The top 10 risks for business phần 2 ppsx

If imposed in the United States, price controls could transform the global pharma market, including business models and the development of new drugs in the future.” The compliance challe

One analyst noted, “The revenue generated from the US pharma

market, the largest in the world, enables pharma companies to

remain profitable [despite] strict price controls in other major

markets and the inability of [customers] in developing markets to

pay full prices for their products If imposed in the United States,

price controls could transform the global pharma market, including

business models and the development of new drugs in the future.”

The compliance challenges are particularly strong in highly

regulated industries such as banking, insurance, pharma, and

biotech, where the regulatory burden is increasing fast, and where

firms are feeling pressure to demonstrate a return on investment

for long-term risk management initiatives One banking panelist

noted, “Banks are experiencing significant fatigue around

managing the myriad of often redundant compliance and

regulatory reporting activities, the cost of which is massive and

burdensome.” Similarly, a biotech analyst wrote, “A mounting

regulatory compliance burden in areas such as privacy,

post-marketing monitoring of drug safety and sales force compliance…

poses a management and internal controls challenge to biotech

companies.” Increasingly, companies may seek risk convergence

initiatives which allow them to coordinate the various risk and

control processes, reduce redundancy, which drives down costs,

and, perhaps most importantly, more comprehensive

enterprise-wide risk reporting to senior management and the board

As companies become more and more global, compliance becomes

a greater challenge, forcing them to manage diverse regulations

in different markets A specialist in business strategy noted,

“Managing regulations in 10 jurisdictions is one thing What

happens when a firm has significant markets in 30-40 countries at

varying levels of development and with very different regulatory

traditions? This is not to say that global regulatory [diversity] is

necessarily increasing; 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 those companies expanding their global reach

“The failure of one or more major financial institutions

remains a real worry and could turn the crisis into

systemic failure in the year ahead.”

Jens Tholstrup, Oxford Analytica

Our analysts acknowledged that few sectors would escape the impact of major global financial shocks Biotech and utilities firms, for example, would have trouble raising capital; banking, asset management, and insurance companies would be likely to suffer direct losses from market movements; and after making high-cost exploration investments — oil and gas companies might suddenly find themselves facing low prices if the global economy moves into sudden recession

Since our research began in April 2007, the August credit crunch, forced by the US sub-prime mortgage crisis has provided

a real-life demonstration of how highly contagious such shocks can be across sectors — and indeed — globally Rory MacLeod, the former Head of Global Fixed Income at Baring Asset Management, somewhat predicted 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 be unexpected pockets of vulnerability

Disintermediation has replaced international banking as a finance source with a range of specialized credit instruments held widely, with risk exposures that regulators find it difficult to assess

A credit shock could lead to a temporary closing of the market for new credits, while traditional lenders such as banks have moved away from the area.”

A crisis could spread from alternative investment vehicles such

as hedge funds or private equity One analyst wrote, “Financial innovation and structural changes have contributed to the success

of private equity, but cyclical factors have also played an important part in their over-expansion… High-profile failures of some investee companies could lead to a loss of confidence among investors and lenders.” Another remarked, “A crisis in CDO/structured finance markets could lead to potential systemic problems Sustainability

of 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 strategies are exposed to a change in the macroeconomic environment There are potential systemic issues in the financial sector.” In the future, continued financial innovation — which tends

to disperse risks and, as a consequence, makes the detection of potential shocks more difficult — is likely to increase the potential for financial shocks

2 Global financial shocks

Continued from page 8

Jens Tholstrup

Oxford Analytica

The credit crunch and its implications for the availability of capital

For the time being the world’s major

central banks have eased the credit

crunch that manifested itself in the

beginning of August, but the risks to

the financial system remain very real

The origin of this financial crisis has been

well documented: the inability of large

numbers of less creditworthy borrowers

in the United States to service the debt

on their home mortgages What has

made this development so contagious are

certain innovations in the global financial

system The securitization of financial

risks has resulted in a wide disbursement

of such risk throughout the financial

system In theory the dispersion of risk

should reduce the risks of systemic failure

but, in fact, the very opposite has been

the case

The negative effects of disbursement are

exacerbated by lack of transparency

In theory, all financial assets have been,

or are capable of being securitized and

traded However, at the present moment,

no regulator or market participant can be

totally clear where the risks lie The use

of off-balance sheet vehicles to hold

sub-prime and other risk assets, has

further reduced transparency

A related issue that has made the sub-prime crisis more contagious is the use of pooling of financial assets

