STRATEGY AND RISK

STRATEGY
Introduction

 Strategy or better stated as “strategic management” is a very important part of any business and as
prospective CA's it is critical that you have an awareness of how strategy widely influences
decisions within the business.
 This is not a strategy course, which means we will only skim the world of strategy, but because
strategy sets the overall context within which a business operates, it impacts every other module
that we cover in management accounting and finance. It is also a very intangible topic, meaning
that it is not packaged nice and neatly, instead the concepts and ideas are big and interconnected.
This means that you will only really start to understand it properly as the rest of this MACF
course progresses.

What is strategy
 Ultimately, a strategy refers to the plans that a company follow to achieve a long-term or overall
goal.
 In a business context we often talk about the primary goal as being to create or maintain
shareholder value in a sustainable way.
 Today, this idea of shareholder primacy is being challenged with many people starting to question
whether a company should consider more stakeholders and their needs when determining a
 company's main goals. Either way, strategy serves to create plans to achieve these broad goals that
companies choose for themselves.

 Strategy is not the goal but what you will do to achieve the goal

- Build a set of activities that lead to the goal

A good strategy provides answers to 4 key questions

1. Where do we compete? Which markets
- Industries, product markets within the industries and geography
2. Why do customers choose our products/services over others? What value?
- Cost or differentiation
3. What resources or capabilities do we utilise to add that value?
- Human capital, technology, reputation, network
- Capabilities = our ability to use our resources
4. How do we sustain out unique value
- Factors that prevent competitors to replicate

Strategic Management
 A process of managing the strategy and strategic decisions

Strategy
 What is the company trying to do to create or maintain a competitive advantage vs competition

Strategic decisions
 Long term decisions
 Significant effect – on business and business process
 Internal and external element – responding to customer needs etc

Involves
 Determining a strategy through a mission, vision and objectives
 Allocating resources to implement the policies and plans to achieve objectives
 Evaluating the progress in achieving objectives

Strategic Management Accounting

 Process of providing management accounting information to support strategic decisions
- Internal business and processes
- External competitors / industry
To use
 to develop a business strategy
 monitor the strategy’s implementation
- i.e. support strategic decisions
- info = customer satisfaction scores, market share, degree of innovation etc to assess and
manage the company in more ways than just financial
-
Traditional management accounting
 Fitting cost systems to a given business environment and production process or technological task
- Can support strategy but mostly focused on operations
 - Take existing cost system (standard costing, absorption costing etc) and fit it to a given
business environment

Strategic management accounting

 Recognises strategic positioning
- i.e. companies in the same industry may adopt different strategies
- They will have different needs for management information and control
 E.g. the strategy may focus on cost control, maintaining quality or new ideas.
 Thus gather info to match the strategic focus

- More reliance placed on bought in goods and services

 Higher proportion of costs external to firm
 May outsource production
 Dependencies require tighter information because must trust that the external companies
are going to be able to provide us with the goods, services and information we need
 Improvements in cost, quality and innovation depend on managing supply chain.
= cant just be a function of the company itself but greater management of supply chain

- Rather than passively adapt to a given circumstance SMA provides info to help make strategic
choices – i.e. an awareness of competitive conditions

 Helps implementation
- Setting up a control system that ensures chosen strategy is driven by the company
- Check against expectations
- E.g. research and development = how many product designs have we made?
- Customer satisfaction = surveys ?

Strategic Management Framework

Statement and purposes
 context within which we make strategic decisions
 Purpose
- Why does the company exist
- Ensure everyone is aligned with common purpose (employees and customers etc)

 Values
- Culture

Formulation

 Analysis
- Analyse where we are at the moment
 Strategy formation
- Set a broad objective we want to achieve
- Competitive advantage
- Core competence

 Goal setting
- Break objective up into a number of goals
- Objectives
- Measures and scorecards
Implementation
 Structure
- People structure = manage
- Investments and initiatives
- Buy other companies or sell non-performing units etc
 Control and feedback
- Have we achieved what we wanted to
- Performance management

