The top 10 risks for business phần 2 ppsx

Strategic business risk 2008 — The top 10 risks for business
10
One analyst noted, “The revenue generated from the US pharma
market, the largest in the world, enables pharma companies to
remain protable [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
rms are feeling pressure to demonstrate a return on investment
for long-term risk management initiatives. One banking panelist
noted, “Banks are experiencing signicant 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 rm has signicant 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nancial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 nancial shocks. Biotech and utilities rms,
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
nd 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 nancial
system. There will be unexpected pockets of vulnerability.
Disintermediation has replaced international banking as a nance
source with a range of specialized credit instruments held widely,
with risk exposures that regulators nd it difcult 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-prole failures of some investee
companies could lead to a loss of condence among investors and
lenders.” Another remarked, “A crisis in CDO/structured nance
markets could lead to potential systemic problems. Sustainability
of nancial 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 nancial
sector.” In the future, continued nancial innovation — which tends
to disperse risks and, as a consequence, makes the detection of
potential shocks more difcult — is likely to increase the potential
for nancial shocks.

2 Global nancial shocks
Continued from page 8
11
Strategic business risk 2008 — The top 10 risks for business
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 nancial system remain very real.
The origin of this nancial 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 nancial
system. The securitization of nancial
risks has resulted in a wide disbursement
of such risk throughout the nancial
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 nancial 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 nancial assets.
Any investment vehicle which has some
exposure to sub-prime mortgages
will be regarded as contaminated.
In this market environment, nancial
institutions become very wary of lending
to other nancial 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
nancing 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 nancial

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 nancial system and in
particular to minimize the likelihood of
economic contagion.
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 nd access to capital
difcult 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 nance 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.
Strategic business risk 2008 — The top 10 risks for business
12
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 rms, 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 nancial needs.” As a
result, a struggle is now emerging between insurance and asset
management rms 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 specic 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 gures highly in oil and gas and is

perceived to be a ‘next ve risk’ for sectors such as banking. These
sectors are already experiencing a signicant 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 ndings 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 rms are competing
with other global players for opportunities in these markets,
although in several sectors, emerging markets rms 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 rms 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 rms 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 signicant.
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 signicant challenge lies in rms effectively
managing outsourced business and supply chains in these markets.
Recent events in the consumer products sector, for example,
have demonstrated the specic need to focus on quality control
standards and compliance testing when sourcing from relatively
unknown suppliers in emerging economies.

3 Aging consumers and workforce

4 Emerging markets
“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
13
Strategic business risk 2008 — The top 10 risks for business
Chris Raham
Ernst & Young
Winning the battle for the savings market
Changing nancial needs

The baby boomer generation is retiring
just as employers and governments are
progressively disengaging from pension
provision. As a result, the nancial needs
of individuals are changing dramatically.
The central nancial 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 nancial services industry.
How can insurers capitalize on
new opportunities?
Occupational pension/cash-balance •
plans, and individuals in the mass
market offer the most signicant

opportunities. Successful ventures here
will benet the largest segment of the
population — those without sufcient
wealth to attract the assistance of wire
houses, retail advisors or independent
nancial planners. Only a handful of
competitors are offering well-planned,
valuable services to these segments,
although most major nancial
institutions are circling the opportunity.
In the dened 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 benets
and competitive advantages from
the employee’s perspective. Such
assessments will help employers and
their benet consultants understand
the value of the product. Insurers may

also support the plan sponsor by
providing nancial 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-efcient 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,
they have been focusing on competition
among themselves. In the US, for example,
insurance companies have only a small
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 signicant 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 ve 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.
• Chris Raham is a Senior Advisor
in Ernst & Young’s Insurance and
Actuarial Advisory Services.
Strategic business risk 2008 — The top 10 risks for business
14
Farokh T. Balsara
Ernst & Young
From emerging markets to surging markets —
The future of global media growth
Emerging markets are attracting
signicant 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

signicantly, 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 lms 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
rms 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 protable
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
rms could soon outpace the growth in
supply of local production talent. This
could lead to super-ination 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 nal critical success factor is exibility.
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 exible business plans
which do not always need to be approved
by the regional ofce and the head ofce.
• 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
15
Strategic business risk 2008 — The top 10 risks for business
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 rms 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’ rms.
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
protability, 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 signicantly. 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 innitely worse.”

5 Industry consolidation/transition

6 Energy shocks
Strategic business risk 2008 — The top 10 risks for business
16
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 proles 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 ve 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 protable
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 signicant
regulatory, market, nancial, 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 exible 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’ condence.
New technologies will change the market.
The successful utilities of the future will be
those who make the bold decisions to ex
their assets, supply chains, and operating
models. Governments, and corporates,
should consider a diversied 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extheirassets,supplychains,and
operating models.”
Tony Ward, Ernst & Young
17
Strategic business risk 2008 — The top 10 risks for business
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
signicantly 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, rms are employing
M&A in the hope of “acquiring… talent that cannot be home-grown.”

We have been operating in a low ination global economy for some
time. Our analysts believe that the return of high ination is a
major risk. Cost ination, though the result of various drivers, is a
signicant 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 renery 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 prole, 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, benets, 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 ination 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 ination
Strategic business risk 2008 — The top 10 risks for business
18
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 scientically conservative
scenarios (i.e., those which most scientists agree are likely). Yet
scientically 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 rms are currently planning for.”

In the short term, barring such unexpected developments, the
strategic challenge centers on how much ‘radical greening’ rms
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 rms 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 inuence 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 xed 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 rms 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 nal 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 signicant, 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.

9 Radical greening

10 Consumer demand shifts
“ 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
19
Strategic business risk 2008 — The top 10 risks for business
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 rms.
Many oil and gas rms are already
demonstrating leading practice in
environmental compliance, but in a
zero tolerance environment mistakes
will occur. New roles, such as an
environmental ofcer, 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 rm a leader in
offshore oil also apply to offshore wind.
Moving into renewable energy is not a
‘one size ts 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 rms are nding
renewables and clean energy a protable
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.