Any investment vehicle which has some exposure to sub-prime mortgages will be regarded as contaminated

In this market environment, financial institutions become very wary of lending

to other financial market players since they will be concerned that others will be holding impaired assets Credit for all but the largest and most secure borrowers will seize up This is precisely what has happened in recent events, where central banks have had to 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, the market for many securitized assets has dried up leaving the holder unable to sell the assets

The commercial paper market for asset-backed securities has all but dried

up with the consequence that borrowers financing such assets will need to draw

on standby lines of credit provided

by banks

Contingent risks become real risks, underwriting positions become stuck and credit becomes severely restricted The failure of one or more major financial institutions remains a real worry and could turn the crisis into systemic failure

in the year ahead The central banks and regulators have already shown their disposition to take the steps which they feel are necessary to maintain the stability of the financial system and in

The implications are:

Even in the event of central bank rate

• cutting, the cost and availability of credit for most borrowers will be negatively impacted for the year ahead Banks will be forced to ration their lending and lower-rated borrowers will find access to capital difficult and expensive

The capital markets may well provide

• better fund-raising opportunities especially if investors believe that the anticipated rate rises will be reversed However, access is likely to be restricted to better credits for some time at least

The funding of off-balance sheet assets

• and other structured finance products will become severely restricted

• Jens Tholstrup is an Executive Director and Director of Consulting

at Oxford Analytica

Prior to joining Oxford Analytica in

2000, Jens had an extensive career

in investment banking

An increasing strategic risk for the majority of industries is the

threat posed by workforce and consumer aging Sectors such as

asset management and insurance are experiencing dramatic shifts

in demand and competitive battles are being fought for savings

products that will appeal to the growing group of older consumers

Other firms, for example, those in the auto sector, are facing

severe competitive 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 most

affected by these shifts include pharma, biotech, consumer

products, insurance, and asset management companies, which

could lose their competitive edge if they cannot effectively respond

to these new opportunities One insurance panelist noted, “People

reaching retirement age have very different financial needs.” As a

result, a struggle is now emerging between insurance and asset

management firms to deliver the innovative products that will

meet these needs, such as income maintenance and health care

spending To be competitive, companies will need to gain an

understanding of the specific needs of these new consumers, and

many will need to have an aggressive approach to key competitors

that may increasingly come from outside their sector

The other strategic challenge posed by an aging population is

workforce aging, a risk issue that figures highly in oil and gas and is

perceived to be a ‘next five risk’ for sectors such as banking These

sectors are already experiencing a significant human resource

challenge Perhaps the most extensive example of this threat can

be seen in the US auto industry, which is particularly weighed down

by pensions and health care costs “There remains a possibility of

insolvency in the US auto industry, and a long line of dependent

component companies have yet to construct a path to safety.”

The findings of our survey Risk Management in Emerging Markets

2007 reveal that, while many companies have been in these

markets for some time, emerging markets remain dynamic for developed market (DM) companies Over 60% of DM companies have been in these countries for less than 10 years, and almost 20% less than two years In most cases, global firms are competing with other global players for opportunities in these markets, although in several sectors, emerging markets firms are themselves entering the global stage

Often companies are being driven to these markets by the saturation of existing markets An analyst in consumer products commented, “Over the next few years nearly all of the increase

in world population will take place in the developing countries

In the meantime, other established markets will reach maturity.” Similarly, in real estate, “Intense competition for a limited pool of desirable assets, combined with yield compression in most global markets, has resulted in real estate funds needing to broaden their geographic search for opportunities This has created an increased number of competitive variables in real estate markets.”

For other sectors, such as biotech and consumer products, emerging markets offer supply chain advantages One biotech analyst remarked, “The sources of biomedical innovation will become more diverse in a globalized marketplace The implication

is that while, in the past, the main source of competitive advantage for firms throughout the industry has been technology, in the future the supply chain will be important as well Global companies will need to partner/form networks with firms in many markets.”

