the top 10 risks for business

Strategic Business Risk2008 – theTop 10 Risks for Business

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In collaboration with:

About this ReportRisks are inherent in every forward-looking business decision so successful risk management shouldbe an integral part of an organization’s strategy and operations – an important dimension of goodmanagement practice.

There has been a great deal of work done in the area of risk management in recent years.Ernst &Young has been engaged in significant global activity to clarify stakeholder perspectives,map management activities and identify leading practice from which all can benefit. Likewise, manycompanies have invested significant resources globally in risk and compliance initiatives.

Financial risk and regulatory risk have been the focus of much of this effort. In both cases, there areexternally determined rules and frameworks with which companies need to comply and emergingbest practice guidance on processes and controls that can help. We have worked with manycompanies who have found that the challenge of compliance can lead to opportunities forperformance improvement through improved processes and enhanced communication. Somecompanies are now looking more closely at their operational risks, prioritizing these and thinkingabout how they can manage and monitor these in a coordinated way, the result of which can againbe opportunities for performance improvement. What is clear is that to gain further businessadvantage, companies must increasingly look at the extended risk universe, from finance andcompliance risk – to operational and finally, strategic risk.

A Different Perspective on Strategic RiskOur experience, however, suggests that strategic risk has not necessarily benefited from developmentsin management practice. Much that has been written about strategic risk seems to be at such amacroeconomic level that the implications for action by the management of a specific companycan be lost. More significantly, the different implications for companies operating in different sectorscan be blurred. Someone’s challenge is frequently someone else’s market opportunity.

We decided to explore the area of strategic risk from a different perspective. In collaboration withOxford Analytica we focused on the strategic risks facing 12 of the world’s most important sectors:asset management, automotive, banking & capital markets, biotechnology, consumer products,insurance, media & entertainment, oil & gas, pharmaceuticals, real estate, telecommunicationsand utilities. These sector studies served as the primary source for the overall comparative reportof our findings.

STRATEGIC BUSINESS RISK: 2008 – THE TOP 10 RISKS FOR BUSINESS

It is never the risk thatcauses damage orcreates opportunities –it is how we respond

Contents

The Ernst &Young Strategic Business Risk Radar 2

Scanning the Sectors 3

TheTop 10 Risks for Business 8

– Regulatory and Compliance Risk 8

– Global Financial Shocks 10

– Aging Consumers and Workforce 12

– Emerging Markets 12

– Industry Consolidation/Transition 15

– Energy Shocks 15

– Execution of Strategic Transactions 17

– Cost Inflation 17

– Radical Greening 18

– Consumer Demand Shifts 18

The Next Five 21

Conclusion 26

Contacts 28

1

2 STRATEGIC BUSINESS RISK: 2008 – THE TOP 10 RISKS FOR BUSINESS

The Ernst &Young StrategicBusiness Risk Radar

Strategic Risk (str_-t_‘j_k r_sk)

– a risk that could cause severe

financial loss or fundamentally

undermine the competitive

position of a company.

We have found the use of the radar – our risk radar –to be a simple and useful device to allow us to presenta snapshot of the top 10 strategic business risks fora company, a sector or indeed the global economy asa whole. The radar allows us to show both the scale ofthe challenge and its nature.

To arrive at our findings, we worked with Oxford Analytica to interview more than 70analysts from around the world and from over 20 disciplines that shape the businessenvironment, including law, finance, the sciences, business strategy, geopolitics, regulation,medicine, economics and demographics. The focus of our interviews was to identify theemerging trends and uncertainties that will drive the fortunes of leading global businessesover the next five years.

Our interviews were open-ended in that we did not provide a list of pre-determined risksfor the analyst to rate. Rather we asked each analyst to tell us what he or she believed wouldbe the most important strategic challenges for global business ahead. Many different risksand challenges were identified, with in excess of 40 by more than one analyst. In orderto prioritize the top risks for each sector, panels of sector experts including journalists,researchers, advisors and our own Ernst &Young practice professionals rated the severityof each of the risks for the sector concerned.

The risks that appear at the center of the radar are those that our panels believed will pose thegreatest challenge to business in the coming year. Those on the outer edge – whilst not smalland still in the top 10 – are considered to be of slightly lower priority.

It rapidly became clear that not all strategic business risks are the same in nature. We havetherefore also divided the radar into three broad sections: (1) macro threats that emergefrom the general geopolitical and macro environment in which we all operate; (2) sectorthreats that emerge from trends or uncertainties that are re-shaping the specific industry;and (3) operational threats that have become so intense that they may impact the strategicperformance of leading firms. We believe this distinction is helpful, whilst recognizing thatthese categories are not completely exclusive. Hence, we can present one radar for a companyor sector, as collectively, these are the principle strategic risks that industry-leading firmsmust manage if they are to maintain their dominant competitive position.

Macro Threats

OperationalThreatsSectorT

hrea

ts

3

We have assumed that a ‘scan’ is or should be the mostappropriate collective noun for the resulting grouping ofstrategic business risk radars and present (overleaf) theresults of this analysis for each of the 12 core sectors.

We hope that what is immediately clear is the extent of variation between these 12 radarsnapshots. The most significant strategic business risk is different for most of them and thenature of those strategic business risks is varied for all of them.

Variation in RiskClose examination of the radars – individually and collectively – shows that there is noconsistent list of top 10 strategic business risks faced by the sectors. It is not just the weightingof risk that varies, but the positioning and the nature of risk. Moreover, it is not just the sector-specific risks that vary, but the macroeconomic and operational risks as well. This does notsurprise us or any who recognize the importance of sector in determining business challenges.

Variation in Significance of RiskWe have highlighted one of the most significant strategic business risks – regulation andcompliance – in red. This makes it easier to see that for four of the sectors – real estate,biotechnology (biotech), pharmaceutical (pharma) and banking and capital markets –this is perceived as one of the top strategic business risks. Three other sectors – consumerproducts, media & entertainment (M&E) and automotive (auto) – believe that the same issuebarely makes the top 10 of their strategic risks.

Equally, a fundamental shift in consumer demand (marked in green) is a top risk for consumerproducts and media & entertainment, but barely features for four of the other sectors.

Scanning the Sectors

Risk Weighting and Risk Prioritization

Phase 1:

• We asked the pool of analysts to listand to rate (on a scale of one to ten,with one having the least impact),the 10 most significant trends oruncertainties that may impactcompanies, and to provide commentaryon why these are important totheir industry.

• Analysts were then asked to list thefive most significant business risksto firms within their industries –considering in particular those of astrategic nature – that might bringabout shifts in the industry or putleading firms in peril of losing theirposition. A numerical rating wasapplied from one to five.

Phase 2:

• In order to prioritize the top risks foreach sector, panels of sector expertsincluding journalists, researchers,advisors and our own Ernst &Youngpractice professionals rated the severityof each of the risks for the sectorconcerned. Panelists were asked toassign a numerical severity rating,from one to five, based on the likelihoodthat a risk issue would lead either tosevere financial impact or underminethe competitive standing of the leadingfirms in their sector. The ratingsassigned by each sector panelist wereaveraged to build the lists of top risksby sector.

• The risks that were rated as having thegreatest impact across the largestnumber of sectors were identified as the‘top10 risks for global business in 2008.’


