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Enterprise value at risk

New report on risk management in consumer sectors is launched by the Centre for Risk Studies at Cambridge Judge Business School in collaboration with the Institute for Risk Management.

Figures trying to find a path through the traps.

A new model to assess six types of risk in the consumer sector, developed by the Centre for Risk Studies at Cambridge Judge Business School in collaboration with the Institute for Risk Management, was unveiled today (14 November) at a conference in London.

The new report translates six types of risk to value lost to a consumer business over a five-year period, and adopts a yardstick to measure this loss called “5yrEV@Risk” – or “Five-Year Enterprise Value at Risk”.

“This provides a consistent risk metric that is meaningful to managers,” the report says. “Enterprise Value at Risk is a proxy for stock price instability, and can be derived for a wide range of different types of risk.”

As consumer spending comprises more than 50 per cent of gross domestic product in many advanced economies, and more than 65 per cent in the UK and US, risk assessment is increasingly important to firms in the consumer sector.

“Traditional dimensions of inherent risk in consumer sectors include thin profit margins, global supply chain challenges regarding operations and sustainability, and economic fluctuations affecting both retail demand and cross-border supply costs,” the report says.

The 47-page report – entitled “Risk Management for the Consumer Sectors” – was launched at the Institute of Risk Management’s 10th Annual Risk Leaders Conference in London.

“The scenario-based approach developed in this report will provide useful guidance to practitioners looking for robust and objective ways of evaluating and prioritising these risks in the context of the business balance sheet,” said Socrates Coudounaris, IRM Chair and Risk Management Director of the Reinsurance Group of America, in a foreword to the new report.

The report looks at risks faced by a “fictional but realistic” company in the consumer sector, called Avocado plc, a leading food company in the FTSE 100 list of top UK stocks. The report’s case study draws on information modelled from several real businesses to represent various elements of this fictional avocado business.

The six risk scenarios modelled for Avocado are:

  • A trade dispute involving the United States and European Union
  • Geopolitical conflict, in this case involving India and Pakistan
  • Cyber attack in the form of a contagious malware infestation
  • Natural catastrophe involving flooding to a key facility
  • Pandemic, in this case a highly infectious influenza virus
  • Governance issues in the form of an equal pay movement.

These are chosen to represent six major risk classes: financial, geopolitical, technology, environmental, social and governance.

The report develops a method for translating each of these major risk classes into explicit scenarios in an organisation’s risk register, representing how it might occur and how it could affect the business. Such a model is derived by devising a “digital twin” of the company’s five-year balance sheet with and without the six risks occurring, which “provides an objective way of ranking them and exploring the most effective risk management actions”.

Professor Daniel Ralph
Professor Daniel Ralph

For example, the US-EU trade dispute scenario looks at the impact on a UK-headquartered European business that has a major component of its revenues in the US. It looks at what might happen if tariffs are imposed by both sides, evaluating four different levels of severity with tariffs ranging from 10 per cent to 140 per cent. Risks from the other five scenarios are evaluated based on three different levels of severity.

The report says there is unpredictability in whether any of the six modelled risks may occur, but it views all six types as “foreseeable in that history provides some basis for estimating future impacts”.

“Unpredictability or low risk of a damaging event is no excuse for lack of preparation,” says Professor Daniel Ralph at the Centre for Risk Studies. “Enterprise Value at Risk converts any risk scenario into a loss number, and puts a value on any mitigation. This is the building block for managing a firm’s resilience in a universe of risks.”