In many sectors, the value chain will increasingly extend well beyond the developed markets and the BRICs, and the volume

of business conducted in these markets will be significant

On the downside, global expansion into foreign and/or emerging markets has always carried with it traditional threats such as: currency, operational, regulatory, language, and cultural risk Increasingly, a significant challenge lies in firms effectively managing 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 control standards and compliance testing when sourcing from relatively unknown suppliers in emerging economies

“Only 41% of developed market companies have a risk

strategy for emerging markets, with more than half

(56%) saying that no strategy is in place.”

Ernst & Young, Risk Management in Emerging Markets study, October 2007

Chris Raham

Ernst & Young

Winning the battle for the savings market

Changing financial needs

The baby boomer generation is retiring

just as employers and governments are

progressively disengaging from pension

provision As a result, the financial needs

of individuals are changing dramatically

The central financial challenge for these

retiring baby boomers is how to transform

the wealth they have accumulated in their

pension accounts into a steady income

stream To a large extent this is a decision

that they will have to face alone

The vast majority of baby boomers have

only three assets: house, occupational

plans and social security With the

exception of the high net-worth segment,

the value of additional savings is minimal

These trends will transform the

savings-products industry, which so far, has been

accumulation-oriented The business

challenge over next 15-20 years will be to

create products for the pay-out phase

The strategic risk for insurers is their

inability to adjust, develop products for

new needs, and compete against other

sectors of the financial services industry

How can insurers capitalize on

new opportunities?

Occupational pension/cash-balance

•

plans, and individuals in the mass

market offer the most significant

opportunities Successful ventures here

will benefit the largest segment of the

population — those without sufficient

competitors are offering well-planned, valuable services to these segments, although most major financial institutions are circling the opportunity

In the defined contribution market,

• insurers should offer employers products that combine the accumulation and payout phase These products transfer most of the risk from the individual to the insurance company

Combining the two phases can represent a competitive advantage

At present, the asset management industry has the capability to offer only investment products

To sell against investment-only

• solutions, insurers must have the ability

to provide key constituents with clear information about product benefits and competitive advantages from the employee’s perspective Such assessments will help employers and their benefit consultants understand the value of the product Insurers may also support the plan sponsor by providing financial advice to employees

In the retail market, insurers must take

• steps to leverage their ability to write contracts that will provide more dollars

of lifetime income per dollar of investment A retirement program that combines decisions around the timing

of social security elections, the use of home equity, and the disposition of cash balance plans into an easy-to-use, cost-efficient menu approach will be effective in the mass market

Barriers to success — the threat

of competition

To be successful, insurers must change their approach to the competition and take

a broader view of the market For years,

share of the US savings market Their true competition is represented by other providers of savings products, in particular, mutual fund entities Insurers must become as aggressive as other institutions competing for the same dollar

As the only writers of payout annuity products, insurers should be well positioned to take advantage of the shift from accumulation to payout However, they face three significant obstacles Most of the retirement wallet is now

•

in the hands of other asset managers, who are in a strong position to retain customers

Even though pay-out annuities

• provide the most income for a given investment, individuals dislike the idea

of suddenly transferring all of their assets to the insurance company They feel that they are losing control over the wealth and they would prefer to keep the money with the insurance industry’s competitors

Some sales practices related to

• deferred annuities, have created negative sentiments that have been actively expressed in popular media and by regulators

Twenty five years ago, insurance companies were strongly positioned against asset managers to dominate the savings industry Mutual funds were vulnerable and their market share was relatively small However, insurers were complacent and lost the battle for individual retirement assets The demographic shift

is creating new demands that insurers are well-placed to satisfy It would be a shame for insurers to repeat the same mistake and squander their opportunity to recapture lost territory

