As all businesses expanding beyond national boundaries learn, global market opportunities go hand in hand with intrinsic risks. Whether one is aware or not, SMEs operating in foreign markets are routinely exposed to many risks. Examples include:
· Price risk—probability of loss due to unforeseen price fluctuations
· Credit risk—probability of loss due to nonpayment for goods supplied in compliance with contract terms
· Political risk—probability of loss due to political instability in countries in the supply chain
· Transit risk—probability of cargo loss or damage during shipping and warehousing
· Performance risk—probability of loss due to underperformance or nonperformance of contractual obligations by counterparties in the supply chain
· Operational risk—probability of loss due to human error and failing internal controls and procedures
· Legal risk—probability of loss due to flaws and inconsistencies in international contracts, deeds, and legal frameworks
· Fraud risk—probability of loss due to misrepresentation, forgery of documents, corruption, and other fraudulent actions
· Compliance risk—probability of loss due to unintended violation of laws and regulations
· Exchange rate risk—probability of loss due to currency exchange rate fluctuations
Most of these risks are inevitable, but you may considerably reduce their adverse effects through proactive risk management. In practice, while everybody agrees that prevention is better than cure and that one should better learn from others’ mistakes, most SMEs engaged in export activities prefer to “do it yourself”—that is, develop risk management practices in response to adverse events in international business. Inadequate or nonexistent risk management policies raise the probability and magnitude of losses, impede global competitiveness, and exacerbate “knowledge leaks” as these organizations grow.
Formalized vs. informal
In essence, a risk management policy consists of formal procedures for continual identification, appraisal, and mitigation of potential events that may harm your business. An all-important ingredient of a functioning policy is recognition of risk management as a distinctive business process in the C-Suite. ISO 31000:2009 provides a methodology for building a solid risk management policy for any organization.
No risk can be dealt with before it is recognized. A major threat to new exporters relates to unpremeditated ignorance concerning certain risks due to a lack of relevant experience. In the context of international trade, critical areas include contract interpretation, performance and enforcement, cargo safety and condition during transportation, handling and warehousing, compliance with national and international regulations and sanctions, shipping documents, collection of payments, claims presentation and settlements, and so forth. Latent risks may be only recognized by experienced professionals, so you should bring them on board early.
A thorough appraisal of risks is required to strike a balance between the financial effects of risk reduction and resources applied. Some events are very unlikely to occur, but the mitigation of related risks is costly and onerous. Such risks may be accepted as a general precondition of doing international business. You should find out, however, how these risks are addressed by the competition.
The risk should be mitigated when the financial benefit of risk reduction significantly exceeds the cost of risk reduction. Risk mitigation techniques include partial transfer of the risk to a third party (such as in insurance), reducing the risk likelihood (such as in verifying counterparty credentials), and reducing adverse effects of the risk (such as in establishing maximum customer credit exposure).
And what to do if you face a high-probability risk that may have a devastating effect on your business and cannot be mitigated? It all depends on the circumstances, but the best default strategy is to avoid such risk altogether.
Risk management vs. insurance
A proficient risk management policy is tailored to each organization and spans all functional areas. On the contrary, insurance policies—which many SMEs mistakenly equate to risk management—are uniform legal agreements establishing very stringent performance criteria. Insurance coverage may be denied if the assured fails to perform in strict compliance with the policy. As the current economy renders some insurance companies increasingly vulnerable, you should exercise due diligence in selecting your underwriters, as well as develop techniques to mitigate the related counterparty risk.
If your company is serious about growing international business, ignoring risk management is akin to sticking one’s head in the sand. To fully embrace the benefits of globalization, the SMEs should proactively identify and manage international trade risks. Once established, your risk management policy will not only avert losses, but also underpin commercial success in the long run.