Posts Tagged ‘Risk management’

Top five risks for business in 2011

Sunday, January 30th, 2011

Our risk management systems constantly scan the immediate course ahead to detect those hazards that could put a hole in the ship of commerce, and potentially sink the business. Ongoing dialogue with leaders around the world, combined with environmental scanning and deep reflection, indicate that a number of significant issues will confront business this year. Here is what we believe are the top five risks:

1. One complaint becoming an epidemic

In the latter half of 2010 the power of a mass consumer complaint leveraged by connectivity became evident. Angry customers were able to register online to join a class action over bank fees. Vodafail.com, born out of the frustration of one customer, provided a flashpoint for disgruntled Vodafone customers.

The focus is shifting to insurance companies whose customers, having been adversely affected by floods, feel quite poorly treated. Retailers who have sent Australian jobs offshore by their purchasing policies, and now complain about Australian consumers purchasing products offshore, also risk a disgruntled customer creating a viral campaign.

The lesson is to take each customer complaint extremely seriously, and treat each person as you would want to be treated.

2. Social enterprise overtaking commercial enterprise

We are now witnessing the rise of social enterprises – profit making organisations which emerge in direct response to a particular social need – such as Fair Trade coffee and the Green Pages directory. They keep costs low in order that maximum profit can be directed at the immediate social need and fostering systemic change to eradicate the causes of the problem.

This contrasts with existing business models which have a primary focus on shareholder return. Social enterprises experience explosive growth as customers engage specifically to support the cause – and then tell all their friends.

Twenty first century organisations must look to harmonise social and commercial objectives as new entrants launch to fill a social need and scale too fast for traditional slow moving businesses to respond. They must review their original purpose, recast this in the context of 21st century needs, and align every aspect of the business with this renewed purpose, eliminating the fundamental dichotomy between market acceptance and customer fulfilment.

3. Failure to recognise the normalisation of complexity

During the last decade we have witnessed a never-ending series of natural and man made crises: 911, SARS, bird flu, GFC, devastating fires, hurricanes, cyclones and now floods. Crises are nothing new, but in a less complex and interconnected world we were largely quarantined from their effects by time and geography.

The deep global linkages between people and organisations now mean that our world can change overnight because of the ripple effect of a single major event. Last year’s eruption of a volcano in Iceland brought air transport to and from Western Europe to a complete standstill, impacting industry around the world. Economic shocks will become more frequent because of the complexity and connectivity of the system of which we are a part.

Our fundamental challenge is to work effectively and efficiently in this new normal and deliver results that move us towards our purpose, understanding that doing so will contribute to a sustainable business. Organisations need to develop people at every level of the organisation who are systems thinkers, who are comfortable with complexity, and who can function well in chaos.

4. Increasing self-interest

The crises identified above have deprived many people, organisations and nations of expected income, profits and living standards, creating a sense of scarcity and an inclination to guard what we have. This can drive a protectionist response, whether at a political or commercial level, which easily translates into inadvertently putting profits before people, control before collaboration, and politics before principles.

Self interest reveals itself in the person who takes advantage of a crisis to advance their own cause and further their own career, and in the firm which extracts an unreasonable discount from a supplier. It is not hard to spot in the increasing xenophobia dominating the agenda in many countries.

The solution to self interest is a combination of increased self awareness and social responsibility; appreciating that what is good for the other is ultimately good for me.

5. Wilful ignorance

One effect of living with a tidal wave of information is the capability to be selective about where we source our news. This allows us – both intentionally and unintentionally – to feed our biases and prejudices. Wilful ignorance occurs when we make an active choice to ignore what challenges our thinking, and consume what supports our thinking. One can readily observe increasing divergence between what many people choose to believe and what is actually the case.

Leaders need to carefully and consistently explain their rationale and message, educating and informing people, who may have built up resistance to new data, that will challenge their assumptions.

