Economic uncertainty, the cost of energy and currency volatility are among the major risks facing the metals industry, and executives are always looking for effective ways to manage these risks. Enterprise risk management (ERM) is a business approach that helps companies identify the most harmful risks, prepare a response strategy and find ways to control those risks.
The first step is to ensure there is a common understanding of the terminology and identify risks specific to a business goal, according to Marc Dominus, a senior manager with consulting firm Crowe Horwath LLP. Risk is any event or uncertainty that creates a deviation from your intended outcome. ERM is the ability to gather management-strategic processes in such a way that we are able to create protection that shields the entire organization, he said.
After consulting dozens of companies on how to launch ERM in their businesses, Dominus said the most important step is eliminating the blame culture, where managers find someone to blame and not necessarily the root of the issue. For example, company management may blame the IT department for a network malfunction when sometimes the issue is caused by underinvestment in software or human resources failing to hire adequate personnel, he said, and division managers may try to downplay the risks in their division to avoid blame.
Companies should become more open and forthcoming about the risks they face and not withhold information, which is not possible if the blame culture flourishes in the company, Dominus said.
There are risks involved every time a company sets a business goal, but not all risks deserve the same amount of attention. We have a limited amount of risk management resources and we want to allocate those resources effectively, so we want to prioritize, Dominus said. The simplest way to prioritize risks is to consider the impact of the risk and the likeliness of its occurrence.
ERM can involve different software applications: an additional module of enterprise resources planning software, such as from SAP Inc. or Oracle Corp., or a standalone program that is designed to connect with the IT systems the company already has. The most basic version can be an Excel spreadsheet, where each business objective is accompanied by a list of risks and the priority of those risks. Separate cells or pages can describe the experience with the risks in the past, tracking indicators to control the risks and who is responsible for monitoring the risks. When there is a system in place to monitor the key risk indicators, a company can control the risk, Dominus said.
But the key to success in implementing ERM is a commitment to the process--it can take three to five years for a company to fully implement an ERM system, he said, and many companies expect too much too soon. Another part of the commitment is to hire people on staff to work on the risk management system.
Beyond the fancy software and a newly hired ERM administrator, the company must adopt a risk management culture, Dominus said. The culture spreads from the top down, starting with the executive board discussing the risks associated with a new project or investment.
Some risks can be anticipated and prepared for, such as new regulations, but some risks come unexpectedly--and thats when the organizations culture really comes into play, he said. ERM can be effective when it becomes part of the culture, the collective consciousness of the organization.
One of the newer trends is for manufacturers to look at their suppliers ERM practices, because if things go awry on the supply side the company risks not delivering the product on time and may lose its clients, Dominus said.
More than 80 percent of chief executive officers in the metals industry are concerned with the cost of energy and raw materials, according to a survey earlier this year by New York-based PricewaterhouseCoopers LLP. The overall economic uncertainty was the second-biggest concern, and almost 70 percent of the chief executive officers are concerned with exchange rate volatility.
Anjani Agrawal, a partner in the global mining and metals team at London-based Ernst & Young, said companies are trying different measures to protect themselves from risk. Margin protection is the No. 1 risk for many of the metal companies, he said. Then you have excess capacity--a big risk, particularly for the steel sector.
To protect margins, companies work on optimizing long-term operational costs by increasing productivity or using recycled materials. Companies also choose to move up the value chain and create value-added products to protect the business from thinning margins.
Agrawal said the steel industry suffers excess capacity of up to 35 percent because China and other countries are adding capacity when overall demand is shrinking. Therefore, companies in the United States and Europe are shutting down some of their capacity as they cannot continue producing at current steel prices.
One way companies are addressing price volatility is by looking at their value chain. Metals industry players that do not have access to resources are looking to integrate vertically, which is to say looking to acquire mines, Agrawal said, noting that companies that have their own raw materials are less subjective to the input price volatility.
For companies in aluminum and copper, hedging is very common because there is an established futures market for these metals, he said, but hedging is not so much prevalent in the steel industry yet.
Price volatility hedging and margin protection are emerging trends in the industry, where risks such as currency volatility has been dealt with through currency hedging for a long time.
There are different risks that are more specific to mining or production, but it is important to identify the key risks and to concentrate on those.
Agrawal said that effective ERM managers have to ask these questions: What are my important risks? How am I covered against these risks? Is what I am doing right now adequate to address these risks and how do I manage and monitor these risks on a continuous basis? Thats what ERM essentially is, he said.