Farokh T Balsara

Ernst & Young

From emerging markets to surging markets — The future of global media growth

Emerging markets are attracting

significant attention because of a surge in

demand for content With China and India

accounting for one-third of humanity,

these markets are the future for global

media growth Currently, some of the

largest global media and entertainment

companies are making less than 5%

of their global sales from emerging

markets, but the management within

these companies are spending a

disproportionate amount of their time

dealing with these markets

It is partly a lack of both content and a

handle on distribution in Europe and

North America that is preventing

emerging market companies from

moving into developed markets More

significantly, however, the growth in their

home markets is so fast that they don’t

have the bandwidth to think about it

Another important growth factor in these

markets is technology Broadband

connectivity in South Korea is 98%,

enabling the push-through of huge

amounts of content In India, a global

multinational company has recently

conducted the world’s biggest rollout of

digital cinema through satellite This

means that these companies can control

exactly where movies are showing and

how many times they are shown It also

means they can control piracy And it

allows them to release not just in 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 the global industry, emerging markets are the fastest adopters of technology They provide an ideal test-bed where global firms can trial new technologies, before bringing them out in their home markets

Winning in emerging markets

To win in these markets, companies need

to localize content and be sensitive to local culture, rather than automatically dubbing and repurposing It is possible to sell from media libraries, but this will not make you a winner in these markets One major global media player had been in India for seven or eight years, with a mostly English offering In 2000, they invested in 24-hour Hindi programming with local productions and quickly became the largest and most profitable channel Firms that don’t localize their content can also run higher risks One foreign broadcaster that was in the Indian market showed too much adult-oriented content in its programming before 11pm and the government took the channel off the air

However, growth in demand for local content by these global players and by local companies funded by private equity firms could soon outpace the growth in supply of local production talent This could lead to super-inflation which should

be factored into business plans

It is important to understand that even

a single emerging market country has multiple markets within Southern India

is completely different from the North

To win in a national market, investors may need a very different strategy in each region There will be differences in where the demand is, the type of content, the distribution of content, and how to take out earned revenues

The price points in emerging markets are also often a fraction of what consumers would be charged for similar content

in developed markets, often due to regulations, competition or extensive piracy However, the huge and fast growing volumes more than make up for the low charges As a result, a thorough assessment of the market and

distribution channels is needed to 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, local entrepreneurs have an big

advantage, and right now, a lot of local media companies are beating the global players in China and India Multinationals will need to have flexible business plans which do not always need to be approved

by the regional office and the head office

• Farokh T Balsara is the National Sector Leader for Media and Entertainment and the Markets Leader for Advisory Services at Ernst & Young, India

“ 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 global players

in China and India.”

Farokh T Balsara, Ernst & Young

Part of the consolidation phenomenon has been driven by the

global M&A boom, which several analysts believe may slow in years

ahead However the majority of sector analysts we polled believed

that industry transition would continue to pose a key strategic

challenge in 2008

This continued transition will be driven, in most sectors, by

underlying structural trends One analyst, commenting on the

auto sector noted, “Population growth and GDP growth are

highest outside of the US, EU, and Japan, resulting in a global

misalignment in the location of industry capacity and the location

of demand The industry, especially in the US market, is in

transition including consolidation, restructurings and spin-offs.”

Another analyst highlighted that, in asset management, transition

entails the migration of the industry’s leading firms towards one

of two opposing business models, “On the one hand, massive asset

gathering [companies] that drive down costs and provide cheap

access to markets and market risk and, on the other, those companies

that… (as a business proposition) offer better-than-market

returns.” In the media and entertainment sector, M&A is a central

feature of many companies’ attempts to respond to the internet’s

impact on the sector, for example, via the acquisition of ‘new

media’ firms

Companies in other sectors may continue to merge, driven by

competitive pressure In banking, “Many of the deals are of sizes

never-before experienced The trend to become bigger and more

dominant by acquiring existing franchises is an ongoing driver for

growth.” And in telecoms, “Accelerated M&A trends in the telecoms

industry will lead a transition to three to four players per country.”

