Are Mid-Market Businesses Ready to Take on the World?

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Are Mid-Market Businesses Ready to Take on the World?As mid-market firms expand internationally, they need a new, holistic approach to risk management.

WSJ. Custom Studios ©2014The Wall Street Journal news organization was not involved in the creation of this content

GOING GLOBALMID-MARKET BUSINESSES TAKE ON THE WORLD

A significant number of mid-market companies plan aggressive expansion into international markets, but most are not adequately prepared to

manage and mitigate the risks that come with moving operations into new areas around the world.

According to a new survey conducted by AIG in partnership with WSJ. Custom Studios and IPSOS, mid-market firms share a striking similarity in the risk challenges they face, the deficiencies in their current risk-management programs, and the risk-management strategies they are employing or need to employ as they take advantage of opportunities in new regions of the world.

Amid the troubling warning signs of inadequate risk management, there is good news: A clear path is emerging for how mid-market companies should handle their expansion risks. Leading firms are adopting a holistic approach to risk management and finding new ways to measure and address risk. A thoughtful, all-encompassing strategy — driven by the support of top executives — can position a mid-market company to reap the full benefits of an expanding global economy in the safest possible way.

Raising the Profile of Risk ManagementAIG’s risk survey showcases how mid-market firms are globalizing rapidly and consequently facing new risks, such as unfamiliar local business conditions, suppliers, and laws and regulations. The most challenging risks vary substantially by industry, but threats from natural and non-natural catastrophes are of broad concern, as are liability claims. The methods mid-market firms use to control risks differ for each risk category, with risk transfer standing out as the most important for property and catastrophic risks. Executives say that difficulty identifying risks and lack of offshore market expertise are the biggest obstacles they face in achieving better risk-

management outcomes — and that external risk-management experts are the most powerful solution.

“Risks that can impact businesses may never be completely avoided, but mechanisms can be put in place to gather information quickly about exposures in a particular region — natural catastrophes, political turmoil, labor unrest, port closures and the like. This type of due diligence evaluation is critical to the expansion process, and becomes even more so as mid-market companies expand into global markets,” says Carol Barton, Head of Product Strategy, AIG Global Property. “With knowledge of the risks at hand, steps can be taken in advance to help reduce the impact of unfamiliar risks that can cause large-scale events.”

As the world evolves and the global landscape becomes more competitive, mid-market companies need to raise the bar on risk quality around the world. Barton states, “Global competition doesn’t just mean companies need to strategically position themselves in the four corners of the world. They need to take steps to adequately protect their facilities and resources, because the fate of their business may depend on it.”

Identifying Risks of Global ExpansionDonald Roy Lessard, a professor of international management at the MIT Sloan School of Management, quickly ticks off a long list of reasons why global economic boundaries are disappearing, from technology and travel improvements to greater knowledge sharing to the fact that smaller companies can more easily develop a niche in the global economy than in the past.Indeed, in a world with ever-shrinking economic and communication borders, mid-market companies across all industries are reaching the conclusion that they can no longer afford to remain isolated in their home markets.


“ With knowledge of the risks at hand, steps can be taken in advance to help reduce the impact of unfamiliar risks that can cause large-scale events.”

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“While there are risks in going abroad, not going abroad also has its risks,” states Anil K. Makhija, dean of The Ohio State University Fisher College of Business and academic director of the National Center for the Middle Market (NCMM). “Foreign competition is likely to appear on your shores soon in a shrinking world. You cannot be assured of a permanent cocoon protected from foreign competitors. And those firms that have gone abroad assert that, as a result, they became more competitive in their domestic market.”

Most Firms Lack a Holistic Risk StrategyDespite the compelling evidence that international expansion is fast becoming an economic imperative, the lack of familiarity with these new markets provides far-ranging challenges to mid-market companies in terms of risk management.

According to the AIG risk survey, little more than one-third of respondent middle-market companies have a comprehensive enterprise risk management (ERM) program at their organization. ERM is a holistic approach to risk management that can help identify and manage all types of risk. The process requires a company to

segregate the different categories of risk and go through them systematically. This figure is significantly less than the number of larger firms with ERM programs, as reported in other risk management surveys.