Macro Threats

OperationalThreatsSector

Thre

ats

Fuel price shocks

Compliancerisks

Cost controls andcash flow pressures

Workforce aging andescalating legacy costs

Failed productlaunches

Environmental pressures

Emerging markets

Consolidation, restructuring

and poor execution of M&A

Consumer demands

Entry ofprivate equity

Macro Threats


Thre

ats

Managing sourcing strategies

Cutting edge IT

Emerging markets strategies

Pricing pressures and input price risks

Strategic alliances and transactions

Consumer demand

shifts

Shifting regulatory threats

Marketing and branding

Supply chain risks

Product development

and innovation

Macro Threats


Thre

ats

Geopolitical ormacroeconomic

shocksGlobal financialshocks Difficulty of

developing retail competencies

Cost and pricing controls

Poor execution of M&A

Changing needs ofan aging population

Polarization between alpha and beta business models

Growth ofalternatives

Rise of financialconglomerates as

asset gatherers

Innovation away from traditional asset managers

Macro Threats


Thre

ats

Corporate governanceand internal

controls failures

IT risks

Reputation risks

Credit shocks and exposures

Global financialshocks

Geopolitical shocks

Compliance and regulatory risk

Competition from non-bank banksand specialists

Increasing pressureon margins

Global market liberalization

and consolidation

Macro Threats


Thre

ats

Monitoring drug safety

Raising capital

Product development and clinical trials

Strategic transactions

Accessing talentProtecting intellectual

property

Price pressures and access

Demonstrating value

Regulatory compliance

Harnessing emerging markets

Macro Threats


Thre

ats

Securities markets Emerging markets

Regulatory intervention

Geopolitical ormacroeconomic shocks

Channel distribution

Integration of technology with

operations and strategy

Legal risk

Climate change

Demographic shifts in core marketsCatastrophic events

Asset Management Automotive Banking &Capital Markets

Biotechnology Consumer Products Insurance

The Ernst &Young Strategic Business Risk Radars

Indicates regulatory and compliance risks

Indicates consumer demand shifts

5

Macro Threats


Thre

ats

Human capital deficit

Cost controls

Worsening fiscal terms

Competition forreserves from NOCs

Political constraintson access to reserves

Energy conservation

Climate concerns

Supply shocks

Demand shocks

Uncertain energy policy

Macro Threats


Thre

ats

Failure to generate sustainable

revenues from new business models

Inappropriate processes and

systems to support new

business strategy

Privacy and security risks

Inaccuracy in forecasting returns from infrastructure

investments

Decline in fixed and

mobile voice ARPU

Competition from internet

companies

Consolidation and M&A

Regulatory risks

Technological shifts

Globalization of markets and services

Macro Threats


Thre

ats

Inability to control costs

Corporategovernance andinternal controlsMaturation of

key markets

M&A activityand entry of private equity

Emerging markets

Asset protection risks including piracy and digital intellectual property rights

Consumer demand shifts

Business modelinnovation

Managing the infrastructure of new business models

Backlash against globalization

Macro Threats


Thre

ats

War for talent

Cost pressure

Product diversion and parallel trade

Regulatory risk

Possible overriding of intellectual property rights

Global pandemic

Price controls and reimbursement levels

Drug counterfeiting

Product pipeline

Adverse drug effects

Macro Threats


Thre

ats

Geopolitical shocks

Global economic and market fluctuations

Rise of private equity

Increased complexityof real estate finance

Green revolutionShakeout of real

estate finance

Regulatory andcompliance risks

Infrastructure investment challenges

Volatility in emerging markets

Inability to find and exploit global

and non-traditional opportunities

Macro Threats


Thre

ats

Energypoliticization

Entry of infrastructure and private equity

Inability to respond to market liberalization

Access to competitively priced

long-term fuel supplies

Compliance andregulatory risks

Strategic exploitation of monopoly advantages

by incumbent firms

Damage ordisruption losses

Challengesof scale

Climate change/environmental awareness

Cost or accessibility

of capital

Media & Entertainment Oil &Gas Pharmaceuticals

Real Estate Telecommunications Utilities

Indicates regulatory and compliance risks

Indicates consumer demand shifts


DifferentTypes of RiskIt is also apparent that the nature of risk varies considerably between the sectors. Analysts intwo of the sectors – biotech and consumer products – did not perceive a single macroeconomicthreat as being in the top 10 strategic business risks, but were focused entirely on operationalor sector-specific challenges. By contrast, the oil & gas and insurance analysts we interviewedindicated a much greater exposure to the global environment, and at least half of the top 10strategic business risks for these sectors are macroeconomic in nature.

Some sectors are undergoing dramatic transformation. In industries such as telecoms andmedia & entertainment, sector-specific challenges dominate the risk lists. Technologicaladvances are driving change in the basic business models of many firms in these industries.In five other sectors – auto, asset management, biotech, consumer products and pharma –the analysts indicated that half of the most significant strategic business risks are specificto their sector.

This analysis highlights the importance of sector in driving strategic business risk analysis andmanagement action. Hence, we have produced separate reports exploring strategic businessrisk in detail for each of these 12 sectors. (Contact information for each report can be foundon page 28).

Given the observations above, what conclusion, if any, can be drawn from the aggregation ofthese sector findings? We believe that there are two sets of valid conclusions to be drawn:

Firstly, we believe that, because we have followed a consistent process and used a weightingsystem, it is possible to compare the riskiness of sectors one with another.

Secondly, from consolidating the findings of the 12 sector studies, it is possible to form aview of the 10 most important strategic risks across these sectors and hence for the economy,and this is the focus of the bulk of this report.

Two of the sectors did not perceive a single macroeconomic threat...oil & gas and insurance, however, perceive that half of their top 10 strategicbusiness risks are macroeconomic in nature.

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Critical ImpactHigh ImpactMedium ImpactModerate Impact

Key

RealEstate

Biotechnology

Oil&Gas

Banking&

CapitalMarkets

Insurance

Telecomm

un-ications

Utilities

Consumer

Products

Media

&Entertainm

ent

Automotive

Risks

Industries

1 Regulation and Compliance

2 Global Financial Shocks

3 Aging Population

4 Emerging Markets

5 Consolidation/Transition

6 Energy Shocks

7 Strategic Transactions

8 Cost Inflation

9 Radical Greening

10 Consumer Demand Shifts

Pharmaceutical

AssetM

anagement

Identifying the Global Top 10By consolidating and aggregating the findings of our 12 sector studies, it is possible to forma view of the 10 most important strategic risks across the sectors – concerns that will becommon to leading firms in many industries.

The table below shows the weighting of the top 10 strategic business risks across the 12sectors that we studied. While many risks were unique to a sector, a few key challenges hada high or critical impact for many, or even all of the sectors. Hence the risks at the top of thechart are those that, according to the analysts we interviewed, will do the most to influencemarkets and drive corporate performance in 2008 and beyond.

Our analysis would suggest that the sectors that broadly have the greatest exposure to the top 10strategic business risks are automotive (auto) and real estate, with four critical strategic businessrisks each. Media & entertainment, utilities, banking & capital markets and biotech follow withthree of the top 10 risks rated critical within their sectors. At the other end of the spectrum,pharma had only one of the top 10 strategic business risks marked as critical in its top 10 risks.

This cannot, however, be used to definitively conclude that one sector is more or less riskythan another. It may be that the unique sector-specific factors are in themselves more highrisk than these 10. However, we can infer that, compared with what we believe are the mostcommon strategic business risks, some sectors are more exposed than others.

Macro Threats

OperationalThreatsSectorT

hrea

ts

Energy shocks

Industry consolidation/transition

Regulatory andcompliance risk

Emerging markets

Radical greening

Consumerdemand shifts

Aging consumersand workforce

Cost inflation

Global financial shocks

Execution ofstrategic transactions


As the greatest strategic challenge facing leading global businessesin 2008, the industry analysts we polled selected Regulatory andCompliance Risk. This is being driven by an escalating regulatoryburden in many markets, as well as numerous compliance challengesas companies extend their value chains well beyond Europe,North America, and the BRICs (Brazil, Russia, India and China).

The possibility of regulatory intervention in sectors such as pharma,biotech, insurance, telecoms and utilities, is further elevating this risk.Such intervention could shape the competitive environment and drivefundamental change in business models. One telecoms analyst wrote,“Regulation has a tremendous effect on the competitive landscape,not only between incumbents and new entrants, but betweencountries.” In other sectors, the continued viability of currentbusiness models may be threatened by future regulatory decisions.

Continued on page 10

The Top 10 Risksfor Business

1 Regulatory and Compliance Risk

Top 10 Strategic Business Risks

Regulatory and Compliance Risk

Global Financial Shocks

Aging Consumers and Workforce

Emerging Markets

Industry Consolidation/Transition

Energy Shocks

Execution of Strategic Transactions

Cost Inflation

Radical Greening

Consumer Demand Shifts

7

8

9

10

1

2

3

4

5

6

In the following section, we explore the top 10 strategic business risks that have emergedfrom our study, and we share the thinking of some of the leading analysts to whom wehave spoken.

There’s never been amore challengingtime for banks and capital markets firms.The complexities of the business continue tomultiply. The landscape keeps changing throughglobalization, the emergence of newmarkets,and the advent of cross-border expansion.Add to the mix ever-evolving risk management,regulatory, and compliance requirements and it’seasy to see why many senior executives spendtheir days scrambling to keep pace and theirnights worrying about whether or not they arefully compliant and can meet expectations.

The concern is not unfounded. Many of thelargest institutions have multiple risk governanceprocesses and infrastructures amongst variouscorporate and business units. Because theseoperating models have sprung up over time asneeds dictated, they often operate in silos,leading to substantial inefficiencies.

These models may prove to be insufficienttomorrow as cross-border consolidationadds another layer of complexity. Competingregulatory regimes and variances in compliancerequirements are just a few of the ways in whichthe demands and challenges of risk managementwill be compounded. At the same time,companies will be expected to provide greatertransparency and more accurate risk and controlinformation. Institutions can prepare themselvestoday to effectively manage the risks inherent inthis future scenario by aligning or “converging”their current risk and control processes.

Risk convergence allows organizations tocoordinate the various risk and controlprocesses, effectively and pragmatically.In our experience the result is reducedredundancy, which drives down costs, and,perhaps most importantly, allows morecomprehensive, enterprise-wide riskreporting to senior management andthe board. While risk convergence is nota minor undertaking, it represents a majoropportunity to more effectively mitigatecurrent and future risks that otherwisecould impact an institution’s reputation,bottom-line and ability to compete globally.

A few, forward-thinking institutions haverecognized this need to streamline risk andcontrol processes and present a moreconsolidated view to senior management and theboard. Consequently, they are beginning to takesteps toward risk convergence. It’s unchartedterritory, however, so few, if any best practiceshave been established. A critical foundationalelement is the creation of a common datastructure, common terminology for risk andcontrol process, and a common technologyarchitecture. In addition, the following questionscan also help to guide the process:

• Has the vision been clearly defined? It’s notsufficient to focus only on what’s not working.The future state-vision should be well-definedand communicated so that all parties areclear on what is to be achieved.

• Has a responsibility matrix beenestablished? Amatrix of current rolesand responsibilities helps to visuallyidentify existing duplication of riskmanagement resources.