In utilities, one analyst commented, “Size is vital when negotiating

with the owners of major primary resources; size is vital as some

protection against hostile acquisition Hence, the impact of failing

to grow can be a loss of competitive supplies or even loss of the

business.” There is a growth imperative in many sectors, and if it

cannot be met by organic growth, then it may need to be met

by acquisitions

Fluctuations in energy prices and access to supplies pose a clear challenge to the energy sector, including utilities and oil and gas

In utilities, for example, loss of access to competitively priced long-term fuel supplies is the top strategic risk One analyst noted,

“The impact on the business is the need to acquire short-term supplies to meet demand obligations and can lead to a huge loss of 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 could also trigger economic shocks that could impact sectors such as insurance, consumer products and real estate Few leading global companies are immune to this risk One telecoms analyst remarked, “As more and more equipment is racked up in data centers, more and more power is needed to run and cool down the servers that are at the heart of the web infrastructure.” Even the virtual world needs ‘real’ world energy

Various potential causes of such energy shocks were noted, including a US strike on Iran, a breakdown in relations with Russia, contests for control of ‘strategic’ energy supplies, or an action to disrupt shipping through one of several key maritime choke points The risks of a shock are also dramatically heightened in today’s environment of increasing energy nationalism One analyst noted that on the supply side, “The development of the world’s oil and gas supplies over the past 40 years, with concomitant advances

in extractive technologies, has been undertaken largely by private sector enterprises Now, however, the global supply of prime energy fuels has become dependent on a few national, state-owned suppliers.” In the future, the risks associated with the continued and sustained supply of such fuels to 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 needs to be pursued actively The reality may be quite different, but the perception could trigger a crisis [caused by] desperate efforts that countries may make to secure their supplies (paying above market rates, long-term deals, etc.) If markets then panic, this would cause governments to respond with even more uncoordinated, unilateral steps, making the situation infinitely worse.”

Tony Ward

Ernst & Young

A loss of access to fuel supplies — mitigating the risk

Whilst global primary energy prices

remain volatile, power utilities remain

generally high-volume, lower-margin

operations The primary risk for utilities

is to balance relatively short-term

customer contracts with the longer-term

nature of fuel supply and, in doing so,

deliver access to economically attractive,

secure and reliable contracts, whether

for their primary fuel needs, or eventual

customer off-take In part, this is a matter

of trading strategy, procurement and

hedging, but the choice of technology to

convert fuel to power, is also a key issue

Decisions made today to embed fuel

needs, emissions profiles and cost drivers

may have long-term implications These

assets can have economic lives of up to

50 years, and investment lead times of

over five years, as is the case with some

coal and all nuclear assets

The interaction of these two short and

long-term pressures is mirrored in the

convergence of the respective interests

of the private sector utilities and national

governments — the former managing

their discrete businesses for profitable

growth on behalf of their shareholders,

and in competition with others, and the

latter focusing on the aggregated

concerns of diversity and supply-security

of fuels, minimal environmental impact

and overall national economic

competitiveness

Managing the risks for contracts and fuel supplies

Securing access to fuels and supply contracts for a utility carries with it substantial risks and uncertainties This is true both in mature markets with an aging infrastructure and greater competitive pressures, and in developing countries that may struggle to match generation capacity to rapidly growing demand

In committing to asset construction programs, companies face significant regulatory, market, financial, and public relations risks Access to adequate amounts of capital at reasonable rates may also be a factor as the industry enters

a period of escalating infrastructure investment The effective management of the risks associated with pursuing organic growth will enable utilities to deliver predictable value to shareholders

Being flexible is the key to success for both governments and companies At a national level, certain countries are responding by moving towards greater self-reliance, focusing on making use of local resources and markets, and looking for diversity of fuel technology and fuel type Companies are building up their portfolio of relationships and supply sources with crossholdings and minority interests in assets Key strategies to reduce the risk of supply shortages include scale, collaboration, supply chain shortening, infrastructure investments, 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 larger entities which automatically create larger off-takes for suppliers Scale mitigates risk through

spreading the portfolio of contract timescales, geographies, and fuel types, reducing reliance on vulnerable areas Joint operations, asset swaps and other alliances may provide an alternative to

a single company striving for scale Collective weight can help in negotiations and the mitigation of risk

Shorter supply chains can also help

to reduce the risk arising from intermediaries This is especially true from a security of supply perspective, but can also limit overall losses The use of local resources, an approach increasingly taken by companies, can also reduce the supply chain

Infrastructure and technology investment

Infrastructure investments are needed to reduce supply shortages, especially in developing economies, and also to restore aging assets elsewhere Investors are aware of the degree to which national politics can destroy their contractual positions Given the long-term nature of these investments, investors require a clear understanding of the political environment and the risks A national framework on security of supply is crucial

in order to achieve investors’ confidence New technologies will change the market The successful utilities of the future will be those who make the bold decisions to flex their assets, supply chains, and operating models Governments, and corporates, should consider a diversified fuel mix as an important means of mitigating the risk of loss of access to competitively priced long-term fuel supplies

• Tony Ward is a Director within the Transaction Advisory Services Team

at Ernst & Young

“ New technologies will change the market The successful

utilities of the future will be those who make the bold

decisions to flex their assets, supply chains, and

operating models.”