Summary
 strategic management is the process of managing the strategy and strategic decisions in a business
and that this process can be broken down into the following stages (although our framework is not
the only framework around).
 Strategic intent - setting the context of strategy i.e., knowing our purpose
o Determine vision, mission and values
 Formulation - coming up with the strategy
o Analysis - evaluating the company's current situation
o Design - formulating the actual strategy and making strategic choices
o Goal setting - coming up with objectives that are most appropriate to help achieve the
strategy (and measures for the objectives)
 Implementation - implementing and managing the strategy
o Action plans - determining what needs to be done and how it must be done to meet
objectives
o Evaluation - reflecting on the achievement of the plans and adjusting where necessary
 This process is supposed to be a feedback loop where, on a periodic basis, the leadership reflect
on what has happened in the previous period and then adapt the strategy to the new
circumstances, create new plans, implement the plans and then reflect again at the end of the next
period.
 These ideas are big precisely because they should govern everything that is happening in an
organisation.

FORMULATING A STRATEGY
Introduction
 The first part of strategic management is the process of formulating or coming up with a strategy.
Remember, a strategy is concerned with how you will achieve your company's long-term goals.
 But to do this it is important to know what your long-term goals are and where you are relative to
those goals. It should be logical that for you to know how to get from A to B you first need to
know where A is as well as where B is. Only then can you plan the route.
Strategic Intent
 Knowing why you’re doing what you’re doing, where you’re trying to go, and how you’re going
to go about it, represents the strategic intent of the organisation and are the overarching
elements that holds the company together.
 Before developing your strategy, it is important that you determine the company's strategic intent
as it is an essential part of building your strategic foundation and developing a strategy.
 It is common to represent your strategic intent through the concepts of a company vision, mission
and values, although there are a number of other ways of communicating your strategic intent
and not all company's follow this particular method *.
 Remember that although you may modify the words to your vision, mission or values over time,
the underlying intent must stay unchanged so that you have complete clarity when making critical
business decisions that impact the company's future. The idea is that your strategies and goals
change in response to the dynamic context that the company finds itself in, but the strategic intent
remains constant.

Determine vision, mission and values

 Provide direction for everything that happens in an organisation
 Vision
- where the company wants to be in the future
 Mission
- what the company must do now to achieve its vision
 Values
- defines what the company believes in and
- how people in the company are expected to behave

Vision
 A statement of what the company hopes to achieve or to become
 Designed to inspire and motivating instead of being practical
 Idealistic future state
- Disney: To make people happy
- IKEA: To create a better everyday life for the many people
- BBC: To be the most creative organization in the world
- Nike: Bring inspiration and innovation to every athlete* in the world. (*If you have a body,
you are an athlete.)
- Sony: to be a company that inspires and fulfills your curiosity

 Note
- No specific targets
- Broad description of value the company wants to add
- Designed to inspire / motivate – heart not head

Mission
 Describes what the company needs to do now to achieve the vision
- More actionable than vision

 Provides the framework to formulate strategic goals

- Key market – who is your target client/customer?
- Contribution – what product or service do you provide to that client?
- Distinction – what makes your product or service unique, so that the client would choose
you?
 McDonald’s – To provide the fast food customer food, prepared in the same high-quality manner
world-wide, that has consistent taste, serving time, and price in a low-key décor and friendly
atmosphere.
- Key Market - the fast food customer world-wide
- Contribution - tasty and reasonably-priced food
- Distinction - food prepared with high quality, delivered consistently in a friendly atmosphere
Values
 The vision and mission state where the organization is going and what it will do to get there.
 Value statement defines the moral direction for the company
- Guides decision making
- Establishes a standard for assessing actions

 Cannot be just written

- Needs to be reinforced at all levels of the organization
- Must be used to guide attitudes and actions

 Companies with strong values follow their values even when it is easier (or cheaper) not to
- But people are also often to pay premiums for companies that align with their own personal
values

Step 1: Situation Analysis

 First step in deterring a strategy

- process of identifying and evaluating existing internal and external factors that may impact a
company's ability to achieve its objectives (i.e. strategic intent).
- Put simply, if you want to know how to chart a path from where you are to where you want to
be, you need to understand where you are.
 Collect and study past and present information
 Identify trends, forces, and conditions

- Which may influence

 the performance of the business
 and choice of appropriate strategies

- Internal environment
 SWOT analysis (Strengths and weaknesses)

- External – micro environment

 External environment but what is very close to the business
 Porters 5 forces = buyer power, supplier power, threat of new entrants, threat of
substitution, competitive rivalry
 SWOT analysis (Opportunities and Threats)