• Is there buy-in from the right stakeholders?Support from chief executives is important,but getting buy-in from key corporate controlgroups and business units is critical: they’rethe ones that will make it work.

• Can expected benefits be tested?The goalhere is to support the future-state hypothesiswith empirical information in order to builda compelling case to present to seniormanagement and the businesses.

With an eye on what the future operating modelshould look like, it’s possible to move toward thedesired end-state in incremental steps. As eachbuilding block is put in place, efficiencies aregained and begin to multiply. This approach canmaximize the return-on-investment in the shortterm by avoiding large-scale investment whilereducing waste and process redundancy. In ourexperience, those financial institutions thatembark on this journey may be rewarded witha flexible, efficient, and sustainable riskmanagement framework that effectivelymeets not only today’s requirements butthose of the future.

� Jim Fanning is the Global Leader ofErnst &Young’s Banking &CapitalMarkets Center.

9

Jim FanningErnst &Young

Beyond the Horizon: Forward-looking Risk Management


“The failure of one or more major financial institutionsremains a real worry and could turn the crisis intosystemic failure in the year ahead.”Jens Tholstrup, Oxford Analytica

Our analysts acknowledged that few sectors would escape theimpact of major Global Financial Shocks. Biotech and utilitiesfirms, for example, would have trouble raising capital; banking,asset management, and insurance companies would be likely tosuffer direct losses from market movements; and after makinghigh-cost exploration investments – oil & gas companies mightsuddenly find themselves facing low prices if the global economymoves into sudden recession.

Since our research began earlier this year, the August credit crunch,forced by the US sub-prime mortgage crisis has provided a real-lifedemonstration of how highly contagious such shocks can be acrosssectors – and indeed – globally. Rory MacLeod, the former Headof Global Fixed Income at Baring Asset Management, somewhatpredicted in April 2007 that if there was a “worldwide credit crunch– spread widening would not lead to bank collapses, as in the past,but would be spread throughout the financial system. There will beunexpected pockets of vulnerability. Disintermediation has replacedinternational banking as a finance source with a range of specializedcredit instruments held widely, with risk exposures that regulatorsfind it difficult to assess. A credit shock could lead to a temporaryclosing of the market for new credits, while traditional lenders suchas banks have moved away from the area.”

A crisis could spread from alternative investment vehicles suchas hedge funds or private equity. One analyst wrote, “Financialinnovation and structural changes have contributed to the successof private equity, but cyclical factors have also played an importantpart in their over-expansion… High-profile failures of some investeecompanies could lead to a loss of confidence among investors andlenders.” Another remarked, “A crisis in CDO/structured financemarkets could lead to potential systemic problems. Sustainabilityof financial sector growth is more fragile than markets realize.There is the potential for dramatic fallout from excessive leverage.Carry trades are cited as a risk area, but other hedge fund strategiesare exposed to a change in the macroeconomic environment.There are potential systemic issues in the financial sector.” In thefuture, continued financial innovation – which tends to disperserisks and, as a consequence, makes the detection of potentialshocks more difficult – is likely to increase the potential forfinancial shocks.

One analyst noted, “The revenue generated from the US pharmamarket, the largest in the world, enables pharma companies toremain profitable [despite] strict price controls in other majormarkets and the inability of [customers] in developing markets topay full prices for their products. If imposed in the United States,price controls could transform the global pharma market, includingbusiness models and the development of new drugs in the future.”

The compliance challenges are particularly strong in highlyregulated industries such as banking, insurance, pharma, andbiotech, where the regulatory burden is increasing fast, and wherefirms are feeling pressure to demonstrate a return on investment forlong-term risk management initiatives. One banking panelist noted,“Banks are experiencing significant fatigue around managing themyriad of often redundant compliance and regulatory reportingactivities, the cost of which is massive and burdensome.”Similarly,a biotech analyst wrote, “A mounting regulatory compliance burdenin areas such as privacy, post-marketing monitoring of drug safety andsales force compliance… poses a management and internal controlschallenge to biotech companies.” Increasingly, companies may seekrisk convergence initiatives which allow them to coordinate the variousrisk and control processes, reduce redundancy, which drives downcosts, and, perhaps most importantly, more comprehensive enterprise-wide risk reporting to senior management and the board.

As companies become more and more global, compliance becomesa greater challenge, forcing them to manage diverse regulationsin different markets. A specialist in business strategy noted,“Managing regulations in 10 jurisdictions is one thing. What happenswhen a firm has significant markets in 30-40 countries at varyinglevels of development and with very different regulatory traditions?This is not to say that global regulatory [diversity] is necessarilyincreasing; but rather, that corporate exposure to existing [diversity]is increasing.” The importance of understanding local regulations,as well as major global industry regulations is crucial to thosecompanies expanding their global reach.

2 Global Financial ShocksContinued from page 8

For the time being the world’s major centralbanks have eased the credit crunch thatmanifested itself in the beginning of August,but the risks to the financial system remainvery real.

The origin of this financial crisis has been welldocumented: the inability of large numbers ofless creditworthy borrowers in the United Statesto service the debt on their homemortgages.What has made this development so contagiousare certain innovations in the global financialsystem.The securitization of financial risks hasresulted in a wide disbursement of such riskthroughout the financial system. In theory,the dispersion of risk should reduce the risksof systemic failure but, in fact, the very oppositehas been the case.

The negative effects of disbursement areexacerbated by lack of transparency. In theory,all financial assets have been, or are capable ofbeing securitized and traded. However, at thepresent moment, no regulator or marketparticipant can be totally clear where the riskslie. The use of off-balance sheet vehicles to holdsub-prime and other risk assets, has furtherreduced transparency.

A related issue that has made the sub-primecrisis more contagious is the use of pooling offinancial assets. Any investment vehicle whichhas some exposure to sub-primemortgages willbe regarded as contaminated.

In this market environment, financial institutionsbecome very wary of lending to other financialmarket players since they will be concerned thatothers will be holding impaired assets. Credit forall but the largest and most secure borrowerswill seize up. This is precisely what has happenedin recent events, where central banks have hadto intervene and act as lenders of last resort.

Any institution that is holding high-risk assets,particularly asset-backed or pooled vehicles,is facing substantial losses. In addition, themarket for many securitized assets has driedup leaving the holder unable to sell the assets.The commercial paper market for asset-backedsecurities has all but dried up with theconsequence that borrowers financing suchassets will need to draw on standby lines ofcredit provided by banks.

Contingent risks become real risks, underwritingpositions become stuck and credit becomesseverely restricted. The failure of one or moremajor financial institutions remains a real worryand could turn the crisis into systemic failure inthe year ahead. The central banks and regulatorshave already shown their disposition to takethe steps which they feel are necessary tomaintain the stability of the financial systemand in particular to minimize the likelihood ofeconomic contagion.

The implications are:

• Even in the event of central bank rate cutting,the cost and availability of credit for mostborrowers will be negatively impacted for theyear ahead. Banks will be forced to ration theirlending and lower-rated borrowers will findaccess to capital difficult and expensive.

• The capital markets may well provide betterfund-raising opportunities especially ifinvestors believe that the anticipated raterises will be reversed. However, access is likelyto be restricted to better credits for sometime at least.

• The funding of off-balance sheet assets andother structured finance products will becomeseverely restricted.

� JensTholstrup is an Executive Director andDirector of Consulting at OxfordAnalytica.

Prior to joining OxfordAnalyticain 2000, Jens had an extensive careerin investment banking.

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Jens TholstrupOxford Analytica

The Credit Crunch and Its Implications for theAvailability of Capital


The findings of our survey Risk Management in Emerging Markets2007 reveal that, while many companies have been in these marketsfor some time, emerging markets remain dynamic for developedmarket (DM) companies. Over 60% of DM companies have beenin these countries for less than 10 years, and almost 20% less thantwo years. In most cases, global firms are competing with otherglobal players for opportunities in these markets, although inseveral sectors, emerging markets firms are themselves enteringthe global stage.

Often companies are being driven to these markets by the saturationof existing markets. An analyst in consumer products commented,“Over the next few years nearly all of the increase in worldpopulation will take place in the developing countries. In themeantime, other established markets will reach maturity.” Similarly,in real estate, “Intense competition for a limited pool of desirableassets, combined with yield compression in most global markets,has resulted in real estate funds needing to broaden their geographicsearch for opportunities. This has created an increased number ofcompetitive variables in real estate markets.”

For other sectors, such as biotech and consumer products,emerging markets offer supply chain advantages. One biotechanalyst remarked, “The sources of biomedical innovation willbecome more diverse in a globalized marketplace. The implicationis that while, in the past, the main source of competitive advantagefor firms throughout the industry has been technology, in thefuture it will be the supply chain. Global companies will need topartner/form networks with firms in many markets.” In manysectors, the value chain will increasingly extend well beyond thedeveloped markets and the BRICs, and the volume of businessconducted in these markets will be significant.

On the downside, global expansion into foreign and/or emergingmarkets has always carried with it traditional threats such as:currency, operational, regulatory, language, and cultural risk.Increasingly, a significant challenge lies in firms effectivelymanaging outsourced business and supply chains in these markets.Recent events in the consumer products sector, for example,have demonstrated the specific need to focus on quality controlstandards and compliance testing when sourcing from relativelyunknown suppliers in emerging economies.