Tony Ward, Ernst & Young

Strategic risks often result from an attempt to take advantage of

major opportunities Nowhere is this more evident than in the area

of transactions Too often a move that seeks to quickly and

significantly respond to an opportunity, becomes an expensive

and long-term risk in its own right

There is a major risk that transactions undertaken in response

to industry consolidation may fail to deliver, not because they are

poorly conceived, but because of a failure to meet operational

challenges This was perceived as a high risk by analysts in a

number of sectors including auto, asset management, media and

telecoms A banking panelist wrote, “Stakeholders expect M&A

to very quickly have a positive effect on the bottom line and

create synergies between the acquirer and the target Required

integration may challenge the people, process, and technology

of the combined entity Stakeholder expectations may not be met

or the deal may ultimately need to be unwound.”

New types of strategic transactions, including divestitures in real

estate, spin-offs in auto, and separation of telecom companies into

utilities and service providers are driving further risk While it is

the big mergers that dominate the headlines, in some sectors,

excellent execution of small and highly strategic transactions may

have as great a competitive impact Consumer products companies

are, for example, using transactions more strategically to acquire

innovation Similarly, in asset management, firms are employing

M&A in the hope of “acquiring… talent that cannot be home-grown.”

We have been operating in a low inflation global economy for some time Our analysts believe that the return of high inflation is a major risk Cost inflation, though the result of various drivers, is a significant operational threat for all sectors In oil and gas, for example, the problem extends from exploration all the way through the value chain, impacting everything from refinery build costs

to pipeline construction costs One sector analyst commented,

“The impact on oil and gas companies is increased pressure on operating margins, higher risk investment profile, increased asset portfolio 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 the fundamental structure of an industry Demographic changes and the rising costs of health care are creating a serious challenge for

US auto manufacturers One analyst noted, “American automobile companies labor under the weight of health care costs eroding their international competitiveness.” Another predicted, “The aging workforce at established Western producers leads to costly buy-outs, benefits, and so on There will be an ongoing decline in employment in the sector in the Western World, with large impacts for affected economies.”

In biotech, cost inflation is driven by regulation, as well as the increasing focus on drugs targeting chronic diseases, which means that “clinical trials are increasingly expensive, and higher costs to develop drugs put pressure on raising capital and drug pricing.”

In consumer products, by contrast, the structural shifts that make cost control 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 control over pricing through strong buying power and hard discounters” and, on the other, “volatility of raw materials prices,” making management of input prices a crucial challenge In other industries, radically changing business models are making cost a centerpiece of competitive strategy One notable example is asset management, where the best performing companies are often those that control costs through overall scale, or product specialization

7 Execution of strategic transactions 8 Cost inflation

We use the term radical greening to apply to the increasing

environmental concerns which could be the result of a wide range

of pressures — from the voluntary world of corporate social

responsibility — to hard regulatory and economic necessity

Radical greening is a strategic risk, partly driven by the consumer

and regulatory responses to climate change, and also by the

weather events resulting from climate change A specialist in

science and international affairs wrote, “Current climate

predictions are based on models and, naturally, the scenarios

communicated to the policy world are the scientifically conservative

scenarios (i.e., those which most scientists agree are likely) Yet

scientifically conservative scenarios are not necessarily what will

happen; it is possible that the hazard is actually more imminent

than is commonly understood In this case, we may see physical

climate surprises as well as an increased policy response that is

more abrupt than most firms are currently planning for.”

