Risk Management in an Uncertain World

Strategies for Crisis Management

Bill Sharon

• Publisher: Bloomsbury Information
• Year: 2012
• Print ISBN: 9781849300452
• eBook ISBN: 9781849300612
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

In an increasingly uncertain world, the pace of change is swift and quickening. Risk management is more important than ever before, and adaptability is key. Not every negative event can be mitigated, but the right approaches will allow a company to respond effectively and even to thrive in crisis situations. This approachable book features the advice of expert practitioner and academic authors, benefiting companies whatever their culture and operating environment. Worked examples and case studies span the operational aspects of risk management, reputation risk, and risks outside the control of any organization, forming a comprehensive guide. Detailed coverage includes: * Risk, metrics, and complexity
* Countering supply chain risk
* Business continuity management
* Reputation risk and financial performance
* Moving beyond compliance
* Integrating catastrophe management
* Human risk and rogues
* Strategic risk management
* Crisis management strategies
* Exposure to country, political, and interest rate risks

Risk in the Operational Disciplines

The Missing Metrics: Managing the Cost and Risk of Complexity

by John L. Mariotti

President and CEO of The Enterprise Group, Powell, Ohio, USA

This Chapter Covers

Despite the best efforts in many areas, the accounting and finance systems currently in use overlook the costs of complexity—it’s all talk and too little action.

Complexity costs are hidden, buried in the accounts of a company until the period-end statements reflect the adverse effects on profitability.

The time to recognize that these costs exist is now, after which they can be identified and new metrics found or developed to take the place of those that have been missing for far too long.

Introduction

Accounting systems have come a long way in the past decades. Activity-based costing revealed where costs were being incurred and what was driving them. The blizzard of regulations following debacles involving Enron, WorldCom, etc., led to the passage of the Sarbanes–Oxley Act. The most recent financial crisis spawned the Dodd–Frank Wall Street Reform and Consumer Protection Act (2010), which will undoubtedly lead to many more new regulations (in the United States).

These burdensome new laws impose some necessary disciplines on finance and accounting but fail to deal with a huge unmeasured and unmanaged area—the costs of complexity. When I began studying this area in earnest about a decade ago, I discovered just how far-reaching the negative impact of complexity has grown, and how much it has gone unnoticed. Certainly there is discussion of complexity, but following all the talk there is very little organized action.

Back in 2001, Oracle CEO Larry Ellison described a “war on complexity” in computer software. There were simply too many systems that were not integrated, and others that were very difficult to integrate. This fragmentation of systems caused huge complexity, duplication of effort, and waste—which Ellison’s Oracle Corporation hoped to solve.

In 2006–08 there was another flurry of reports and articles from major consultancies (Bain, McKinsey) and universities (Wharton, Harvard). More recently, IBM’s May 2010 report described a comprehensive survey of 1,500 CEOs, which confirmed the breadth, depth, and magnitude of the risks of complexity and how dangerous it is to do business around the world. And yet words have not been converted into action effectively, and complexity management continues to be situational and far from fully effective. A great opportunity still awaits global business.

Variety Can Add Value—If Managed Properly

There are clearly instances where complexity, properly managed, can be a source of great competitive advantage. In these cases, the organization’s structure, systems, and processes must be carefully designed to minimize transaction costs and make complexity manageable.

One notable success in the use of complexity for competitive advantage is the web retailer Amazon, whose breadth of offering is extensive and growing, thus making it a “one-stop shopping” site for millions. Amazon’s distribution system, however, is always at risk of being overwhelmed by complexity, even as its front-end systems handle the huge variety of goods which it sells seamlessly.

Similarly, US sandwich seller Subway assembles sandwiches to order from 30–40 containers of meat, cheese, and vegetables, using just a dozen varieties of breads and wraps. Thus it can make to order millions of sandwiches (and salads) with minimal waste and great flexibility.

There are many other examples like these two. All depend on the right systemic design to keep complexity from growing out of control, causing harmful, costly waste and inefficiency.

Complexity Costs Are Hidden

When I first researched why the costs of complexity remained unmeasured in so many companies, I discovered that it was because these costs are, by their nature, hidden by conventional accounting systems. To bring the problem into perspective, consider how complexity occurs and what kinds of waste result. It will become apparent how financial systems simply overlook complexity’s costs—until the end-of-period reporting shows the detrimental effects and true costs.

There is no doubt that complexity’s effects are readily apparent in monthly, quarterly, and year-end results, where they reduce income and impact the balance sheet adversely. Unfortunately, this is too often the only time and place where they are visible. Even then, there’s no indication of how or where these costs were incurred, or how to manage and minimize them.

Seeking High Growth in Low-Growth Markets

So much of the complexity that goes unmeasured and unmanaged is created, with the best of intentions, in search of revenue growth. Many developed countries (the United States, Europe, Japan, etc.) are growing very slowly, in population and economically. When companies seek growth in such mature markets, they resort to proliferation, which leads to complexity. The gain in revenue is redistributed across a broader range of products and services, with only modest increases in total revenue. The many resulting new products, customers, markets, and suppliers add much more in complexity costs than in profit. As rapidly growing economies like China slow, even slightly, complexity costs will start to impact them as well.

Mergers and acquisitions are another source of complexity. If either of the two combined companies is burdened with complexity (most are), this will transfer to the merger. If both are thus burdened, real trouble is likely. Simply combining the DNA of two companies is a daunting task without struggling under a burden of being “infected” with the complexities of two different “strains.” There are issues of product and customer overlap, organizational and/or facility redundancy, and inevitable information systems redundancies. When these are combined with cultural conflicts that must be sorted out, the problems become almost insurmountable. This is one of the main reasons why mergers seldom lead to long-term growth in shareholder value.

Less developed countries typically grow at much higher rates (China, India, Brazil, etc.). Emerging consumer societies with favorable balances of trade fuel their economic growth. There’s a different complexity problem here: most of these countries save more and spend less—both as consumers and as governments. Further, these countries are less familiar to sellers who operate in developed countries, and therefore marketing and operating mistakes are made. These mistakes also lead to proliferation, often due to errors in targeting, product configuration, branding, and/or how to serve the targeted markets and customers.

Profits Are Proportional to Revenues; Costs Are Proportional to Transactions

Thus, either approach to growth adds to complexity, but for different reasons and in different ways. Profits are derived from increased revenues, but costs are incurred by increased transactions. Therein lies the root of the complexity problems. A few simple reports can expose the problem, but more sophisticated solutions are needed later. Starting with the simpler metrics is advisable (I will say more on “simplicity” later).

First, calculate sales per customer, per product, per location, etc., and track the trends. They are typically declining, indicating more transactions for less revenue.

Next, sort the annual sales, profits, etc., for customers and products, in descending order of value, and compute a cumulative column. Now look at the bottom of the list. There is always page after page ...

Table of contents

• Cover
• Title Page
• Contents
• Contributors
• Introduction
• Risk in the Operational Disciplines
• Risk to an Organization’s Reputation
• Risk in the External Environment
• eCopyright