“ While there are risks in going abroad, not going abroad also has its risks.”

Braving a New WorldAccording to a new survey conducted by AIG in partnership with WSJ. Custom Studios and IPSOS, a significant number of mid-market companies plan aggressive expansion into international markets, but most are not adequately prepared to manage the risks. Some of the most difficult risks to manage are:

CATASTROPHIC RISKCYBER SECURITY

REGULATORY RISK

POLITICAL UNREST

BU

SINESS INTERRUPTIO

N

LOSS

O

F INTELLECTUAL CAPITA

L

LOCAL SUPPLIERS

EQUIP

MENT BREAKDOWN

35% 24% 23% 22%

21% 17% 16% 14%

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More than one-quarter of mid-market executives say that business unit leaders are responsible for risk management only within their own operations. This relative lack of a comprehensive strategy undermines the ability of many companies to adequately identify, assess and manage unfamiliar risks in new offshore markets. For mid-size companies, an ERM strategy need not be as elaborate as those employed by larger companies; however, companies should still view risk through a methodical and systematic lens.

Leading Strategies for Controlling RiskMid-market executives concede they have large gaps in their ability to cope with the wide variety of risks found in different markets. While large organizations tend to grapple with organizational silos, that concern appeared at the bottom of the mid-market list. The biggest internal challenges for mid-market firms are lack of offshore market expertise (38 percent) and lack of risk-management expertise within the organization (32 percent).

Companies take a variety of approaches to deal with risk. Risk reduction — defined as “implementing operational procedures to reduce risk exposure” — is most typically applied for physical security, as cited by 39 percent of executives in the survey, followed by loss of intellectual capital at 36 percent. Risk mitigation


Expanding Abroad: Risk Through the Lens of 7 Industries

Catastrophic risks are top-of-mind for construction and real estate executives, with 44% including

CATA

STROPHIC RISK 44%

them as one of the top three external risks. Relative to other industries, construction and real estate stand out for attributing the largest importance to political/social unrest (26%).

2Not surprisingly, professional services firms have a strong concern for loss of intellectual capital, with

3Executives at mid-market manufacturers perceive a broader array of risks from international expansion than other industries. Business interruption is the most threatening preventable risk; reliability of local suppliers/partners is their top strategy risk (26%).

1 4 5 6 7While this segment is concerned about catastrophic risk (40%), it stands apart from other industries in assigning the highest importance to civil disruptions (30%).

These firms worry most about cyber security. More than four out of 10 executives cite it as one of their most important risks, more than any other industry. Regulatory/legislative/fiscal uncertainty is the second-ranked issue. This industry is only concerned about non-natural catastrophic risks, as opposed to natural catastrophes. This type of risk was cited by nearly a quarter of respondents.

Far and away, these executives are concerned about catastrophic risk (45%, weighed heavily to natural risks).

More than a third of executives in this category consider business interruption their most important risk. Catastrophic risk ranks second at 30%, with non-natural risks weighing on their minds twice as much as natural risks. Liability claims and regulatory/legislative/fiscal uncertainty are also top worries at 25% each.35%

catastrophic risk

Even so, this segment has two greater worries:

32%

regulatory/legislative/fiscal uncertainty

29% citing it as one of their top issues, more than in any other industry.

FINANCIAL SERVICES AND INSURANCE

ENERGY, RESOURCES, CHEMICALS

PROFESSIONAL SERVICES

CONSTRUCTION AND REAL ESTATE

MANUFACTURING TECHNOLOGY,TELECOM, IT

TRANSPORTATION, LOGISTICS, DISTRIBUTION

Far behind is regulatory/legislative/fiscal uncertainty, mentioned by roughly a quarter of those polled.

CATA

STROPHIC RISK 45%

CATA

STROPHIC RISK 40%

Catastrophic risk, loss of intellectual capital, business interruption — a new survey conducted by AIG in partnership with WSJ. Custom Studios and IPSOS reveals that mid-market firms expanding internationally perceive a variety of challenges ahead. Here’s a comparative look at those risks, by industry.