- External – macro environment

 PESTEL analysis

 From a generalists perspective – i.e. across all business functions

- As a broad overall business, not the specific divisions etc
 Consider the dynamic nature of the real world
- complexity, ambiguity and uncertainty
- rivalry and competitor responses over time

 Grounded in analytics and data

- Cant be based on intuition
- But based on research etc

Situation analysis tools

 Think about how the different tools can be used when needing to identify and consider the various
aspects impacting a company and its choice of strategy.
 Please be aware that the NB skill here is not in repeating the tools but rather in using the tools to
trigger thinking that can help you appropriately analyse a company’s situation. Not all aspects of
all the tools are necessarily relevant to every company.
Strengths
- Core competences where the business excels
Weaknesses
- Areas that need improvement, placing the company at a disadvantage to competitors
Opportunities
- Favourable factors with the potential to improve current positioning
Threats
- Factors arising in the external environment that have the potential to hurt a firm’s business
 Look at video – lesson 2

Step 2: Determine strategy

 a) Determine vision, mission and values
b) Determine strategic positioning
- Be aware of current strategic position
- Future valuable strategic positions
 And how to achieve them

c) Determine strategic goals

- Long term and short term
- Include completion dates

d) Develop implementation plans / projects

- i.e. how to achieve strategic goals

Strategic Positioning – the challenge

Michael Porter’s (HBS) competitive strategy framework

 4 generic approaches to strategy
 2 perspective –
- Scope – global or high end, low end (broad vs narrow)
- Source of competitive advantage
 Either differentiate or cheapest cost
Cost leadership
 either one of the following or combination
- High asset turnover
- Achieve low direct costs or operating costs
- Control the supply chain

 High asset turnover

- I.e. spread fixed costs over a higher number of units
 Economies of scale = bigger than competitors thus providing us with larger scale and
lower costs
 Learning curve effects = make so many, we learn about how to make it better or cheaper
- Service industries
 Restaurant turns tables quickly – Spur
 Airline turns aircraft around quickly – Kulula (thus less aircraft required)
- Manufacturing
 High volumes of output - stickers
- Approach gains market share and creates barrier to entry

 Achieve low direct costs or operating costs

- I.e. standardised products
 No frills, no customisation or personalisation
 Use fewer components / standardised components
 Limit no of model variations
 Ikea
- Pay low wages or automate manufacturing
- Move to low rent areas (countries)
- Requires a continuous search for low costs = as you lower costs, competitors will then follow
you. Thus need to constantly research ways to decrease cost
- Promote low cost item with certain features = add little tweaks e.g. Bluetooth to a cheap car to
increase perception of car

 Control the supply chain

 Access to strategic suppliers and ensuring you have sufficient scale to negotiate suppliers
to decrease costs
- Bulk buying
 - Squeezing suppliers on price (Wal mart)
- Institute competitive bidding for supply contracts  get suppliers to bid for your support
- Use JIT inventory management (early Dell)  don’t stock much inventory and make to order
- Preferential access to raw materials (Apple)

 Don’t need to be big

- E.g. small local restaurant can attract price sensitive customers
 locates in a low rent area
 Offers limited menu
 Rapid table turnover
 Employs staff on minimum wage

Differentiation
 Create a competitive advantage through uniqueness
 Uniqueness is a perception
- Brand image
 Works well when
- Customer not price sensitive = if price sensitive, won’t care about brand or be willing to pay a
premium
- Market is competitive or saturated
- Customers have specific needs not met
- Company has unique resources
 E.g. tech skills / design skills / patents / brand

 Examples
- Apple products = more expensive, perception of quality. Apple don’t manufacture, just
design. Apple are the owners of the brand but don’t manufacture and thus take a
disproportionate amount of the value
- Adidas etc
- Pink lady apples
- Pepperdews = hybrid between different peppers
- Origin coffee
 Need to continually innovate or have a permanent differential advantage – so that competitors
don’t catch up

Niche
 Refers to differentiating in a narrow market  in narrow market, you differentiate yourself
- Servicing a specific segment with specific needs not served
- Highly customised product and marketing
 Example
- Bottled water - Evian
- Luxury yachts
- CA Connect / Milpark PGDA  whereas UNISA would be low cost, differentiate instead of
high cost