Conclusions

Although any of these risks taken alone could do serious damage, the combined effect of two or more operating together could be disastrous. For example, wilful ignorance and an epidemic of complaint in a complex world requires attention at the most senior level and a well crafted response to avoid customer backlash, staff disengagement and subsequent loss of value. Smart organisations however, will alter their trajectory ever so slightly to chart a course around and between these obstacles, ensuring they don’t fall foul of them in the first place.

Have you experienced these risk factors (or others) at work? Join the conversation and share your thoughts below.

Global Risks 2011

Monday, January 17th, 2011

What are the biggest risks the world faces in the next ten years? With the annual meeting of the World Economic Forum beginning next week in Davos, Lachlan Jobbins takes a look at Global Risks 2011, the latest report from the WEF’s Risk Response Network.

Climate change? Economic disparity? Cyber security? The world is still struggling with aftershocks of the Financial Crisis, food and oil prices are increasing, and closer to home, much of Australia’s east coast is under water. You could be forgiven for saying ‘enough already. We don’t need another crisis.’

And that’s pretty much the message of the World Economic Forum’s Risk Response Network. According to the authors of Global Risks 2011, ‘The world is in no position to face major new shocks’.

Released this month, the report is a high-level overview of 37 global risks as identified by the members of the WEF’s Global Agenda Councils. It aims to enhance understanding of how global key risk factors are evolving, how their interaction impacts stakeholders, and what the trade-offs are for those responsible for managing them.

The Global Risks 2011 microsite contains the text of the report, as well as interactive tools to explore the data in different ways.

Interconnectedness is a major theme of the report. Risks cannot be dealt with in a vacuum, nor can they be assessed without an eye to the broader context. With risk playing out at global and national scales, coordinated responses are the only effective way of addressing them. And while it is tempting to focus on the most recent risk event, the report’s ten-year outlook encourages decision-makers to take a long-term perspective.

So what are the biggest risk factors facing the world in the next ten years? The report highlights two cross-cutting risks (major factors whose interrelationship with other risks makes them critical): ‘Economic disparity’ and ‘Global governance failures’.

After a generation of (mostly) sustained economic growth, the world is a much smaller place, and our knowledge, connections and relationships with the countries around us are closer than ever before.

But while globalization has brought widespread benefits, its economic ones have been far from evenly shared. Wealth and income disparity, both within and between countries, is growing. Inequality, debt and employment (in the developed world), widening wealth gaps (especially in the developing world) are just a few related challenges.

One result of inequality is political upheaval and social fragmentation. It has never been easier (or more important) for nations to work together to solve the enormous challenges posed by climate change, energy crises and the global financial crisis. Yet recent years have seen some significant failures in global governance: the failure of the UN Climate Change talks in Copenhagen; the Doha Development Round of the WTO. These point to weaknesses in global institutions and networks.

One of the aims of the World Economic Forum is to bring together stakeholders from across business, government and civil society to look at ways of addressing these challenges. By focusing on the connections between global risks, the WEF aims to inspire collective approaches to problem solving, beyond limited national interests.

Global Risks 2011 also features three ‘risks in focus’, again chosen because of their interconnectedness.

• The ‘macroeconomic imbalances’ nexus highlights the issues raised by the increasing wealth and influence of developing economies versus increasing debt and trade imbalances in developed countries.

• The ‘illegal economy’ nexus highlights the links between illicit trade, corruption, organized crime and fragile states – and hence terrorism and geopolitical conflict.

• Finally, the ‘water-food-energy’ nexus highlights the challenge of food and water security (and pricing), and the threats to environmental sustainability as world population and prosperity continues to grow.

The report is based on the World Economic Forum Global Risks Survey 2010, in which business leaders and policy makers were asked to assess risk likelihood and impact over a ten-year period (2010-2020).

Workshops and discussions were then held with the forum’s community, and insights were added from the Forum’s Network of Global Agenda Councils and the Forum’s Risk Partners: Marsh & McLennan Companies; Swiss Reinsurance Company; Wharton Center for Risk Management, University of Pennsylvania; and Zurich Financial Services.

The complete report is available at the World Economic Forum’s website.