Other important risks include regulatory/legislative/fiscal uncertainty (30%) and business interruption (25%).

LOSS

OF INTELLECTUA

L CAPITAL

29%

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is widely used to control labor unrest and uncertainty, and reputational risk. Risk transfer is most popularly used to manage property risk and catastrophic risk.

While insurance can help a company rebuild a facility or manufacturing plant, it will not stem the loss of market share or reputational damage from an extended closure, or the loss of trained employees who leave while the rebuilding takes place.

For those reasons, there is a growing call for risk-reduction strategies that focus on business continuity. Business contingency planning should be a growing priority, in light of the complexity of global supply chains and the interconnectedness of the world’s economy. One-quarter of companies use employee training and awareness-raising measures to reduce risk.

Still, experts say that some vital risk strategies are overlooked. “Many companies do not set aside money for risk improvement as part of their annual budgeting process,” says Barton. “It’s human nature to think, ‘It won’t happen to us’ or ‘We have insurance.’ But in this globally competitive environment with just-in-time manufacturing, preferred supplier lists and lots of competitors ready to step in, companies cannot afford to sustain a business interruption for an extended period — they need to take steps to reduce their exposure to loss. A large accident or event can result in serious consequences to market share, brand reputation and the bottom line. It also can generate unwanted attention from the media, creating adverse publicity, and from local governmental authorities, which could result in penalties and additional scrutiny in the future.”

Another less commonly talked-about risk strategy is deciding who at the company should oversee a global expansion. “There is an old story that smaller companies tend to send their brother-in-law to head up local programs in


The Deceptive Risks of Supply Chains The search for efficiency can increase supply chain mishaps

Supply chains bring special challenges. For example, many

organizations fail to understand the link between greater

efficiency and increasing supply chain risk, according to John

Hampton, former executive director of the Risk and Insurance

Management Society.

He assisted a middle-market company that shipped products

from three warehouses and wanted to assess the cost

savings from consolidating into one large distribution site.

“The most important finding was the lack of a plan for

disruption if a single warehouse suffered a fire or other serious

damage,” he says. “Since the company sold a high percentage of

its inventory as Christmas seasonal items, a disruption for only

a few weeks would likely bankrupt it. This finding caused the

company to develop a backup strategy.”

Hampton adds that failing to examine risks across an entire

supply chain can cause disruption that is totally unexpected.

For example, electronics companies were caught completely

off guard by the 2010 floods in Thailand when they could

not get components and repair parts from flooded factories

for months. Companies were seriously hurt from failing to recognize the risk of sole sourcing key components.

“ Many companies do not set aside money for risk improvement as part of their annual budgeting process.”

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“ ...you need to get to know international partners and get them to trust you, so you should have a key member of your own team on the ground to establish that relationship.”

nearby markets and rely on outside partners when they expand to distant but important markets,” Lessard says. “It should actually be the other way around.”

He points out that when a large American capital goods company announced a big push to expand its global operations, the firm appointed its vice chairman to head the effort and he actually moved to Hong Kong. “There’s an important lesson there for mid-market companies, because you need to get to know international partners and get them to trust you, so you should have a key member of your own team on the ground to establish that relationship,” Lessard says.

Why Are Simple Steps Ignored?The lack of risk preparedness raises an obvious question: If simple and common sense safeguards can reduce the impact of an event, why do companies very often ignore them?

“People tend to do things that make situations worse,” explains Karlene Roberts, director of the Center for Catastrophic Risk Management (CCRM) at the University of California, Berkeley.

She points to a colleague’s research showing that only 20 percent of engineering disasters are the result of “intrinsic uncertainties” — that is, natural events such as tornadoes and dust storms. In contrast, 80 percent

stem from “extrinsic uncertainties” — commonly known as human error. “Companies have the attitude that ‘It won’t happen in my backyard on my watch,’” says Roberts.

Barton relates how following a recent earthquake, she was struck by how many companies that suffered severe damage to their buildings simply repaired them back to their previous condition rather than looking for ways to make them stronger.