An increasing strategic risk for the majority of industries is thethreat posed by workforce and consumer aging. Sectors such asasset management and insurance are experiencing dramatic shiftsin demand and competitive battles are being fought for savingsproducts that will appeal to the growing group of older consumers.Other firms, for example, those in the auto sector, are facing severecompetitive challenges as a result of their aging workforces.

A number of industries are experiencing dramatic shifts in demand –often dramatic growth – as a result of the rising average age in,for example, Europe, North America, and Japan. Sectors mostaffected by these shifts include pharma, biotech, consumer products,insurance, and asset management companies, which could loseheir competitive edge if they cannot effectively respond to thesenew opportunities. One insurance panelist noted, “People reachingretirement age have very different financial needs.”As a result,a struggle is now emerging between insurance and asset managementfirms to deliver the innovative products that will meet these needs,such as income maintenance and health care spending. To becompetitive, companies will need to gain an understanding of thespecific needs of these new consumers, and many will need to havean aggressive approach to key competitors that may increasinglycome from outside their sector.

The other strategic challenge posed by an aging population isworkforce aging, a risk issue that figures highly in oil & gas andis perceived to be a ‘next five risk’ for sectors such as banking.These sectors are already experiencing a significant human resourcechallenge. Perhaps the most extensive example of this threat can beseen in the US auto industry, which is particularly weighed downby pensions and health care costs. “There remains a possibility ofinsolvency in the US auto industry, and a long line of dependentcomponent companies have yet to construct a path to safety.”

4 Emerging Markets

“Only 41% of developed market companies have a risk strategyfor emerging markets, with more than half (56%) saying thatno strategy is in place.”Ernst &Young, Risk Management in Emerging Markets study, October 2007

3 Aging Consumers andWorkforce

Changing Financial Needs

The baby boomer generation is retiring just asemployers and governments are progressivelydisengaging from pension provision. As a result,the financial needs of individuals are changingdramatically. The central financial challenge forthese retiring baby boomers is how to transformthe wealth they have accumulated in their pensionaccounts into a steady income stream.To a largeextent this is a decision that they will have toface alone.

The vast majority of baby boomers have only threeassets: house, occupational plans and socialsecurity. With the exception of the high net-worthsegment, the value of additional savings isminimal. These trends will transform the savings-products industry, which so far, has beenaccumulation-oriented.The business challengeover next 15-20 years will be to create productsfor the pay-out phase.

The strategic risk for insurers is their inability toadjust, develop products for new needs, andcompete against other sectors of the financialservices industry.

How Can Insurers Capitalize onNewOpportunities?

Occupational pension/cash-balance plans, andindividuals in themassmarket offer significantopportunities. However, these benefit only asegment of the population – those withoutsufficient wealth to attract the assistance of wire

houses, retail advisors or independent financialplanners. Only a handful of competitors areoffering well-planned, valuable services tothese segments, althoughmost major financialinstitutions are circling the opportunity.

• In the defined contribution market,insurers should offer employers products thatcombine the accumulation and payout phase.These products transfer most of the risk fromthe individual to the insurance company.Combining the two phases can represent acompetitive advantage. At present, the assetmanagement industry has the capability tooffer only investment products.

• To sell against investment-only solutions,insurers must have the ability to provide keyconstituents with clear information aboutproduct benefits and competitive advantagesfrom the employee’s perspective. Suchassessments will help employers and theirbenefit consultants understand the value ofthe product. Insurers may also support theplan sponsor by providing financial adviceto employees.

• In the retail market, insurers must take stepsto leverage their ability to write contracts thatwill provide more dollars of lifetime income perdollar of investment. A retirement program thatcombines decisions around the timing of socialsecurity elections, the use of home equity, andthe disposition of cash balance plans into aneasy-to-use, cost-efficient menu approach willbe effective in themassmarket.

Barriers to Success – theThreatof Competition

To be successful, insurers must change theirapproach to the competition and take a broaderview of themarket. For years, they have beenfocusing on competition among themselves. In theUS, for example, insurance companies have only a

small share of the US savings market. Their truecompetition is represented by other providersof savings products, in particular, mutual fundentities. Insurers must become as aggressive asother institutions competing for the same dollar.

As the only writers of payout annuity products,insurers should be well positioned to takeadvantage of the shift from accumulationto payout. However, they face threesignificant obstacles.

• Most of the retirement wallet is now in thehands of other asset managers, who are ina strong position to retain customers.

• Even though pay-out annuities providethemost income for a given investment,individuals dislike the idea of suddenlytransferring all of their assets to the insurancecompany.They feel that they are losingcontrol over the wealth and they wouldprefer to keep themoney with the insuranceindustry’s competitors.

• Some sales practices related to deferredannuities, have created negative sentimentsthat have been actively expressed in popularmedia and by regulators.

Twenty five years ago, insurance companies werestrongly positioned against asset managers todominate the savings industry. Mutual funds werevulnerable and their market share was relativelysmall. However, insurers were complacent andlost the battle for individual retirement assets.The demographic shift is creating new demandsthat insurers are well-placed to satisfy. It wouldbe a shame for insurers to repeat the samemistake and squander their opportunity torecapture lost territory.

� Chris Raham is a SeniorActuarialAdvisorat Ernst &Young.

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Chris RahamErnst &Young

Winning the Battle for the Savings Market


From Emerging Markets to Surging Markets – The Future of Global Media Growth

Emerging markets are attracting significantattention because of a surge in demandfor content. With China and India accountingfor one-third of humanity, these marketsare the future for global media growth.Currently, some of the largest global mediaand entertainment companies are making lessthan 5% of their global sales from emergingmarkets, but the management within thesecompanies are spending a disproportionateamount of their time dealing with these markets.

It is partly a lack of both content and ahandle on distribution in Europe and NorthAmerica that is preventing emerging marketcompanies frommoving into developed markets.More significantly, however, the growth in theirhomemarkets is so fast that they don’t havethe bandwidth to think about it.

Another important growth factor in thesemarkets is technology. Broadband connectivityin South Korea is 98%, enabling the push-through of huge amounts of content. In India,a global multinational company has recentlyconducted the world’s biggest rollout ofdigital cinema through satellite. This meansthat these companies can control exactlywhere movies are showing and howmany timesthey are shown. It also means they can controlpiracy. And it allows them to release not justin Delhi or Mumbai, but in the smallest towns,simultaneously. This is a paradigm shift in how

films are released, and it is happening in India.At a time when technology is reshaping theglobal industry, emerging markets are thefastest adopters of technology. They provide anideal test-bed where global firms can trial newtechnologies, before bringing them out in theirhomemarkets.

Winning in EmergingMarkets

To win in these markets, companies need tolocalize content and be sensitive to local culture,rather than automatically dubbing andrepurposing. It is possible to sell frommedialibraries, but this will not make you a winnerin these markets. One major global mediaplayer had been in India for seven or eightyears, with a mostly English offering. In 2000,they invested in 24-hour Hindi programming withlocal productions and quickly became the largestand most profitable channel. Firms that don’tlocalize their content can also run higher risks.One foreign broadcaster that was in the Indianmarket showed too much adult-oriented contentin its programming before 11pm and thegovernment took the channel off the air.

However, growth in demand for local content bythese global players and by local companiesfunded by private equity firms could soonoutpace the growth in supply of local productiontalent. This could lead to super-inflation whichshould be factored into business plans.

It is important to understand that even asingle emerging market country has multiplemarkets within. Southern India is completelydifferent from the North. To win in a nationalmarket, investors may need a very differentstrategy in each region. There will be differencesin where the demand is, the type of content,the distribution of content, and how to takeout earned revenues.

The price points in emerging markets are alsooften a fraction of what consumers would becharged for similar content in developedmarkets, often due to regulations, competitionor extensive piracy. However, the huge and fastgrowing volumes more than make up for the lowcharges. As a result, a thorough assessment ofthe market and distribution channels is neededto appropriately price the content.

A final critical success factor is flexibility.These markets can see growth of 40 to 50%per annum. In such an environment, localentrepreneurs have an big advantage, and rightnow, a lot of local media companies arebeating the global players in China and India.Multinationals will need to have flexible businessplans which do not always need to be approvedby the regional office and the head office.

� FarokhT. Balsara is the National SectorLeader for Media &Entertainment andtheMarkets Leader forAdvisory Servicesat Ernst &Young, India.

FarokhT. BalsaraErnst &Young

“ These [emerging] markets can see growth of up to 40 to 50% per annum.In such an environment, local entrepreneurs have an advantage,and right now, a lot of local media companies are beating the globalplayers in China and India.”Farokh T. Balsara, Ernst &Young

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Fluctuations in energy prices and access to supplies pose a clearchallenge to the energy sector, including utilities and oil & gas.In utilities, for example, loss of access to competitively pricedlong-term fuel supplies is the top strategic risk. One analyst noted,“The impact on the business is the need to acquire short-termsupplies to meet demand obligations and can lead to a huge lossof profitability, hence the need for skilled hedging of sources,types and timing of fuel supplies.”

However, beyond the energy industry, a large swing in prices couldalso trigger economic shocks that could impact sectors such asinsurance, consumer products and real estate. Few leading globalcompanies are immune to this risk. One telecoms analyst remarked,“As more and more equipment is racked up in data centers, more andmore power is needed to run and cool down the servers that are at theheart of the web infrastructure.” Even the virtual world needs ‘real’world energy.