Edition 12: Tourism risk and disaster

Friday, July 30th, 2010

Tourism is Australia’s second largest industry, but it is exposed to all sorts of complex and interrelated risks. What happens when SARS breaks out across Asia, a tsunami destroys a beach resort, or an oil slick wipes out the beach-side economy of the Gulf of Mexico? How do the millions of people who make their living providing leisure environments cope?

Insurance is one way. Karl Sullivan of the Insurance Council of Australia walks us through the insurance products available to tourism operators before the event, in particular ‘loss of attraction’ cover. Suffice it to say that, had the inhabitants of the Gulf of Mexico been aware of the existence of such cover, they might have avoided the financial losses they are suffering from now. As a former risk manager at Qantas, Karl talks about the myriad risks faced by the airline industry, from mechanical delays through hijacking and the GFC, and how they go about managing them.

David Beirman, Senior Lecturer in Tourism at UTS Business, adds the recovery perspective – once a tourism destination has suffered a loss, how can it turn its attention to the future and develop strategies to bring its business back to life? David was manager of the Israel Tourism office for 12 years, with first hand experience of dealing with twitchy tourism customers and volatile destinations.

Lowy Institute discovers cost of stopping climate change – about $10

Monday, May 31st, 2010

The Lowy Institute have just released their Annual Poll. It focuses on Australian Foreign Policy but also continues some long running questions on climate change.

According to the poll, the majority of Australians (53%) said the issue was very important to them – down from 56% last year. An encouraging 72% believed Australia should take unilateral action to combat climate change, ahead of any global agreement being reached. The respondents were then asked how much extra they would be prepared to pay on their electricity bills if it would help prevent climate change. At this point, like the crowd when a street entertainer puts down his unicycle and brings out his hat, people started drifting away.

The majority of respondents were only prepared to pay $10 or less extra per month on their electricity bill. Let’s say the average monthly residential Australian power bill is $150. That’s a 6% increase to prevent climate change.

Earlier this year the NSW Independent Pricing and Regulatory Tribunal (IPART) forecast that electricity prices in NSW will rise by 40% over the next three years. In that context the 6% doesn’t seem like much. Incidentally, that 40% is without the Trading Scheme which shall not speak its name. With the, ahem, ETS, prices are forecast to rise by 60%.

The Lowy Institute did not ask people what they considered to be the cost of doing nothing about climate change.

Thinque tank with Anders Sorman-Nilsson and Nils Vesk

Wednesday, April 21st, 2010

Change doesn’t care if you like it or not. It happens without your permission. How do organisations and people stay ahead of the curve in a world where the fastest growing economy is a communist one, rugby league players are metrosexuals who moisturise, and Susan Boyle took less than 48 hours to reach more people than radio did in the first 38 years of its evolution?

Professional agitators Anders Sorman-Nilsson and Nils Vesk challenged a roomful of Sydney’s best and brightest brains to upgrade their thinking. Sparks flew.

‘Have you ever stopped to think, and forgotten to start again?’  – Winnie the Pooh.

That was not the problem for the audience at the Sydney Opera House on April 15.

According to Sorman-Nilsson, the world has changed, and it’s a little out of whack. Things ain’t the way they used to be and that is exactly how they ought to be. Kids are excelling in second life, but flunking in first life; Maslow’s hierarchy of needs has been flipped on its head. It used to be that we had to learn one new skill every year, then every month, then every week. How long before things will be changing for each and every one of us hourly?

The world has just been through the worst recession we never had, and things are accelerating post-downturn faster than ever before. Companies are struggling just to keep up. It is up to the leaders of business to ensure that they don’t waste a good crisis.

Over first fifteen minutes of the event, Anders and Nils ran through a series of significant trends, observations and external scans that indicate how quickly and unpredictably the world of business is changing in the twenty-first century. Anders flew through his mind-bending presentation assisted by mindmapping software prezi. Take a look here:

Sydney Opera House Thinque Tank on Prezi

View Prezi - large file - please be patient: its worth it!

‘A mind once stretched by a new idea never returns to its original dimensions.’ So said Oliver Wendell Holmes, US author and physician.

