Business-Continuity Plans Evolve

Sticking accelerators and inconsistent braking mechanisms were unrelated design issues, but the highly publicized and closely timed nature of Toyota’s recent product recalls magnified damages to the company’s reputation. This is precisely the kind of crisis scenario that can keep retail risk managers in a state of perpetual paranoia.

Hazardous risks—such as product recalls resulting from potential harm to individuals, in-store accidents like slip-and-fall claims, worker’s compensation claims and property damages—have always been high on the list of critical concerns for risk managers. However, as retailers are increasingly dependent on global commerce and as uncertainties escalate worldwide, retailers have begun to expand the definition of risk management.

Mac Nadel, national retail/wholesale industry practice leader at Marsh Risk Consulting, based in Norwalk, Conn., noted that retailers have become more focused on operational, financial and strategic risks.

The 2010 Global Risks Report, released in January by the World Economic Forum’s Global Risk Network, underscores the need for this shift in focus. The annual report, in its fifth year of compilation, identifies risks that are global in scope, have cross-industry implications and are likely to carry significant economic and social impact. The 2010 report cited fiscal crises and continued unemployment, underinvestment in infrastructures and chronic diseases as risks with the greatest likelihood of occurring and with the most widespread, pervasive repercussions.

“It’s important for retailers to think of all those ‘what-if’ scenarios that are beyond their control, and if there was a crisis how they would respond and reassure customers that they were doing all that could be done to address problems,” Nadel said. “They have to consider all the things with product liabilities and global supply chains that could damage their brand and reputation.”

For example, the recent threats posed by the H1N1 pandemic motivated retail risk managers to “revisit” or create new business-continuity plans.

“Fortunately, H1N1 has not reached the proportions that were predicted, but many retailers have put strategic plans in place to deal with it,” Nadel observed. “If a retailer had five stores in a market and several employees became ill, they might only open three of the five stores—whatever they had enough healthy staff to support. Retailers have also ramped up their Internet fulfillment capabilities, anticipating that people would shop online instead of venturing out in public.”

Rather than the threat of any single risk factor such as a pandemic, the Global Risks Report stresses it is the “interconnectedness” of all risks that must be dealt with, reinforcing that risks must be evaluated operationally, financially and strategically.

Defining the financial implications is possibly the most challenging aspect for a retail organization, but financial institutions and banks increasingly expect businesses to perform stress tests that would evaluate the impact of various risk events on cash flow, capital resources and corporate liquidity, according to Tom Scotti, president, asset appraisal and valuation division, Gordon Brothers Group, which helps retailers identify capital resources primarily through asset-based financing.

“Given the volatility in the marketplace and the changing dynamics we have seen over the last 18 months, there is a growing need to run what-if scenarios that show how collateral values would be impacted,” Scotti said.

The spotlight has begun to shine more intensely on financial risks largely because of the economic crisis and constricted credit lines, which has led to a heightened awareness of the cost of capital.

“Most retail companies have focused on reducing selling and general administrative lines, so even though comp sales were down, they were able to show some increase in margins,” Nadel said. “In the area of risk management, retailers are focused on managing retained losses, such as workers compensation and automotive liabilities.”

Retained losses represent a significant expense for most retail organizations. One way retailers have begun dealing with retained losses has been to transfer their loss portfolios to a third party, effectively removing those old liabilities from their balance sheets.