Focused low-cost
 Refers to low cost but in a narrow market
- Not trying to be the cheapest in a large market only in the segment

 Example
 - Bottled water – nestle pure life  in the segment of low cost bottled water, they are the
cheapest
- Airlink - aims to link small towns to regional hubs
- Low cost tailored suits

Generic strategies
 Must have a clear strategic position
- trying to achieve all but actually achieving none
- No competitive advantage

 Contradiction
- Cost awareness vs differentiation
- Differentiation costs money
- Thus you cant differentiate and be the cheapest

SAF Strategy Model

 As part of formulating a strategy, an entity needs to perform a situation analysis in order to
become better informed of its present strategic position and then needs to decide on where it
wants to be i.e. it's future strategic position.
 When determining a future strategic position for your company, it can often be difficult to select
the right one, never mind implementing and assessing that strategy’s usefulness and
effectiveness.
So how would you choose?
 As a start it’s important to have a framework that you can use to assess which strategic options
make the most sense for your company. A useful approach is to consider
the Suitability, Acceptability and Feasibility (SAF) of each strategic option. Because a strategy
should satisfy these three criteria before it can be successful, the use of a SAF strategy model is a
good way to evaluate all your strategic options.

Suitability
 Is the strategic option Suitable? i.e., does it align with the company’s strategic intent (mission,
vision and goals)?
 Suitability is probably the most important factor in the SAF strategy model, as the option’s
suitability is the key to whether the strategy will do what the company wants it to do.
 To assess the suitability of a strategy you should be asking questions such as “does the strategy
use the company’s strengths effectively?”, “does the strategy overcome the difficulties which
were identified in the analysis?” and “does the strategy fall in line with the goals the business
wants to achieve?”
Acceptability
 Is the strategic option Acceptable? i.e., is it acceptable in terms of return (profitability), risk and
stakeholder expectations?
 The acceptability aspect of a SAF strategy model is all about measuring the return, risk and
stakeholder reactions resulting from a particular strategy. Returns will be measured based on the
benefits that stakeholders expect from the strategy and could be financial as well as non-financial,
depending on what the stakeholders decide.
 In terms of risk, the likelihood of a strategy’s failure and any financial losses, brand or company
impacts should also be evaluated. Risk can be measured by the impact on liquidity, sensitivity
analysis and stakeholder reactions, to deem how acceptable a strategy is.
Feasibility
 Is the strategic option Feasible? i.e., does the entity have the necessary financial and non-
financial resources e.g. skilled employees?
 Ultimately, the feasibility aspect of the SAF strategy model is really the do or die of any chosen
strategy. Whether or not the business has the resources, aptitude and abilities to actually
implement the chosen strategy is critical to its success.
 The financial feasibility needs to be assessed by forecasting and analysing cash flows, performing
break-even analysis and a number of other financial tests.
 Other questions which need to be asked in terms of a strategy’s feasibility relate to how much
human resources, equipment, management ability and materials a company has. Do they have the
organisational structure and the markets needed to make the chosen strategy work?
Choosing a strategy using SAF strategy model
 The strategy that best meets your measure of the suitability, acceptability and feasibility criteria
above is likely the best choice of strategy for your company.

 Note: Here’s an exam tip - SAF is often useful to consider when answering discussion questions
that require a recommendation on or evaluation of strategic or other actions that a company
could take (commonly referred to as qualitative factor discussion).

Summary
 determining what a good strategy is, but also how the strategic process is properly managed with
there being a system that ensures:
- The strategy is determined,
- The strategy is implemented, and
- The strategy is monitored and adapted if necessary.
 In this lesson we specifically discussed the idea of strategic intent, the clear statement that
defines the purpose of a company and sets the context for all its activities. We also discussed the
idea of strategy formulation where we learned about performing a situation analysis using
various tools to collect information that will inform determining a good strategic position. We
then discussed the process of using that information to determine a valuable strategic position by
referencing Porter's generic competitive strategies to give a structure to how to think about
choosing a strategic position.

IMPLEMENTING STRATEGY
 The final aspect to the process of strategic management is implementing the strategy.
 Based on what we've covered so far, we should be clear on a company's strategic intent (its
purpose), we should understand its situation (situation analysis) and we should know how we
want to position it (strategic position).
 These elements give us the answers to knowing where we are and where we want to be, now we
need to determine how to get there.