Various potential causes of such energy shocks were noted, includinga US strike on Iran, a breakdown in relations with Russia, contestsfor control of ‘strategic’ energy supplies, or an action to disruptshipping through one of several key maritime choke points. The risksof a shock are also dramatically heightened in today’s environment ofincreasing energy nationalism. One analyst noted that on the supplyside, “The development of the world’s oil & gas supplies over the past40 years, with concomitant advances in extractive technologies, hasbeen undertaken largely by private sector enterprises. Now, however,the global supply of prime energy fuels has become dependenton a few national, state-owned suppliers.” In the future, the risksassociated with the continued and sustained supply of such fuelsto the developed world may rise significantly. On the demand side,the risks from rising energy nationalism may be even greater,“Governments are increasingly convinced that energy security needsto be pursued actively. The reality may be quite different, but theperception could trigger a crisis [caused by] desperate efforts thatcountries may make to secure their supplies (paying above marketrates, long-term deals, etc.). If markets then panic, this wouldcause governments to respond with even more uncoordinated,unilateral steps, making the situation infinitely worse.”

Part of the consolidation phenomenon has been driven by the globalM&A boom, which several analysts believe may slow in yearsahead. However the majority of sector analysts we polled believedthat industry transition would continue to pose a key strategicchallenge in 2008.

This continued transition will be driven, in most sectors,by underlying structural trends. One analyst, commenting on theauto sector noted, “Population growth and GDP growth are highestoutside of the US, EU, and Japan, resulting in a global misalignmentin the location of industry capacity and the location of demand.The industry, especially in the US market, is in transition includingconsolidation, restructurings and spin-offs.” Another analysthighlighted that, in asset management, transition entails themigration of the industry’s leading firms towards one of twoopposing business models, “On the one hand, massive assetgathering [companies] that drive down costs and provide cheapaccess to markets and market risk and, on the other, those companiesthat… (as a business proposition) offer better-than-market returns.”In the media & entertainment sector, M&A is a central featureof many companies’ attempts to respond to the internet’s impacton the sector, for example, via the acquisition of ‘new media’ firms.

Companies in other sectors may continue to merge, driven bycompetitive pressure. In banking, “Many of the deals are of sizesnever-before experienced. The trend to become bigger and moredominant by acquiring existing franchises is an ongoing driver forgrowth.” And in telecoms, “Accelerated M&A trends in the telecomsindustry will lead a transition to three to four players per country.”In utilities, one analyst commented, “Size is vital when negotiatingwith the owners of major primary resources; size is vital as someprotection against hostile acquisition. Hence, the impact of failingto grow can be a loss of competitive supplies or even loss of thebusiness.” There is a growth imperative in many sectors, and ifit cannot be met by organic growth, then it may need to be metby acquisitions.

6 Energy Shocks5 Industry Consolidation/Transition


“New technologies will change the market. The successful utilities ofthe future will be those who make the bold decisions to flex their assets,supply chains, and operating models.”Tony Ward, Ernst &Young

Whilst global primary energy prices remainvolatile, power utilities remain generallyhigh-volume, lower-margin operations.The primary risk for utilities is to balancerelatively short-term customer contracts with thelonger-term nature of fuel supply and, in doing so,deliver access to economically attractive, secureand reliable contracts, whether for their primaryfuel needs, or eventual customer off-take. In part,this is a matter of trading strategy, procurementand hedging, but the choice of technology toconvert fuel to power, is also a key issue.Decisions made today to embed fuel needs,emissions profiles and cost drivers may havelong-term implications. These assets can haveeconomic lives of up to 50 years, and investmentlead times of over five years, as is the case withsome coal and all nuclear assets.

The interaction of these two short and long-termpressures is mirrored in the convergence of therespective interests of the private sector utilitiesand national governments – the former managingtheir discrete businesses for profitable growthon behalf of their shareholders, and incompetition with others, and the latterfocusing on the aggregated concerns ofdiversity and supply-security of fuels,minimal environmental impact and overallnational economic competitiveness.

Managing the Risks for Contracts andFuel Supplies

Securing access to fuels and supply contractsfor a utility carries with it substantial risks anduncertainties. This is true both in mature marketswith an aging infrastructure and greatercompetitive pressures, and in developingcountries that may struggle to matchgeneration capacity to rapidly growing demand.

In committing to asset construction programs,companies face significant regulatory, market,financial, and public relations risks. Access toadequate amounts of capital at reasonable ratesmay also be a factor as the industry enters aperiod of escalating infrastructure investment.The effective management of the risksassociated with pursuing organic growth willenable utilities to deliver predictable valueto shareholders.

Being flexible is the key to success for bothgovernments and companies. At a national level,certain countries are responding by movingtowards greater self-reliance, focusing onmaking use of local resources andmarkets,and looking for diversity of fuel technologyand fuel type. Companies are building up theirportfolio of relationships and supply sourceswith crossholdings and minority interestsin assets. Key strategies to reduce the risk ofsupply shortages include scale, collaboration,supply chain shortening, infrastructureinvestments, new technologies and ‘convoy’procurement of scarce resources.

By ‘racing for scale’, companies, and increasingly,countries and regions (for example, the EU),are pursuing joint efforts to create largerentities which automatically create largeroff-takes for suppliers. Scale mitigates riskthrough spreading the portfolio of contract

timescales, geographies, and fuel types,reducing reliance on vulnerable areas.Joint operations, asset swaps and otheralliances may provide an alternative toa single company striving for scale.Collective weight can help in negotiationsand the mitigation of risk.

Shorter supply chains can also help to reducethe risk arising from intermediaries. This isespecially true from a security of supplyperspective, but can also limit overall losses.The use of local resources, an approachincreasingly taken by companies, can alsoreduce the supply chain.

Infrastructure andTechnology Investment

Infrastructure investments are needed to reducesupply shortages, especially in developingeconomies, and also to restore aging assetselsewhere. Investors are aware of the degreeto which national politics can destroy theircontractual positions. Given the long-term natureof these investments, investors require a clearunderstanding of the political environment andthe risks. A national framework on securityof supply is crucial in order to achieveinvestors’ confidence.

New technologies will change the market.The successful utilities of the future will bethose whomake the bold decisions to flex theirassets, supply chains, and operating models.Governments, and corporates, should considera diversified fuel mix as an important meansof mitigating the risk of loss of access tocompetitively priced long-term fuel supplies.

� TonyWard is a Director within theTransactionAdvisory ServicesTeamat Ernst &Young.

A Loss of Access to Fuel Supplies – Mitigating the Risk

TonyWardErnst &Young

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We have been operating in a low inflation global economy forsome time. Our analysts believe that the return of high inflationis a major risk. Cost Inflation, though the result of various drivers,is a significant operational threat for all sectors. In oil & gas,for example, the problem extends from exploration all the waythrough the value chain, impacting everything from refinery buildcosts to pipeline construction costs. One sector analyst commented,“The impact on oil & gas companies is increased pressure onoperating margins, higher risk investment profile, increased assetportfolio optimization, consolidation, and risk sharing arrangements.Companies with high cost reserves could be at risk of failure.”

In many cases, these cost pressures are driven by changes to thefundamental structure of an industry. Demographic changes and therising costs of health care are creating a serious challenge for US automanufacturers. One analyst noted, “American automobile companieslabor under the weight of health care costs eroding their internationalcompetitiveness.” Another predicted, “The aging workforce atestablished Western producers leads to costly buy-outs, benefits,and so on. There will be an ongoing decline in employment inthe sector in the Western World, with large impacts foraffected economies.”

In biotech, cost inflation is driven by regulation, as well as theincreasing focus on drugs targeting chronic diseases, which meansthat “clinical trials are increasingly expensive, and higher costs todevelop drugs put pressure on raising capital and drug pricing.”In consumer products, by contrast, the structural shifts that make costcontrol such a strategic challenge are related to consolidation in retail.Consumer products are being squeezed between, on the one hand,a “consolidating base of retailers that has resulted in greater controlover pricing through strong buying power and hard discounters”and, on the other, “volatility of raw materials prices,” makingmanagement of input prices a crucial challenge. In other industries,radically changing business models are making cost a centerpieceof competitive strategy. One notable example is asset management,where the best performing companies are often those that controlcosts through overall scale, or product specialization.

8 Cost Inflation

Strategic risks often result from an attempt to take advantage ofmajor opportunities. Nowhere is this more evident than in the area oftransactions. Too often a move that seeks to quickly and significantlyrespond to an opportunity, becomes an expensive and long-term riskin its own right.

There is a major risk that transactions undertaken in response toindustry consolidation may fail to deliver, not because they arepoorly conceived, but because of a failure to meet operationalchallenges. This was perceived as a high risk by analysts in anumber of sectors including auto, asset management, media andtelecoms. A banking panelist wrote, “Stakeholders expect M&Ato very quickly have a positive effect on the bottom line and createsynergies between the acquirer and the target. Required integrationmay challenge the people, process, and technology of the combinedentity. Stakeholder expectations may not be met or the deal mayultimately need to be unwound.”

