Opportunity versus risk - the ying and yang of commerce

 

All commercial transactions contains an element of risk, yet at the same time how adequate are the mechanics and systems that are in place to manage these risks?

In recent years we have witnessed just how costly the laissez faire attitude to risk was in many institutions be they large corporations or smaller SME’s.

In the never ending quest for larger profits many of the saner measures of business were jettisoned.

An analysis of the most spectacular flame outs all have one common denominator– the architects of these calamities were oblivious to the risks that their organisations were exposed to.

Counter party and accompanying market risk should be under constant evaluation. All areas of exposure need to be constantly policed.

A forensic analysis of the current Debtors Book might make for uncomfortable reading but like most unpleasant tasks it should not be ducked.

It is always preferable to take remedial action such as a write down whilst you are in control of your own destiny rather than have a third party appointed to do it for you.

 

Don’t ignore the tell tale signs

Inevitably when a problem comes home to roost it prompts a round of head scratching and the standard response “why did that go wrong?”

The answer is all too often glaringly obvious and boils down to companies failing to address problem issues early enough to avoid the oncoming crisis.

The signs of a troubled business are all too apparent – these include lack of controls, lack of strategic vision, a demotivated workforce and obsolete or valueless stocks etc

Instead of grasping these nettles, often the preferred option is to engage in a totally pointless exercise such as a rebranding campaign or the launch of another product range destined to fail for the above reasons.

The operating style of many doomed companies can be compared to Nero’s pastime of fiddling whilst Rome burns.

 

Strategy overhaul

 

When attempting to boost the bottom line there are two obvious courses of action, cut operating costs and generate additional revenue.

Many organisations opt to reduce staffing numbers as a quick fix but there is a danger that in line with reduced personnel there is an accompanying decline in operating standards. In such circumstances customers often choose to vote with their feet.

The sales director only has one shot in his/her armoury namely increase sales. Sales targets can always be raised but a sense of commercial realism also needs to be applied.

If you are marketing a totally unique product or service the task is easier but for the most part there are many companies offering a similar range of products in a broadly similar price range.

In many instances companies would be advised to make customer service their USP but this requires the commitment of a dedicated work force not one that is pre-occupied with the spectre of further redundancies.

21st Century leviathan

 

The recent commissioning of the world’s largest container ship the Maersk's Majestic underscores the competitive nature of international logistics.

The vessel is a quarter of a mile long and has the capacity to transport 18,000 20-foot containers.

Manufacturers of electronics and mobile phones are shipping cargo by sea because competition was eroding their profit margins focussing their attention on cutting delivery costs.

Each 20 foot container can hold 13,000 smart phones with a transportation cost from China to Europe of 7 pence per unit and a transit time of approximately 25 days.

Currently there are over 6000 container vessels operating with a significant number engaged in the East to West trade routes.

China’s economic success remains export driven as illustrated by the cost of shipping a container. Inward from China to Europe costs around US$1500 with the reverse journey only commanding a rate of around US$700.

Traffic will continue to moving onto the water because moving goods by air is very energy-intensive and the high cost of jet fuel makes air freight too expensive.

 

Diversification - not a guaranteed silver bullet

 

Without doubt one of the most difficult challenges a business faces is diversification.

Often a company is faced with the dilemma of diminishing revenue returns and a tired business model which is either irrelevant or obsolete.

Diversification is seen as the solution to this dilemma. However, the mechanism for achieving this objective can be particularly difficult.

The first step is examining why the current business model is not working. This requires an honest appraisal from the management in respect of their performance.

Then the areas of diversification have to be closely considered, it is a common mistake for people to plunge into businesses in which they have little knowledge or experience and the results pretty quickly show up these deficiencies.

Thirdly one should always respect geography. It may be very tempting to consider that there are opportunities just waiting to be picked up but to underestimate the advantage of local knowledge and conditions can again prove costly.

In essence diversification can provide the answer to a company’s need for increased revenue but without a clearly defined strategy and executed business plan it can equally provide another drain on an already vulnerable balance sheet.

 

No time for complacency

 

There is a growing trend for companies to bully their suppliers over the question of payment terms. It is not unusual for companies who hitherto had paid on the basis of 30 days to now demand switching their suppliers to 90 day payment terms.

Many companies are seeking to stretch the length of their payment terms by employing a raft of tactics some fair, some foul.

Such extended terms can only be served by larger organisations with adequate cash reserves.

For the small to medium supplier it further ratchets up the pressure as banks are unwilling to increase their credit lines.

As profit margins are further squeezed by increased operating costs the importance of maintaining cash flow is crucial.

Business is hard-won in the current climate, but above all there has to be a commercial raison d’être for any transaction.

Mutual reciprocity has to be the basis for the customer/supplier relationship for it to remain worthwhile.

A question of trust

The integrity and reliability of any organisation’s reporting structure are vital to its long term survival. All too often risk controls are lax or can even be ignored in the pursuit of profits.

It can also prove a false comfort to rely on the findings of the Auditors.

As we have seen some of the financial instruments employed by the banks were so complex that even their own architects could not fully understand the full implications.

Even with the most rigorous reporting procedures any company is still heavily reliant on the calibre of the people operating the business and recording each and every transaction diligently.

A prudent exercise for any organisation is to regularly assess and test the systems in place for monitoring risk both transactional and counter party to judge that they are fit for purpose.

Over reliance on “assurances” can become very costly as in the case of French bank Credit Agricole who this week revealed the damage inflicted by the bailout of Portuguese lender Banco Espirito Santo (BES), as it said profits had almost halved.

Credit Agricole said it has written off £563million – the entire value of its 14.6 per cent stake in BES.

The firm apologised to investors and claimed it had been ‘misled’ as it said profits fell to £770million in the second quarter, from £420million a year earlier.

Portugal is injecting almost £4billion to rescue its largest listed bank, founded by the Espirito Santo family, which last week reported a bigger than expected £2.8billion loss.

This wiped out its capital cushion and caused its shares to plummet by more than 75 per cent before the stock was suspended on Friday. The rescue means shareholders and junior bondholders will be wiped out.

Credit Agricole is the second biggest shareholder after the Espirito Santo parent company, which owns a 20 per cent stake.

The French bank’s chief executive Jean-Paul Chifflet said: ‘We can only regret having been misled by the family with which Credit Agricole was trying to create a true partnership to build the biggest private bank in Portugal.’ Shares in BES have fallen 89 per cent since June.