Introduction
 It should be intuitive that if you are unable to effectively implement a strategy then it makes no
difference how good your strategy is.
 Let's quickly recap on the SAF strategy model covered in the previous lesson. Implementing
strategy essentially starts with assessing strategic choices i.e., possible strategic action(s) that can
be taken by a company. Companies can use the useful SAF criteria when evaluating various
strategic options (choices) that are available, by way of asking the following questions:
- Is the strategy Suitable? i.e., does it fit in with the company’s strategic intent (vision, mission
and values)?
 - Is the strategy Acceptable? i.e., is it acceptable in terms of return (profitability), risk and
stakeholder expectations?
- Is the strategy Feasible? i.e., does the company have the necessary resources (financial and
non-financial e.g. skilled employees)?

 SAF therefore assists with narrowing down potential strategic choices to help determine the best
action that a company should take. Thereafter focus shifts to implementation of the chosen
strategy.
 For this course we will now break down strategy implementation into the following key ideas:
- Objectives - we need to ensure that we choose objectives, that when met, will mean we are
meeting our strategy. These are broad, but key outcomes that form the structure for what we
want to do.
- Measures - you cannot manage what you can't measure. These are the metrics that we choose
to use measure whether we are achieving our objectives.
- Targets - this is what we want our metrics to become. When we meet this we can say we have
met our objective.
- Initiatives - these are the specific actions that we intend to take to cause change in the
measures.
Ability to execute strategy
 • E&Y study of 275 portfolio managers
- Strategy implementation the most NB factor shaping the value of a business
- More NB then quality of strategy
 Fortune study of CEO failures
- 70 – 90% of the problem is not bad strategy but bad execution

Why is it difficult to implement a good strategy?

 Strategies (the way companies create value) are changing but
 Tools for measuring strategies have not kept up
- Moved away from tangible assets to intangible but tools have not kept up

Industrial economy
 Companies create value with tangible assets – turn RM into FG
 1970’s tangible value (book value) = 85% of MV
 1980’s tangible value (book value) = 65% of MV
 1990’s tangible value (book value) = 35% of MV
 2000’s tangible value (book value) = 15% of MV

Modern Economy
 Value creation moving away from tangible assets to intangible assets
 I.e. managing strategies that use
- Customer relationships
- Innovating new products and services
- Responsive operating processes
- Information technology and databases
- Employee capabilities, skills and motivation

Measurement tools
 Have historically been focused on Tangible assets
- Financial measurements are sufficient
 - I.e. recording investments in inventory, PPE on balance sheets and expenses on income
statements
 Intangible assets require new measures
- To describe or measure the knowledge based assets and their value-creating strategy’s
 Without tools
- Battle to manage what you cannot describe or measure

Balanced Scorecard
 Kaplan and Norton formulated a model to focus attention on the whole company

Balanced
 Concern that short term financial focus = long term issues
 Integrates
- Financial and non-financial measures
- Internal and external
- Current and the future (balance of lead and lag indicators)  more predictive indicators
 4 Perspectives
- Financial and stakeholder expectations
- Customer and external relationships
- Internal business processes and activities
- Organisational learning and growth

Role as a scorecard
 Record and report a small no of key measurements (20 - 25)
 Quick evaluation of critical areas

For each perspective determine

 Objectives
- key outcomes to implement strategy
- Vision  mission (main thing to do today to know we will be implementing our vision) 
strategic goals (to achieve mission)  now need to innovate objectives for each perspectives
that we know if we meet these, then we will be reaching strategic goals which will be
implementing our mission and ultimately our vision
 - e.g. objective = employee satisfaction
 Measures
- a way of measuring outcome
- e.g. measure = employee turnover rate
 Targets
- the goal we want our measure to reach
- e.g. want a low employee turnover – want it to be 3% p.a
 Initiatives
- what we will do to move the measure
- e.g. Payroll reflection, employee training

Financial Perspective
 The financial and economic outcome of implementing strategy in other 3 areas
 General idea is increased profitability
- I.e. how do shareholders want to see you?
 3 generic ways to increase profitability
- Grow revenue
- Reduce costs
- Use assets more efficiently
 Refer to the example of the financial perspective of the score card

