After a year of black swans, growth-focused private companies rethink risk resilience

PwC's Private Company Trendsetter Barometer tracks the business issues and best practices of privately held US growth businesses. It incorporates the views of 226 CEOs/CFOs:127 from companies in the product sector and 99 in the service sector, averaging $315 million in enterprise revenue/sales and including large, $500 million-plus private companies.

New York, March 13, 2012 —– "Black swan” events and other external shocks in 2011, such as the Japanese tsunami, the Arab Spring, and Europe's sovereign debt crisis, exposed vulnerabilities in private companies' risk preparedness. Among the chief executives surveyed for PwC US's Private Company Trendsetter Barometer, only a minority say they're very confident that their current risk management strategies will prove effective over the next few years, with nearly one-third (29%) citing the need to revisit those strategies — this at a time when 40% of Trendsetter executives say their companies feel pressure to take on greater risk to pursue growth.

Notably, Trendsetter companies that feel a need to revisit their risk strategy are the ones most intent on growth over the next 12 months, with 76% planning to increase operational spending. More than half (52%) also plan to make major capital investments (vs 34% of their Trendsetter peers), 38% plan new expansion outside the United States (vs 17% of their peers), and 35% plan to increase operational spending vis-a-vis new product/service introductions (vs 23% of peers).

The need to revisit risk strategy was also cited by a greater percentage of Trendsetter companies that sell abroad (39%), compared with domestic-only companies (21%). International companies are also more alert to the threat and potential effects of low-probability, high-impact events ("black swans"): 81% of Trendsetter companies that feel a need to revisit risk management specifically in light of last year's "black swans" are selling abroad, with one-quarter of their revenue being derived from international sales.

“Regardless of their size or where they operate, private companies are not insulated from large-scale events that happen halfway across the globe,” says Ken Esch, a partner in PwC’s Private Company Services practice. “While international companies are naturally more alert to the fallout from such events, they need to make sure they couple that awareness with sound methods of dealing with their risk exposure. As it stands, the post-2008 adjustments private companies made to their risk management and resiliency programs don't seem likely to suffice in today's increasingly volatile world. Companies recognize that it's also an increasingly competitive world, where taking on risk is part and parcel of pursuing growth through innovation and expansion. The key is to integrate risk considerations across the company as strategy-setting takes place. Treating risk as an afterthought is no longer a tenable approach.”

Economic Risk Ranks Highest, M&A Lowest

The lion’s share of Trendsetter companies (92%) cite an ongoing weak economy and the threat of recession as the top collective risk they face over the next few years, followed by higher costs (74%), heightened competition (68%), and unstable capital markets (68%). Increased taxation to address the public deficit registers considerable concern as well (64%). Of slightly lesser — but still substantial — concern are talent shortages (47%) and information-security breaches (41%). Unsurprisingly, Trendsetter companies' concern about information security has risen in the past two years (up 14 points from 27%), in tandem with greater use of cloud computing, mobile devices, and social networking.

Meanwhile, private companies' concern over the past two years has dropped when it comes to risks related to international expansion (24% — down from 35% in early 2010) and, most strikingly, risks connected with mergers and acquisitions (19% — down from 50%).

"After a couple of years spent battening down the hatches in a decidedly risk-averse response to the global financial crisis, private companies realized that to thrive — or simply survive, in some cases — they would have to stick out their necks and pursue growth again," says Esch. "When we last spoke with Trendsetter companies about risk, they were just getting their feet wet again. Two years on, they've grown more comfortable with making bold moves. Which is not to say they don't recognize the challenges. For instance, our private-company clients are keenly aware of the risks involved in going abroad. What's changed these past couple of years is that private companies have become increasingly sophisticated in gauging and managing those risks."

Such risks include supply-chain issues — cited as a moderate-to-high risk by nearly half (46%) of Trendsetter companies that sell abroad and by an even higher percentage (59%) of companies selling in Brazil, India, and China (as high as 65% when considering China alone). As one might expect, product companies were much more concerned about supply-chain risk than service companies (48% vs 16%). Surprisingly, however, supply-chain risk was rated as "high or very high" by just 9% of Trendsetter companies overall.

"This finding is somewhat worrisome," says Esch, "considering the global linkages in today's supply chains. Even though your company might not be sourcing abroad, that doesn't mean you can safely assume the same of your supplier's suppliers. Our advice to both international and domestic-only companies is to keep risk resiliency top of mind when assessing supplier relationships.”


An analysis of risk types by segment is illustrated in the table below:

Any Risk  
Industry
Geographic Reach
Enterprise Size

(Very High / High / Moderate Risk)

All Firms
Product
Service
Int'l
Domestic
Small
Large
 
  • Recession/ weak economy
92%
94%
90%
93%
91%
91%
93%
  • Rising costs
74%
78%
68%
81%
67%
66%
83%
  • Heightened competition
68%
69%
66%
71%
64%
62%
73%
  • Overregulation
63%
60%
67%
69%
57%
57%
70%
  • Unstable capital markets
68%
68%
67%
69%
66%
70%
65%
  • Increased taxation to address public deficit
64%
62%
67%
67%
61%
67%
61%
  • Talent shortages
47%
40%
55%
53%
41%
40%
54%
  • Information security breaches
41%
35%
53%
49%
37%
41%
44%
  • Supply chain issues
34%
48%
16%
46%
24%
23%
47%
  • International expansion
24%
24%
23%
43%
7%
20%
29%
  • M&A issues
19%
16%
23%
25%
14%
13%
26%

Challenges in Getting Risk Strategy Right
Among Trendsetter companies that are changing their risk strategies in light of black swan events, there's an apparent disconnect between where they think their risk focus should be and where it actually is. While most of them (87%) agree that they need to focus more on detecting a broad range of emerging risks, the bulk of their current risk-management effort (70%) goes into preparing for known, recurring risks; a considerably smaller 30% of their risk-management effort goes into monitoring circumstances to detect as-yet-unknown risks.

"This disconnect may start to lessen in the coming months," says Esch. "What we're finding among our clients is that leading private companies realize their risk strategy needs to change in fundamental ways. The most significant change is a greater focus on consequences. Rather than concentrate predominantly on identifying, measuring, and managing numerous potential causes of the same consequence, such as a supply-chain disruption, leading companies are focusing on how they would mitigate the disruption itself. They're also embedding risk awareness throughout their organizations so that it factors into strategy-setting and operational decisions."

For half (50%) of Trendsetter companies, conflicting corporate priorities is a key obstacle to dealing with risk. However, private businesses might have an easier time aligning those priorities, compared with their public counterparts. That's because in the majority of privately held companies (55%), the responsibility for risk management falls to the CEO. Another 28% of Trendsetter companies say their CFO oversees risk management. Just 15% have a chief risk officer (CRO).

“Lack of a CRO isn't necessarily a bad thing," says Esch. "Because private businesses tend to be less sprawling than public companies, they generally don't put risk management in a silo, remote from the company’s core operations and main decision makers. The key is to have the CEO — or whoever oversees the risk function — recognizing the importance of an integrated approach."

Other risk-management impediments cited by Trendsetter companies include timeliness and quality of information (46%), availability of information (42%), and lack of a formal process for monitoring risk (38%).

“Many businesses do not have adequate data and monitoring systems for today's risk environment,” says Esch. “While embracing the newest generation of data analytics and business intelligence should help private companies get their arms around the many risk factors out there, there are still only so many resources at their disposal. Focusing more on preparing for consequences and less on monitoring possible causes — which can be numerous — may prove not only more effective, but also more economical.”  

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E-mail: amy.w.obrien@us.pwc.com