New types of strategic transactions, including divestitures in realestate, spin-offs in auto, and separation of telecoms companiesinto utilities and service providers are driving further risk.While it is the big mergers that dominate the headlines, in somesectors, excellent execution of small and highly strategic transactionsmay have as great a competitive impact. Consumer productscompanies are, for example, using transactions more strategicallyto acquire innovation. Similarly, in asset management, firms areemploying M&A in the hope of “acquiring… talent that cannot behome-grown.”

7 Execution of Strategic Transactions


9 Radical Greening 10 Consumer Demand Shifts

We use the term Radical Greening to apply to the increasingenvironmental concerns which could be the result of a widerange of pressures – from the voluntary world of corporate socialresponsibility – to hard regulatory and economic necessity.

Radical greening is a strategic risk, partly driven by the consumerand regulatory responses to climate change, and also by the weatherevents resulting from climate change. A specialist in science andinternational affairs wrote, “Current climate predictions are basedon models and, naturally, the scenarios communicated to the policyworld are the scientifically conservative scenarios (i.e., those whichmost scientists agree are likely). Yet scientifically conservativescenarios are not necessarily what will happen; it is possible thatthe hazard is actually more imminent than is commonly understood.In this case, we may see physical climate surprises as well as anincreased policy response that is more abrupt than most firms arecurrently planning for.”

In the short term, barring such unexpected developments, thestrategic challenge centers on how much ‘radical greening’firms should undertake. Going green is expensive, but couldpay dividends if consumer tastes and regulation shift quickly.For example, in real estate ownership, some analysts favored firmswith ‘green’ portfolios. One analyst noted, “As ‘green’ becomeslaw it could result in forced obsolescence and write-downs for non-green real estate assets along with substantial capital expenditureobligations to meet the new standards.” In a similar vein, in utilities,“Carbon trading is a reality in Europe and will almost certainlyhappen in the US. The caps that are set directly influence thecost of generation with different fuels and hence can make anonsense of the wrong fuel generation mix strategy. Fixed agesfor renewable generation are also likely to come. The impositionof fixed percentages of renewable power can expose severe strategicerrors of corporate judgment.”

The pace and extent of this new ‘green revolution’ is hardto predict – but what is almost certain is that some firms willget the right fuel mix, real estate portfolio, or carbon footprint,while others will go either too radically green or, more likely,not green enough.

“This issue of climate change extends beyond just managing regulatory risk.Climate change and the regulatory and consumer response must be seenas a fundamental strategic challenge. We can expect a future of carbonlabeling on products, carbon trading worldwide, and tight regulation andheavy taxes on carbon.”Jonathan Johns, Ernst &Young

Our final strategic risk for business in 2008 is the failure toanticipate and respond to Consumer Demand Shifts. There area number of examples of such shifts, perhaps the most obviousbeing the demand for ‘green’ products or services. Other trendshave already been mentioned, including those driven bydemographic shifts, such as growing consumer aging.

It is the task of business to identify and respond to changes indemand. Such a challenge moves to be a strategic risk when thechanges are significant, fast or unexpected. A general themeacross the sectors was the challenge posed by consumerempowerment making this an area of strategic risk. In media& entertainment, for example, one Ernst &Young panelisthighlighted that, “Consumers today have more power than theydid 10 years ago. Consumers are controlling the decisions aboutthe content they receive and how they receive it. Consumers todayare driving the content and distribution channels.” In auto,“Increased interest in customization of products requires a shiftaway from mass-production philosophies.” Or, as another consumerproducts panelist noted, “Factors such as the web, deregulationof markets and globalization will continue to lead to a rise incustomer expectations and basic customer segmentation strategiesare already becoming less and less effective, as customers lookfor individualized and customized purchase experiences.”As technology continues to expand consumer power, this challengemay well rise higher on the radar in the years ahead.

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Jonathan JohnsErnst &Young

The climate change debate has made theenvironment the biggest single issue in thepublic’s mind. We are moving closer to a world ofzero tolerance for environmental accidents andwe have started to see this in recent incidentsinvolving oil &gas firms.

Many oil &gas firms are already demonstratingleading practice in environmental compliance,but in a zero tolerance environment mistakeswill occur. New roles, such as an environmentalofficer, will begin to emerge at the corporate level.There may also be regular, independent auditsof procedures and we could even see theemergence of environmental stakeholderson an independent board.

This issue of climate change extends beyondjust managing regulatory risk. Climate changeand the regulatory and consumer responsemust be seen as a fundamental strategicchallenge. We can expect a future of carbonlabeling on products, carbon trading worldwide,and tight regulation and heavy taxes on carbon.Companies must make a fundamental decisionabout where they want to be in the newcarbon economy.

For many companies, the decision is whetherto adopt a minimal response and simply followregulation or to make an active decision toreduce their carbon intensity, which could be

achieved by offering blended products,a strategy of acquisitions or by mitigatingthrough carbon sequestration and storage.Others may decide to go one step further andoffer services that help their customers tomanage their carbon footprint. The climatechange agenda also presents opportunitiesfor skills transfer, for example, many of thecapabilities that make a firm a leader inoffshore oil also apply to offshore wind.

Moving into renewable energy is not a ‘one sizefits all’ solution. The fossil fuel era is not over yet.For reasons of security of supply and economicgrowth, petroleum will be used for some time yet.The degree of repositioning will vary and willdepend on the character of the company, butmany firms are finding renewables and cleanenergy a profitable activity. Measures such asgreen-friendly tax regimes, carbon tradingand carbon labeling on consumer productsare, however, accelerating the movement.Those companies that are carbon-friendlywill have a competitive advantage and alsobe able to better attract the young talent theyneed for the future.

� JonathanJohns is a Partner in theInfrastructureAdvisory – Renewables,Waste &Clean Energy Group atErnst &Young LLP, UK.

How to Deal with Climate Change Regulation


The Media &Entertainment industry continuesto evolve at a pace unimaginable even fiveyears ago. Advances in technology haveenabled improvements in content delivery atunprecedented levels. Empowered by mobiletechnology and new home entertainmentdevices such as digital video recorders (DVRs),consumers are in charge. They insist onprogramming tailored to their individual tastes,preferences and schedules and they take theiraudio and video streams on the road andaround the world. We now live in an erawhere consumers expect consumption oftheir personalized content anywhere,anyhow and anytime.

Three years ago in an Ernst &Young survey ofGlobal Media and Entertainment company CEOs,75% of those surveyed believed that DVRs wouldhave the biggest impact on the industry. In asimilar Ernst &Young 2006 study of leadingfinance executives, over 80% of the participantsthought that personal entertainment andcommunication devices and changing contentand distribution models would have the biggestimpact on the industry over the next 2-3 years.

Technology is dramatically changing the playingfield for content production as well. It seemsthat anyone with a digital device and broadbandcapacity can produce his or her own contentovernight and distribute it to a global audiencevia the internet. This growth in user generatedcontent with internet distribution capability hasbroken down barriers to entry and changed thetraditional media production and distributionmodel overnight.

Aware of the issues that faced and damagedthe music business over the last 5-10 years,media and entertainment companies arefocused on maximizing the healthy marginsand cash flows from the mature businesses suchas newspapers and magazines and radio andtelevision broadcast, while being proactive inthe search for new internet and mobile deviceenabled distribution platforms for both theircontent and the related advertising. Within thisstrategic process reside a number of key tacticalissues whose execution can be as important asthe strategy itself. These include assessing thenature of the relationship and business modelwith the internet media company or mobiledevice business, be it merger, joint venture,or basic contractual distribution or licensearrangement. Digging deeper, a number of otherissues arise including assessing the new risksand appropriate controls surrounding these newrelationships, assessing the tax implicationsand ensuring that revenue is being received inaccordance with the arrangement as well asappropriate contractual payments made for therights of distribution.

� John Nendick is the Global Leaderof Ernst &Young’s Media &Entertainment Center.

John NendickErnst &Young

“Advances in technology have enabled improvements in contentdelivery at unprecedented levels. Consumers are now in charge,empowered by technology.”John Nendick, Ernst &Young

Responding to Shifts in Consumer Demand

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Following these top 10 threats to global business, there aresome risk issues with impacts that are – though perhapsless strategic than the top 10 – nonetheless crucial ina number of sectors. We review here the ‘next five,’any ofwhich could easily rise into the top 10 list in the future.

The War for Talent is already having a serious impact in some sectors, notably inoil & gas, which is facing a shortage of technical expertise; asset management andreal estate, which are seeing talented staff poached by alternative investments; and pharma,which is facing a ‘skills crunch.’ More broadly, analysts highlighted that as growth inemerging markets takes off, companies in developed markets would no longerbe able to draw on the “global pool of mobile, multi-lingual professionals possessingadvanced degrees from leading universities, a growing share of whom originate fromemerging markets.” In addition, one of the scientists we surveyed, a specialist in corporateinnovation at the Massachusetts Institute of Technology (MIT), noted that there is a“growing regional concentration/clustering of talent – while expertise can be found inmore nations than ever, within nations it is becoming more concentrated in a small numberof clusters. This phenomenon is particularly true in biotech and other high-tech areas.This leads to increasing wage rates, property rental, and competition for expertise.”

The possibility of a disease Pandemic is a strategic risk that our panelists rated as significant.The potential market, economic and operational impacts of an avian flu pandemic havebeen much discussed, and a major outbreak would have a dramatic impact in nearly everysector. There are also more subtle potential consequences including a dramatic shift inconsumer demand which could have large competitive impacts on the pharma andbiotech sectors.