In the short term, barring such unexpected developments, the

strategic challenge centers on how much ‘radical greening’ firms

should undertake Going green is expensive, but could pay dividends

if consumer tastes and regulation shift quickly For example, in real

estate ownership, some analysts favored firms with ‘green’

portfolios One analyst noted, “As ‘green’ becomes law it could

result in forced obsolescence and write-downs for non-green real

estate assets along with substantial capital expenditure obligations

to meet the new standards.” In a similar vein, in utilities, “Carbon

trading is a reality in Europe and will almost certainly happen in the

US The caps that are set directly influence the cost of generation

with different fuels and hence can make a nonsense of the wrong

fuel generation mix strategy Fixed ages for renewable generation

are also likely to come The imposition of fixed percentages of

renewable power can expose severe strategic errors of

corporate judgment.”

The pace and extent of this new ‘green revolution’ is hard to predict

— but what is almost certain is that some firms will get the right

fuel mix, real estate portfolio, or carbon footprint, while others will

go either too radically green or, more likely, not green enough

Our final strategic risk for business in 2008 is the failure to anticipate and respond to consumer demand shifts There are a number of examples of such shifts, perhaps the most obvious being the demand for ‘green’ products or services Other trends have already been mentioned, including those driven by demographic shifts, such as growing consumer aging

It is the task of business to identify and respond to changes in demand Such a challenge moves to be a strategic risk when the changes are significant, fast or unexpected A general theme across the sectors was the challenge posed by consumer empowerment making this an area of strategic risk In media and entertainment, for example, one Ernst & Young panelist highlighted that, “Consumers today have more power than they did 10 years ago Consumers are controlling the decisions about the content they receive and how they receive it Consumers today are driving the content and distribution channels.” In auto, “Increased interest

in customization of products requires a shift away from mass-production philosophies.” Or, as another consumer products panelist noted, “Factors such as the web, deregulation of markets and globalization will continue to lead to a rise in customer expectations and basic customer segmentation strategies are already becoming less and less effective, as customers look for individualized and customized purchase experiences.”

As technology continues to expand consumer power, this challenge may well rise higher on the radar in the years ahead

“ This issue of climate change extends beyond just

managing regulatory risk Climate change and the

regulatory and consumer response must be seen as a

fundamental strategic challenge We can expect a future

of carbon labeling on products, carbon trading worldwide,

and tight regulation and heavy taxes on carbon.”

Jonathan Johns, Ernst & Young

Jonathan Johns

Ernst & Young

How to deal with climate change regulation

The climate change debate has made the environment the biggest single issue

in the public’s mind We are moving closer to a world of zero tolerance for environmental accidents and we have started to see this in recent incidents involving oil and gas firms

Many oil and gas firms are already demonstrating leading practice in environmental compliance, but in a zero tolerance environment mistakes will occur New roles, such as an environmental officer, will begin to emerge at the corporate level There may also be regular, independent audits of procedures and we could even see the emergence of environmental stakeholders on an independent board

This issue of climate change extends beyond just managing regulatory risk

Climate change and the regulatory and consumer response must be seen as a fundamental strategic challenge We can expect a future of carbon labeling on products, carbon trading worldwide, and tight regulation and heavy taxes on carbon Companies must make a fundamental decision about where they want to be in the new carbon economy

For many companies, the decision is whether to adopt a minimal response and simply follow regulation or to make an active decision to reduce their carbon intensity, which could be achieved by offering blended products, a strategy

of acquisitions or by mitigating through carbon sequestration and storage

Others may decide to go one step further and offer services that help their customers to manage their carbon footprint The climate change agenda also presents opportunities for skills transfer, for example, many of the capabilities that make a firm a leader in offshore oil also apply to offshore wind Moving into renewable energy is not a

‘one size fits all’ solution The fossil fuel era is not over yet For reasons of security of supply and economic growth, petroleum will be used for some time yet The degree of repositioning will vary and will depend on the character of the company, but many firms are finding renewables and clean energy a profitable activity Measures such as green-friendly tax regimes, carbon trading and carbon labeling on consumer products are, however, accelerating the movement Those companies that are carbon-friendly will have a competitive advantage and also be able to better attract the young talent they need for the future

• Jonathan Johns is a Partner

in the Infrastructure Advisory — Renewables, Waste & Clean Energy Group at Ernst & Young LLP, UK