Meanwhile, Nils Vesk asked the audience what was on their minds. The topics for discussion emerged:

  • How to get new ideas to business leaders
  • Risk and risk management
  • How to cope with change
  • Are we happier?
  • How can we control greed? And,
  • What is design thinking?

Through the course of the next 90 minutes, the conversation wended its way through these subjects, assisted on its way by passionate interjections from attendees including CEOs, chief creative officers, writers, managers, designers, academics and thinkers of all stripes.

Nils tracked the course of the conversation by drawing and recording the proceedings. His pictures are here:

Visual thinking

See Nils' drawings

Much of the conversation centred around the age old conundrum of stimulating short term innovation while balancing long term profitability. Craig Davis, chief creative officer of Publicis Mojo went further, saying innovation can no longer be solely about the bottom line, it must be directed towards solving the major problems facing the world. The measurability of innovation is a perennial issue for business leaders.

How to effectively engage with customers and the use of social media was a significant focal point, as were ideas for empowering staff to experiment, take risk, and fail.

Thanks again for the invitation to the B21C event last Thursday night at the Opera House. It was a fantastic event! I really came away with lots of new ideas that I picked up from both Anders + Nils, as well as the other business leaders that were in the audience. The conversations were very thought provoking and I am really looking forward to reading the book we all received. Ive been to quite a few business discussions that have been hosted by a range of companies over the last 12 months and this one was by far the most interesting. Well done !

Killer event last night. I’m churning through the book….Thank you for what was another fascinating evening.

Thanks for a fabulous event – extremely stimulating discussion amongst a great crowd of people. Sydney doesn’t have nearly enough of this kind of thing.

I really enjoyed last night. Its been a long time since I felt so excited at a business event. I’m really looking forward to the next Business21C shindig – what will you come up with next?

Thinque tank photos

See photos from the evening

Can economists learn from how physicists apply universal laws?

Friday, January 29th, 2010

Dr Austin Gerig believes that by following the approach physicists use to describe the workings of the universe, economists may be able to uncover universal principles that explain economic phenomena, and even predict extreme economic events. Perhaps we’ll see the next GFC coming.

‘The supreme task of the physicist is to arrive at those universal elementary laws from which the cosmos can be built up by pure deduction.’
Albert Einstein, 1918.

When researching the natural world, physicists often search for universal laws to explain the systematic working of things. It is an approach that has served them well, but is it one that can transfer to other disciplines? Are there universal laws, for example, that underlie economic systems, and should economists search for such laws?

I believe the answer is yes. I believe there are regularities in social and economic systems that result from universal underlying principles (if not universal laws) and that one task of the economist – perhaps the most important one – is to find these regularities and understand the principles behind them.

As an example, consider the way that prices move in financial markets.

Over a century ago, French mathematician Louis Bachelier proposed that stock prices move up or down in random increments and that price changes are unpredictable. This is called the random walk model for stock prices.

When tested with economic data – real stock prices over time – the random walk model is surprisingly accurate. It holds not only for stock prices, but also for the prices of many other items: stock indices, derivative instruments, commodities and other economic goods, and even for the prices of contracts traded on prediction markets.

The regularity of this behavior across different items suggests some universal principle is behind it. In fact, many economists believe this is true, and they attribute the randomness of prices to the profit maximization (or loss aversion) of investors.

The theory says that if stock prices weren’t random, but were in some way predictable, this predictability would be quickly removed. After all, who would be willing to sell a stock for $90 if everyone knew the price was going to move up to $100? Wouldn’t sellers try to get something closer to $100 right now, and wouldn’t buyers be willing to pay something closer to $100? When these individuals push the price to $100, the predictability in the price movement is removed. If predictable price movements disappear, then the only way for prices to move is with random increments.

A second interesting regularity found in economic prices is that very large price movements, such as stock market crashes, occur frequently. Again, this is true for many different economic items.

To understand just how large these price movements are, consider what it would mean if human heights behaved in a similar way. Assume for a moment that adult human heights were not as they actually are, but instead varied between individuals in the same way that price movements vary. In your city, someone would probably be over 30 feet tall. In your country, the tallest person would likely reach 150 feet, and the tallest person in the world would stand over 1000 feet.