• War for Talent

• Pandemic

• Private Equity’s Rise

• Inability to Innovate

• China Setback

The Next Five


The threat of Private Equity’s Rise has been a serious strategic threat in sectors such asauto, where “new, non-traditional investor groups such as Private Equity firms are leadingunplanned, hostile takeovers within the automobile industry consolidating, and forcingrestructuring and creating spin-offs.” In real estate ownership, there has also been “a shift frompublic to private as record amounts of capital continue to flow into real estate. Companies willneed to re-evaluate their global competitive positioning in light of the wave of recent M&Aactivity.” Several analysts also noted that Private Equity might crash just as quickly as it hasrisen – a risk alluded to in the second ‘on the radar’ risk, global financial shocks.

The threat of an Inability to Innovate is significant for business in 2008. In a numberof sectors, long-standing patterns of innovation are changing dramatically. In pharma,“the productivity of pharmaceutical companies continues to decrease as disease targetsbecome more difficult: big pharmaceutical companies are not discovering or launchingnew products. This will have the greatest impact as the patents for the top 10 sellingdrugs expire.” In asset management, “the best money managers are setting up boutiques…The giants cannot hope to compete with the boutiques, despite the risks.” Firms in thesesectors need to replace internal innovation with acquisition of innovation. Even in sectorswhere the impact is less extreme, innovation is becoming an increasingly crucial strategicchallenge as markets mature. An Ernst &Young consumer products panelist noted,“Most manufacturers’ largest markets are mature. Stagnation in mature markets meansthat companies have to innovate to find profit. However, innovation is a substantial riskas nine out of ten new products fail.”

The threat of a China Setback was the last of the ‘next five’ risks. Several analysts wepolled expressed concern that China might experience volatility as it continues with anextraordinary pace of development. A growth slowdown in China could leave oil & gascompanies suddenly facing a low oil price environment; a severe slowdown could add toturmoil to world markets or threaten banks or insurance companies with large Chinaexposures; or a natural disaster in China could disrupt global supply chains. Just as firmsworldwide must manage the risks arising from potential instability in the US dollar or USfinancial system (see risk two on the radar), China’s emergence as a major global playerdictates that China’s fortunes will soon become a focus of attention even in companieswithout direct China exposures.

Most manufacturers’largest markets are mature.Stagnation in mature marketsmeans that companies haveto innovate to find profit.However, innovation is asubstantial risk as nine outof ten new products fail.

“ In the near future, you will not be able to say you are global unless you area major presence in China, India and a few other countries, because theseemerging markets are going to be a major source of financial sector revenueand profit growth on a global basis.”Keith Pogson, Ernst &Young

Growth Continues

The annual Ernst &Young study ‘How do PrivateEquity Investors CreateValue?’ revealed howthe Private Equity (PE) industry is consistentlyable to grow and strengthen the companiesunder its ownership. By focusing on the businessperformance and strategies of PE firms acrossthe largest deals exited throughout 2006,the study confirmed that the annual rate ofgrowth in EnterpriseValue (EV) achieved last yearby the largest Private Equity-backed businessessignificantly outperformed equivalent publiccompanies in the same country, industry sectorand timeframe. Average annual EVgrowthrates were 33% in the US and 23% in Europe,compared to public company equivalents of 11%and 15% respectively, with over 80% growth intotal enterprise value.

Private Equity ownership creates value fromsustainable improvements in performance andbusiness growth. Two-thirds of the earningsgrowth in PE-owned companies comes frombusiness expansion, with increases in organicrevenue being the most significant element.This includes the benefits of investment insales and marketing, new product launches,acquisitions, investment into attractive industrysectors in the US, and expansion into newgeographies in Europe. Cost reduction,

including operational efficiencies, is also a veryimportant element of earnings growth in boththe US and Europe, accounting for 23% and31% respectively of the total growth in earnings

What are the Secrets of PrivateEquity’s Success?

The study showed that Private Equity investorsare highly selective and well researched whenmaking the decision to buy a business and havethe ability to drive real efficiencies through thebusiness plan under their ownership. This findingwas true across deals in the US and all mainEuropean countries. Three-quarters ofinvestments resulted from proactive dealorigination strategies, including company orsector tracking, building relationships withmanagement, or introductions from establishedcontacts. Across almost all deals and ownershipstrategies, Private Equity investors were activelyinvolved in the business after acquisition,making rapid decisions alongside management,challenging progress and making availablespecialist expertise. The intensity of engagementbetween Private Equity investors andmanagement was often stronger than underthe previous owners.

This rapid growth in the scale and success ofPrivate Equity has brought with it increasedscrutiny: politicians in many countries arereviewing whether and how to regulate and taxthe industry; corporates are considering howto compete with and learn from the differentbusiness model; concerns are being raised aboutthe security of jobs and employment benefits.Despite those concerns, the clear advantagesof the Private Equity model are likely to resultin continuing investment and growth.

The Credit Crunch – Implications forPrivate Equity

Recent developments in the credit marketsmay have caused concern. The liquidity crunchhas meant that the debt markets are more orless closed for new large LBO deals resultingin a significant slowdown in transactions.Market participants view this as a short termdip in activity prior to returning to a morerational climate in 2008.There is a long termbelief in the PEmodel by the market and thelong term fundamentals remain strong.The recent events may well prompt a moreconservative approach by banks, when doingdeals. This could result in an increasing needfor due diligence at acquisition.

Although the credit squeeze may reducethe benefits from leverage and enhance theimportance of underlying profit growth,Private Equity will continue to be an importantfactor in the world’s financial markets.

What are the implications of the continuedgrowth of Private Equity for corporates?Every company needs to develop a strategy forengaging with Private Equity, whether partneringwith, buying from, selling to or competingwith them.

� Simon Perry is the Global Head of PrivateEquity at Ernst &Young.

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Simon PerryErnst &Young

The Importance of Private Equity


Pharmaceutical companies are well accustomedto dealing with frightening diseases. Think of itthis way: the ability of pathogens to evolve rapidlyinto forms that can evade the adaptive defensesof the human immune system is, in a sense,a biological arms race. In any form of warfare,armsmanufacturers stand to make significantprofits. In the fight against infectious diseasesthat present a risk of epidemics, pharmaceuticalcompanies provide the front-line weapons forthe defense of humanity.

However, an influenza pandemic is different. It isdifferent because it will present overwhelmingoperational challenges that will cause manycompanies, including pharmaceuticalcompanies, to fail. Flu pandemics occur onaverage once every 30 years. The last one,the ‘Hong Kong flu’ of 1968, was relatively mild,killing ‘only’ one million people. The last severeinfluenza pandemic was the ‘Spanish flu’ of1918, which killed an estimated 40millionpeople. The most likely candidate for the nextpandemic is the current H5N1 strain of avianinfluenza, which is highly pathogenic to birds.This has spread rapidly (more than half thecountries in which it has appeared first reportedthe disease in 2006), and can infect humans,

in whom it is abnormally deadly, killing roughly60% of confirmed patients. The number ofhuman deaths that might occur if H5N1 becameeasily transmissible between humans isimpossible to estimate, but may far exceed the67million deaths caused by the Black Death.

A flu pandemic differs in three principle waysfrommost other forms of natural disaster.First of all, it is of extended duration, with two orthree successive waves of infection each lasting10-12 weeks, separated by several months.Secondly, it will disrupt all aspects of society,causing a breakdown of most normal servicesand, most likely, widespread civil unrest(e.g., looting). Thirdly, because of its globalnature, there will be no ‘outsiders’ to come tothe rescue and thus recovery by the survivorswill be slow. The potential economic cost of theglobal recession such a pandemic would triggeris put in trillions of dollars.

Individual companies need to consider thepotential impact of a global pandemic on theirworkforce, infrastructure, supply chains andoperational capabilities. How will you continueto function when key staff are ill or dead,absenteeism is at 50%, normal travel andtrade have been severely curtailed, and thereare national shortages of food and energy?The decision to make adequate preparation fora flu pandemic must come from the highestlevels of management and involve everydepartment – this can make the differencebetween the survival or the collapse ofcompanies. Pharmaceutical companies must

develop contingency plans detailing what todo in preparation now, how to cope during thepandemic, and how to survive afterwards duringthe long recovery process, where the well-prepared will have large commercial advantages.Critical functions must be defined, and plansmade for backup, cross-training and workingfrom home, using decentralized IT. Essentialsupplies including emergency generators,fuel and rawmaterials may need to be stockpiledif work is to continue. Provision must be madefor illness and deaths on the work premises,and for the care and quarantine of thoseaffected. Clear criteria are required concerningwho will trigger the emergency plan and underwhat circumstances, and any plan must betested in reality and refined iteratively.

� David Shotton is Reader in ImageBioinformatics within the Department ofZoology, Mathematical, Physical and LifeSciences Division, University of Oxford.

Will the Pandemic Make You or Break You?

