally, organisations following differentiation or focus strategies are essentially using non-price competition. They aim to make their products different so they are particularly attractive to consumers, who are willing to pay premium prices. Arguably, Apple is using non-price competition among the laptop producers. Its laptop looks different and unique, they have different a different operating system and run different (but compatible) software. This makes it more expensive than others. Nevertheless they sell so well and profitably too.
Suppliers must keep in mind both what the end consumers are willing to pay and also the profits that would be expected by intermediaries in the supply chain. Most industries have ‘rules of thumb’ about the mark-ups to apply to their products.  It is widespread in markets segments according to wealth to have a value range of goods for poorer or thriftier customers who might respond to price change competition, and a more exclusive range for better-off customers, who might respond to non-price competition. It is possible to charge different prices for the same product for different groups, even if there are no different lines of goods for different customer groups. This is called price discrimination. It is mostly cheaper to buy electronic goods in the US than in Europe. Leakage of goods information from cheaper to expensive markets is prevented in some way that makes the products different. In the pharmaceuticals industry, leakage from one market to the other is reduced by giving the products different names (though pharmacologically they are identical) and by carefully controlling distribution through government agencies and hospitals.
The perceived value of goods is a concept which is related to non-price competition and, also price. The thought that a higher price implies goods of a higher value is something we have all experienced, even though we are often ignorant about the merits of such goods. Consumers’ reactions to prices and price changes are influenced by whether the good are a necessity or a luxury. Goods that are very sensitive to price changes on the quantity demanded are luxury products. Goods that less sensitive to price changes on the quantity demanded are likely to be necessities. This is known as elasticity of demand of a product which is beyond the scope of this article. There are exceptions to this rule however.
Some industries are heavily regulated by statute and regulation giving them little or no power to choose their own prices. Others are able to influence final prices charged to consumers. In the perfume and cosmetic industries for example, exclusive producers resist price competition by insisting in their supply contracts that their retailer do not discount their products. Also not all contractual arrangements are legal. Pricing cartels (competitors fixing prices) are frowned upon by most government by bringing in anti-competition laws.
I had been looking at influences on price from a strategic perspective. Prices are influence by and large by costs, competition, consumers and control. In the second part of this article I will be looking at specific approaches to pricing.
Further reading:

Thursday, 4 August 2011

Tempering The Pursuit of Profit

Organisations of all kind whether for profit or not-for-profit need to generate enough revenue to survive. Entrepreneurial spirit and profit motive are integral to the successful conduct of any business anywhere. Any entity which aims to succeed in the longer term will need to be aware of the various threats and challenges to its viability and adapt its behaviour accordingly. In summary, it needs to balance risk and reward.

Business risk comes in many forms. A new business is a high-risk exercise in itself. Investment decisions of new product or entry into a new market will need to take into account achieving a profitable rate of return, over time. Some organisations face special challenges when operating in markets or market sectors that need to be identified, understood and assessed. These are strategic and operational issues which an organisation's management must address as part of responsible business planning.

In the external environment comes other threats and challenges. The law and other form of regulation for example imposes a wide and growing range of compliance obligations on organisations. There is an increasing awareness of the wider group of stakeholders. These include target market of consumers, the media and the general public.

The global banking crisis demonstrated the effect of failing to reconcile the management of operational and reputational risk. Serious errors were made in assessing and managing inherent risk in a number of financial institutions. Mismanagement of credit appraisal and operational risk was compounded by policies on incentives and remuneration, which directly encouraged excessive risk leading to commercially disastrous consequences.

Bad publicity was generated by some institutions after they had been bailed out by the taxpaying public by awarding enormous bonuses to some of their staff. This questions not only their handling of reputational risk but also with companies’ responsibility to act in the best long-term interest of their shareholders and their stakeholders. The crisis has raised the key issue of what ethical principles can play in acting as responsible constraints on decision making in the commercial world.

The theories, practice and inter-relationship of risk, ethics and governance and how these can be harness by businesses to improve stakeholder value is very important. There are clear limits what regulation can do. They need to be accompanied by a genuine commitment of ethical behaviour by businesses, starting from the top. Compliance with regulation is important only to the extent that companies are willing to go beyond it if they see the bottom line benefit of ethical corporate approach. It is encouraging to see a growing evidence of link between ethical behaviour and business success. Companies that have a narrow and short-term view of shareholder value need to be aware that in today's regulatory, political and business environment such an approach will come under increasing strain.

Saturday, 30 July 2011

Changes Transforming the Global Business Environment

Since the recession and financial crisis that ended in 2009 business leaders and executives are facing a transforming global business environment according to an economics researched paper. The world economy is now characterised by slow growth in the west, increasing power in the east, and value-driven customers with rising risks everywhere.  The economic downturn has speeded up the adoption of key technologies like mobility, cloud computing, business intelligence and social media that are transforming businesses and stirring up a new wave of wealth creation especially in the emerging economies.

Technology and economic growth are inextricably related. Whilst the advanced economies are seeking new ways to cut costs and drive innovation, emerging economies are shaping up their demand for technology to fuel growth in the wake of current economic climate that is demanding investment in technology. A virtuous circle emerges as increased economic growth, especially in emerging economies, results from digital technologies driving consumer income and demand, education and training and efficient use of capital and resources.

As market momentum accelerates, business leaders and executives must be aware of new challenges facing their organisations. The paper mentioned six significant changes that organisation will need to address in the next five years as follows:

1.       The global digital economy comes of age. Mobility, cloud computing, business intelligence and social media are changing the marketplace through the use of internet  technology setting in motion a third wave of capitalism from consumer behaviour to new business models in both advanced and emerging economies.

2.       Industries undergo digital transformation. Organisations across a range of industries have seen their businesses models toppled as they deal with the double forces of technology and globalisation as a result of a maturing digital economy. Many sectors including technology, telecommunication, entertainment, media, banking, retail and healthcare will continue to be reformed through the use of information technology in the next five years.  

3.       The digital divide reverses. As economic power changes to the East, companies in the developing economies are investing heavily in technology. This presents a new competitive challenge – aggressive technology-charged firms from emerging economies to business leaders and executives in advanced economies.

4.       The emerging-market customer takes center stage. Rising populations and income levels, together with rapid economic growth are putting emerging economies at the center of corporate growth strategies. Huge opportunities exist for organisations that adapt to the needs of customers in emerging economies – including consumers, business and government sectors.

5.       Business shifts into hyperdrive. Fast-growth economies and new technology that had been fuelled by ever-changing global marketplace has accelerated the momentum of most business activities. From product development to customer response, real-time business intelligence and predictive analysis will be required for quicker decision making and to handle unexpected market risks and opportunities.

6.       Firms reorganise to embrace the digital economy.  Organisations are moving away from a hierarchical decision making to a networked structure that is more market like and organic to operate on the global digital playing field where new rivals are unencumbered by rigid policies and thinking.

These changes will have thoughtful consequences for organisation in the years ahead. The paper highlighted a number of imperatives business leaders.  A forward-looking mobile strategy for emerging markets where the phone is the primary means for internet access is advised. A consideration of improving data analysis to anticipate rapid global market changes is not over looked.  And also remembering that in a fast-moving world, the threat of security breaches rises necessitating the building of stronger safeguards into operations. Finally, protecting market share in their home countries for organisations in emerging economies as markets grows rapidly – rivals may be looking over your shoulder.