The distinction between human heights and price movements is important because most financial models assume that the distribution of stock returns is the same as the distribution pattern for human heights – the ubiquitous bell-shaped curve known as the normal (or Gaussian) distribution. If this were the case, very large returns (analogous to a 150 foot person) should never occur. But this is wrong. For reasons we do not fully understand, stock returns are not distributed according to a normal distribution. Instead, they have a much larger peak and the ‘tails’ or extremes of the distribution are thicker. This means that large price movements occur more often than predicted.

20100129-Gerig-Fig1

Figure 1 shows the distribution for the daily returns of the S&P 500 stock index from January 3, 1950 to November 25, 2009. (This plot uses publicly available data and can be replicated by downloading data here
). The horizontal axis measures the different sizes of returns (0.02 is a 2% return, 0.04 is a 4% return, etc.). The vertical axis shows the relative likelihood of these price changes – the higher the red bar, the more likely that event is observed. Small returns, close to zero, are the most likely occurrence. A normal distribution is also shown in the figure – it is the blue line.

The inset plot shows the probability that a daily return is above a certain threshold value. It enlarges the tail of the distribution – the area where large price returns are recorded. You can see that the probability of large returns is much higher than what normal distribution predicts, i.e., the red curve is above the blue curve for large values of x. The five highest returns, their values, and the dates they were observed are highlighted. Not surprisingly, the largest return occurred on Black Monday, October 19, 1987, when stock markets crashed around the world.

If you look at the y-axis in the inset plot, the probability for a daily return to exceed 10% is around 10-4. This means it has happened approximately once every 40 years. For comparison, the blue curve – a normal distribution – predicts this to happen once every 7×1018 years, which for all practical purposes means never.

One way to explain the discrepancy between observed stock returns and financial models is to consider large price movements as outliers – surprising events outside of the normal model. There are several reasons to do this. First, there are good underlying reasons to assume a normal distribution for returns as a first guess, and no one has yet developed a theory for why it should be otherwise. Second, we usually explain large price movements in this way – stock markets crashed because computer trading malfunctioned or the global financial crises occurred because banks made large mistakes. With these explanations, we implicitly suggest that they are one-time events – outliers – that can be accounted for and controlled in the future. The problem is, despite our efforts, they keep happening.

An alternative explanation is that something more fundamental is causing these events – perhaps an elementary principle underlies the existence of extreme price movements. There are several reasons to believe this is true. First, these events occur universally across traded items. I’m unaware of any economic price series that does not exhibit this property. Second, the empirical evidence does not show these events as statistical outliers. You can see this for the S&P 500 index in the inset plot where the red curve extends continuously in a uniform way down to the points where extreme price movements are recorded. These points do not exist by themselves but fit nicely where you’d expect them when extrapolating the red curve from smaller price movements. Finally, there is evidence that price returns for different stocks all deviate from the normal distribution in the exact same way.

20100129-Gerig-Fig2

Figure 2 shows this result for six stocks that are traded on the New York, London, and Madrid stock exchanges. This data is not all from the same time period. By appropriately rescaling the axes for each stock, the distributions collapse on the same non-normal curve. Why would these unrelated price series all behave in the exact same way unless something fundamental was the cause?

As I mentioned, I believe there are regularities in social and economic systems that can be explained by universal principles. The regularity of economic price movements is one example. The reason why prices are random is understood – it occurs because individuals are profit maximizing. The reason prices deviate from a normal distribution is not understood and is currently a matter of much debate. I believe the evidence suggests that some universal mechanism underlies these deviations, and that large price movements are not outliers to an otherwise correct (normal) model. If this is true, the methodologies used in physics can help economists understand what is driving the result. If it is due to something such as human behavior or the way in which markets are structured, then there might be ways to curtail behavior or structure markets differently such that these extreme events do not occur. If it is due to some economic principle, then perhaps it is something we can only understand and better prepare for.