“ Individual companies need to consider the potential impactof a global pandemic on their workforce, infrastructure,supply chains and operational capabilities.”Dr. David Shotton, University of Oxford

Dr. David ShottonUniversity of Oxford

25

Three of China’s banks are already included inthe global top 10 banks by market capitalization.Chinese banks bring a new and decisivecompetitive advantage as they have a verydifferent cost base. They have lots of cash,and with a 40% savings rate in China,that liquidity isn’t going away. These banks arealso able to borrow at 1 to 2% so they can easilylend at 3 to 4% andmake a coupleof hundred basis points.

These banks could be concerned about lossesfrom a revaluation of the renminbi (officalcurrency of the Republic of China), but thesebanks are extremely motivated to go global.Eighty to 90% of their exposure is to the Chineseeconomy, so almost anything outside of Chinacreates diversification and reduces their risk.This makes major global expansion, includingacquisitions likely to happen, which will havea major impact on global markets withinthree years.

The Risks for Global Banks EnteringAsia

If foreign banks enter the Asian market toolate, they will be unable to keep up with thecompetition. In the near future, banks will notbe able to say they are global unless they havea presence in China, India and a few othercountries, because these emerging markets aregoing to be a major source of financial sectorrevenue and profit growth on a global basis.

The secondmajor risk is the failure to manageinternal controls. This is especially true for aEuropean or American bank, that may havelimited knowledge of the fast-paced growthin distant markets. The question for manyis what to do first, implement their controlinfrastructure or grow revenues? Foreign bankscan find themselves in a situation where theyare suddenly managing 50,000 people insteadof 50 people. This stresses existing controlsand can lead to serious mistakes withglobal consequences.

The third risk for foreign banks is regulation.Regulators in Asia have varying degrees ofsophistication and regulatory responses canbe local or political, which can be difficultto address. Reputation is critical to market entryand a bad reputation could result in a foreignbank being barred from amarket.

TheTop Risks forAsian Banks

Themain threat for Asian banks is that theyare transforming very rapidly from governmentbureaucracies into corporate governance andtransparency-driven organizations.

This could lead to significant challenges,some of which could threaten their survival.For example, Chinese banks have enviablecost-income ratios of 35%. But these ratios oftenrely on cheap, manual labor. As China developsand labor costs rise, banks will need to automateto keep costs down. Some of these banks have10,000 or more branches. If a system isautomated incorrectly, this ‘cost saving’ mightcause profitability to collapse.

Another major issue is deregulation. Someof these banks will make the transition to aderegulated, more competitive environment,and some will not. In China, the central bankmaintains a 300 basis point borrowing-to-lendingspread. When this situation changes, and thesebanks suddenly need to manage interest raterisks, not all of them will be able to managethese effectively.

� Keith Pogson is a Senior Member ofthe Hong Kong Financial ServicesTeamat Ernst &Young.

Keith PogsonErnst &Young

Explosive Expansion in Asian Banking


This has not been a random selection exercise but, rather,a structured consultation with both sector and subject-matterexperts from around the world. They have identified trendsand uncertainties, and assessed risks and their impactboth on individuals and on the markets the conclusionsmerit attention.

Together, we have identified the top 10 risks for business for the coming year and haveoutlined our view of other major risks that lie just “below the radar.” These are notpredictions, but considering them can help companies to prepare.

We acknowledge that this is just a snapshot of the risks that we see at this time. Change isconstant in the market so risks will change over time; so do our perceptions. If we had donethis exercise 10 years ago, it is fair to question whether climate change would have featuredso significantly. The climate was already changing, but our awareness of the fact and ourperception of its importance was much different.

Yet, even as a snapshot and even recognizing the consistency of change, no company shouldtreat this list as applying in totality to them. Just as the global market is everywhere andyet, paradoxically, nowhere – each point of contact, each purchase or sale, is both specificand local. So it is with strategic business risk. We have done the analysis and mapped outour conclusions accurately for the macro-economy.Yet, for every sector, and indeed,for each company within a sector, the strategic business risks will vary.

This was the hypothesis for our research and why we have based the work on the 12 sectors.Our studies show tremendous variation in risk and the relative importance of each factordepending on sector.

Today’s Strategic Risk could beTomorrow’s Strategic OpportunitySo what is the value of such analysis and what, most importantly, should managementdo with it? We hope that our work illustrates the range of strategic business risks thatcompanies need to be aware of. We have consulted widely, but this is not an exhaustivestudy and there can be no exhaustive list of risks. We hope some of the risks we haveidentified surprised you and some of the weightings that we have attached to them in therankings differ from those that you would apply. This is an ongoing dialog and one webelieve that you need to have within your organizations.You may have in place your ownequivalent of a strategic business ‘risk radar’, but how is this kept current, and does itadequately warn you of potential strategic risks in an appropriate manner?

Conclusion

Properly approached,the process of riskmanagement can addvalue even if, fortunately, theevent never happens.

27

Properly approached, the process of risk management can add value even if, fortunately,the event never happens. One client we worked with was concerned about the impact ofavian flu on their business. In working through scenarios and impact analysis, the clientidentified numerous opportunities to tighten processes and controls that have had abeneficial impact despite the non-occurrence of the pandemic that they feared. It wasthe dialog and management action that delivered the value, not an improved response tothe event.

Our work with companies around the world suggests that there is a body of leading riskmanagement practice emerging, but that many companies are still doing too little in thisarea. In our recent study, Companies on Risk: The Benefits of Alignment, 42% of globalcompanies identified gaps in their risk coverage. Our subsequent study found that,overwhelmingly, these gaps were in business and operational areas, rather than financial.There is a growing recognition of the problem – indeed 66% of companies in the samestudy forecast that their investment in risk management was going to increase over the nextthree years.

Company leadership must:

• Conduct an annual risk assessment that defines key risks and weights probability andimpact on business drivers. Many companies undertake some form of risk assessment,but our experience suggests that too many do not do this on a frequent enough basis.Our research suggests that one in five do not perform a risk assessment and over one-third conduct a risk assessment less than once a year.

• Such a risk assessment needs to go beyond financial and regulatory risk to considerthe wider environment in which your organization operates and the full extent of itsoperations. Less than 50% of respondents to our survey, Compliance to Competitive Edge:New Thinking on Internal Controls, believed that they had effective controls for M&A,IT implementation, business continuity planning, real estate construction, transactionintegration and expanding into new international markets.

• Conduct scenario planning for the major risks that you identify and develop a numberof operational responses – this can be a useful part of the planning cycle and helpencourage innovative thinking.

• Evaluate your organization’s ability to manage the risk that you identify – in particularensure that your risk management processes are linked to the risks that your businessactually faces. The responsibility for risk must sit with the business. Do you have a‘risk radar’? Is it current, and how will it warn you of potential risks?

• Effective monitoring and controls processes can give you both earlier warning andimproved ability to respond. There can be value from much of the compliance activitydemanded from regulators, but this has to be mined.

• Keep an open mind about where risks can come from. Ours is an increasinglyinterdependent global economy and risks that can damage your business can initiate inmarkets and sectors a long way from your own. High risk mortgage lending in the US topeople with limited or no creditworthiness ends up hurting the pension funds of the mostcautious saver.

Test your corporatecompetency in identifying,assessing, managing andmonitoring strategic risk.Turn today’s strategicrisk into tomorrow’sstrategic opportunity.


RiskAdvisors Name: Telephone: E-mail:

Global Jim Holstein +1 216 583 4001 [email protected]

Americas Frank Gori +1 216 583 2981 [email protected]

Central Europe Gerd Stuerz +49 211 9352 18622 [email protected]

Continental Western Europe Maxime Petiet +33 1 55 61 3147 [email protected]

Northern Europe, Middle East, India &Africa Alan McGuinness +44 207 951 4119 [email protected]

Singapore Michael Sim +65 6309 6706 [email protected]

Japan Takaaki Nimura +81 3 3503 1272 [email protected]

Oceania Craig M. Jackson +61 2 8295 6551 [email protected]

Business Risk Services Inge Boets +32 3 270 1223 [email protected]

Financial Services Risk Management Lawrence Prybylski +1 212 773 2823 [email protected]

Tax Accounting and Risk Advisory Services Joseph Hogan +41 58 286 3184 [email protected]

Technology and Security Risk Services Paul van Kessel +31 20 549 7271 [email protected]

Fraud Investigation and Dispute Services David Stulb +1 212 773 8515 [email protected]

Actuarial Services Tim Roff +44 207 951 2112 [email protected]

Sector Leaders Name: Telephone: E-mail:

Automotive Mike Hanley +1 313 628 8260 [email protected]

Asset Management Ratan Engineer +44 207 951 2322 [email protected]

Banking &Capital Markets Jim Fanning +1 212 773 3144 [email protected]

Biotechnology Glen Giovannetti +1 617 859 6598 [email protected]

Consumer Products Howard Martin +44 207 951 4072 [email protected]

Insurance Peter Porrino +1 212 773 8468 [email protected]

Media & Entertainment John Nendick +1 213 977 3188 [email protected]

Oil & Gas Rob Jessen +1 713 750 4952 [email protected]

Pharmaceutical Carolyn Buck-Luce +1 212 773 6450 [email protected]

Real Estate Dale Anne Reiss +1 212 773 4500 [email protected]

Telecommunications Vincent De La Bachelerie +33 1 46 93 6205 [email protected]

Utilities Ben van Gils +31 10 406 8555 [email protected]

Contacts

© 2007 EYGM Limited. All Rights Reserved.

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the top 10 risks for business

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