Customer Perspective
 Supports revenue side of financial perspective
- i.e. if you achieve the customer objectives you should achieve your revenue objectives
 Core objectives are supported by customer value propositions
- i.e. if you achieve your value propositions you support achieving the core objectives
Internal Business Process Perspective
 Critical processes required to achieve financial and customer perspectives
- I.e. what should you do well to achieve the customer objectives and your financial objectives
(cost and asset efficiency)
- Business efficiency
 3 parts to process value chain
- Innovation = future
 Long term value creation
 Researching needs
 Coming up with products / services
- Operations = how we deliver today
 Short term value creation
 Making and delivering products / services
 Traditionally a major focus of companies
- Post – sales service = how do we support customers after sale
 Supporting products (software updates / paypal)
 Warranty and repair activities
 Treatment of defects and returns (Le Crueset vs Makro)
 Customer payments processing= calling and emailing customer where there is a payment
processing issue and following up
 Software updates
Learning and Growth Perspective
 This quadrant focusses on enabling the company
- To continue to make excellent use of resources
- To continue to have loyal satisfied customers
- Business needs to be concerned with long-term development and improvement
 I.e. invest effectively in people, systems and procedures to ensure a sustainable
competitive advantage in the future
- Not about the product, this is how the organisation learns and grows
 People and employment environment
 Corporate culture
 Social awareness

Balanced Scorecard
Lag and lead measures
- When we choose the measures for the objectives, we need to have 2 types of measures
 Maintain balance between two types of measures
 Outcome measures (lag)
- Measures that look back
 Describe the results of past actions
 Mostly fall in the financial / customer perspective
- Ensure that the strategy is being achieved
 Performance drivers (lead)
- Represent a hypothetical relationship to performance
- E.g. if we improve staff training we will retain customers and earn higher margins
 % of staff trained or average staff level of training
 Does not reflect a strategic outcome
 We assume it will result in strategic outcome

 E.g. if we improve staff training

- Lead = more staff in training programme = more likely customers will be satisfied
(predictive)
- Lag = customer satisfaction in the past

Cause and effect relationships

 Realise the relationship between quadrants
- Use a strategy map – layout of expected relationships
- Careful of contradictory measures  don’t want different managers to disagree e.g. financial
department want decreased costs but customer satisfaction wants increased marketing
- All perspectives interact with each other
 e.g. financial perspective will increase resources which may improve learning and growth
or customer satisfaction
 Customer satisfaction my lead to financial growth
 Increased learning and growth can impact internal business and how we operate

 Understand timeframe
- I.e. training staff may take years to solve staff shortage problem and longer to affect
profitability

 Be careful of unintended consequence

 Strategy map example
- If you increase investment in skills training increases productivity which decreases costs and
increases financial perspective
- Increased productivity also results in greater quality which further internal business
perspective
- Increased quality results in customer satisfaction
- Better internal business process = improved product development time which increases
customer retention

Strategic management process summary

- Create Balanced scorecard
- Setting objectives
- Relationships between objectives and the different perspectives
- Measure objectives appropriateky
- Correctly target want we want to achieve with the objectives
- Come up with initiatives to ensure we are making change in the business by changning the
measures to meet the targets and then meeting objectives
- By meeting objectives, meet strategic goals
- Meeting strategic goals will be achieving strategic mission
- Strategic mission will thus move our business towards it vision

Reflecting on Implementing Strategy

 Balanced Scorecard as a tool to think about strategy implementation. In no way is this the only
framework that is used in strategic management, but it is a common and well thought through
framework.
 Remember that you need to consider choosing objectives from all the perspectives to ensure a
well implemented strategy namely:
- Financial,
- Customer,
- Internal business processes, and
- Learning and growth.

 Remember that for each objective you need to identify:

- The objective itself,
- A measure of the objective,
- A target for the objectives, and
- Plans, actions or initiatives to implement in order to achieve the objective.
 Finally, it is important to remember to reflect on what has happened over the period to adapt
and inform the strategy so that your company's strategy can be responsive to changing
circumstances over time.

Reflection on Strategic Management

 Strategic Intent represents the core "Why?" of the company and that this normally stays (or
should stay) more or less the same over time. That is why it is depicted in the centre of the
strategic management process. The other activities loop onto each other as the company grows
and adapts over time.
 We determine where we are at the moment;
 We determine where we want to go;
 We determine how we will get there;
 We determine whether we are getting there;
 (The process repeats again and again)

INTRODUCTION TO RISK MANAGEMENT

Introduction
 This aim of this lesson is to introduce you to the idea of Risk and Risk Management.
 Why is this important?
 The goal of a company is to add value. When we think about what value is, we recognise that it’s
about balancing risk and return. This means you cannot focus only on trying to maximise returns
to add value, you also need to recognise the role that managing risk plays in the value creation
process.
 In this lesson the goal is not to try to comprehensively deal with this big idea of risk management,
instead at the end of this lesson we specifically want you to:
 Have a broad understanding of the risk management process,
 Have an understanding of the relationship between risk and return,
 Have an understanding of the various categories of risk, and
 Be able to assess a company's context or decision to identify the risks associated with that context
or decision.
 Although this is a short(ish) lesson on this course, the ideas are important as they broaden our
understanding of the implications of different strategic choices as well as the implications of
different decisions a company may make.
Defining Risk
 What is Risk? Before we begin it is important that we have a clear understanding of what risk is.
Risk is not the same thing as losing something.
 Because of the strong relationship between risk and loss students often have a misunderstanding
of risk and confuse risk as simply being the risk of losing something. This creates an impression
that risk is just a negative thing that needs to be avoided. This is not true as the process of
operating a business requires the company or person to take on risk.
 The simplest way to understand risk is as follows:
 Risk is the chance that what actually happens differs to what you expected to happen.
 No risk is certainty. Certainty is when what actually happens will be exactly what
you expected to happen.
 This is not just negative - you should agree that this means that risk could result in a positive
outcome as often as a negative outcome.
 A positive outcome would mean that what actually happens is better than what you expected
to happen i.e., a company outperforms its expectations.
 A negative outcome would mean that what actually happens is worse than what you expected
to happen i.e., a company underperforms its expectations.
 The reason that risk is closely associated with loss is because of the fact that no one
minds outperformance and so we only worry about underperformance.
 We measure risk using a statistical concept called the standard deviation
- you don't need to know much about this in this course other than to know that the higher the
standard deviation the higher the risk.
 The next step is to unpack how risk and return are related
Risk and Return
 It should be evident to you from the three questions you have answered that there is the following
relationship between risk and return:
- The higher the risk, the higher the expected return
- The lower the risk, the lower the expected return
 It is important to note that the higher risk does not guarantee a higher expected return - simply
that over time a higher return is expected but there is a greater chance that what actually happens
is different to that expectation (could be both higher or lower).
 We can draw a conclusion that value creation is not just about maximising returns. It is about
maximising the risk return relationship. This means that value can be created in either of 2 ways:
- Increase the returns for the same level of risk, or
- Decrease the risk for the same level of return.
 We traditionally spend significant time teaching you about trying to increase returns but it’s
important to recognise that learning how to reduce risk is equally important. This is where risk
management comes into play.

Overview of Risk Management

 You have already learnt about the importance of strategy and how to formulate a strategy. Risk
management naturally links with strategy because, as you pursue strategic objectives to add value,
you necessarily expose your company to the risks that are associated with that strategic objective.
 As we have said, one of the objectives of financial management is to create value. We now know
that value is the result of balancing the growth in returns with the risk associated with those
returns. It follows that the process of managing risk has the potential to add value through
the reduction of risk for the same expected returns.
 Risk management has become a topical issue in business. This has largely happened because as
the world has globalised and become interconnected, it has become increasingly complicated.
This has resulted in high profile corporate failures and a systematic misunderstanding of the true
risk in the global economy.
 There is more focus placed on risk management than ever before and this has also resulted
in increased regulatory requirements and additional reporting. Risk management is seen as a key
responsibility of the board of directors with the reporting requirements under King IV and IFRS 7
requiring increased disclosure of information on risk and risk management.

Overview of Risk
 What is risk?
- the chance an outcome will differ from the expected
- the intentional interaction with uncertainty
- risk isn’t a bad thing but is more about volatility

 Why do we want risk?

- Risk is not only bad
 chance of good and chance of bad with expectation of good
- Taking risk increases expected returns
 In the long run can improve performance

 Why do we want to manage risk?

- Reduces risk without giving the return adds value
- Creates more certainty of the same return
- Can either create more returns through investment or operations that will add to return for the
same level of risk
- Or can reduce risk for the same level of retufn
Risk Management Process
The risk management framework consists of the following steps:
1. Identify risks
2. Measure risks
- Analyse and evaluate risks
- Determine the impact of the risks
- Determine if significant or not
3. Manage risks
- Deal with risks according to entities strategy and risk appetite
4. Monitor the risks
5. Report on the risks

Risk management and governance

 Key part in terms of corporate governance
- Thus growing expectation for business to manage and disclose risks etc
 Key responsibility of the board of directors (King IV)
 Important reporting requirement – IFRS 7
- Exposure to risk and how risk arises
- Objectives, policies and processes for managing risk

Risk and Types of Risks

Business risk
- risks specifically taken in order to add value
- E.g. marketing a new product in order to obtain sales
- Normal risk that the business wants to take to add value
Non – business risk
- risks that are not under the control of the company
- E.g. political and economic risks
- Ideally would like to be avoided
Financial risk
- risk of direct financial loss to a company
- E.g. currency changes cause imported goods to cost more

Risk Management Process

Ways to manage risk
 Accept the risk – small risks not worth managing
 Avoid the risk – change your plans or processes to avoid the risk
 Transfer the risk – use contracts to shift risk e.g. insurance
- Derivatives as another form of transferring risks
 Mitigate the risk – put plans in place to limit the impact of a risk
- When risk materialises, the plans decrease the impact
 Exploit the risk – prepare to take advantage of the situation
- Capitalise on new opportunities risk may provide

Risk Identification
 The first stage in the risk management process is identifying risks.
 Risk identification is the process of determining the risks that could potentially prevent a company
from achieving its objectives. It includes documenting and communicating the concerns regarding
risk.
 The first step in identifying the risks a company faces is to define the risk universe. The risk
universe is simply a list of all possible risks.
 It goes without saying that this is probably one of the more important parts of the risk
management process, as failing to identify a risk will result in it being entirely unmanaged.
 After listing all possible risks, the company can then select the risks to which it is exposed and
categorise them into core and non-core risks.
 Core risks are the necessary risks that the company must take as part of its business to
succeed and grow.
o e.g., the risk associated with developing and marketing a new product - this is core to
normal business.
 Non-core risks are not necessary to and can be minimised or eliminated completely.
o e.g., the risk of theft of your company delivery vehicle - this is non-core and can be
removed using insurance.
 There are several techniques used in the real world to try to systematically identify risks
including:
 Holding brainstorming sessions
 Conduction interviews
 Performing surveys
 Holding working groups
 Using risk lists
 Reflecting on past lessons learned
 etc.
 What is most important, is for you to be comfortable with a way of organising risks into
categories that makes sense. One way to do this is to break down company risk into the following
categories:
 Strategic risks - these are risks that affect or are created by a company's business strategy and
strategic objectives.
 Business risks - these are major risks that affect a company's ability to execute its strategic
plan. Sometimes called operational risks.
 Financial risks - these relate to the risks that affect a company's financial performance,
position and cash flows.

Risk Identification Questions

List of Risks
Strategic frameworks used to identify risks
Reflection
 At this point you should simply feel comfortable with the idea that risk management adds
value to a company through the improvement in the risk/return relationship.
 You should also be clear that risk management is an important responsibility held by the board
of directors, and that it is important for companies to have a risk management process. This can
be implemented using the risk management framework which is:
 Identify
 Measure
 Manage
 Monitor
 Report
 On this course we are only concerned with the first step in the risk management process, namely
your ability to identify risks. It is important to understand the other aspects of the risk
management process, but they will not be specifically covered or assessed in this course.

Conclusion
 Strategy is a critical part of leading and running a business. A company's strategy is a framework
for making decisions. These decisions, which occur daily throughout the company, include
everything from investments, to operational priorities, to marketing, to hiring, to sales approaches,
to branding efforts, to how each employee organises their daily tasks.
 Risk management connects to strategy as the decisions taken by a company in order to achieve its
strategic objectives necessarily expose the company to risks. It is important that a company is
aware of and responds to these risks in order to properly manage them as part of the value
creation process.