Contingency Planning Think about the little things when shoring up your officesBusiness contingency planning, which takes into account a lot of “the simple stuff,” should be a growing priority for companies setting up shop in new regions, particularly in light of the complexity of global supply chains.

Address single supplier risks through appropriate contract verbiage.

EXITPut expensive equipment on higher floors prior to vacating the building for a flood warning.

Have temporary housing for employees ready to be set up near the plant.

Strengthen your property in preparation for the next event and make improvements based on lessons learned when repairing your facilities after a catastrophe.

Understand where the items that are critical to your operation are sourced and make sure to have more than one source in your back pocket.

Transfer backup data to a distant locale from your primary operations, so all facilities won’t be destroyed by the same disaster.

Teach employees risk-safety measures. When a company demonstrates concern for physical safety, employees take more personal responsibility to reduce risk.

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“One hotel had television sets in every room that were connected to the walls by little hooks, so the TVs flew all over the place during the quake,” she says. Meanwhile, down the road, a different hotel had televisions that were securely fastened to its walls — they suffered little damage and were back in operation quickly.

“Companies overlook simple solutions because they may not be focused on how to prevent a recurrence,” Barton explains. “The first hotel may not have been aware that the second hotel suffered much less damage, so it had nothing to compare itself to. It’s important to reach out to strategic partners who can help by sharing lessons from losses.”

Along the same lines, Roberts points to the Deepwater Horizon oil spill that occurred in the Gulf of Mexico in April 2010. A year before that devastating incident occurred, a similar, albeit smaller episode took place with another company in Australia. It could have served as a model to reduce risk if the information about the mishap had been shared and analyzed more thoroughly.

Conclusion: Risk Management as Competitive AdvantageThe world is shrinking, and business opportunities are growing. Over the next 12 months, globalization will continue at pace for mid-market companies — and it will not be limited to particular industries. Increasingly, opening offices abroad will become part of the standard business plan.

Many companies are aware of the risks, but now they are beginning to couple that awareness with the recognition that they also need a formal structure to monitor, measure and manage risk. While few mid-market firms now employ ERM, most of those that do rate their risk-management ability “well above average”— a crucial finding in a time when “black swan” events increasingly disrupt global supply chains and show how interconnected the world has become.

Mid-market companies need to think bigger and consider more proactive ways to reduce potential setbacks. They must take a holistic approach to risk, ensuring that all elements of the challenges they may face are being considered in a methodical way. In a global marketplace, strong risk management can emerge as a competitive advantage, preparing companies to gain or maintain a leading position in their industries when catastrophic events inevitably occur.

“ People tend to do things that make situations worse.”


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This work was commissioned by AIG.

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New York, NY 10038www.aig.com

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IN COLLABORATION WITHGOING GLOBALMID-MARKET BUSINESSES TAKE ON THE WORLD

Who took the survey?

In July 2014, WSJ. Custom Studios worked with Ipsos to carry out a global survey of 300 senior executives from mid-market firms with revenues between US$50MM and $500MM, using quota sampling. Approximately equal proportions are located in Europe (33%), North America (31%) and Asia-Pacific (30%), with the remainder from Latin America. Respondents are engaged in more than 20 industries, with the strongest concentration coming from manufacturing (11%), professional services (11%), financial services (11%) and construction/real estate (9%). More than 60% are C-level executives, another 25% are VPs or SVPs, and 13% identify themselves as risk managers.

Asia-Pacific

Latin America

North America

Europe33%

6%

31%

30%

American International Group, Inc. (AIG) is a leading international insurance organization serving customers in more than 130 countries. AIG companies serve commercial, institutional, and individual customers through one of the most extensive worldwide property-casualty networks of any insurer. In addition, AIG companies are leading providers of life insurance and retirement services in theUnited States. AIG common stock is listed on the New York Stock Exchange and the Tokyo Stock Exchange.

Additional information about AIG can be found at www.aig.com YouTube: www.youtube.com/aig Twitter: @AIG_LatestNews LinkedIn: http://www.linkedin.com/company/aig

AIG is the marketing name for the worldwide property-casualty, life and retirement, and general insurance operations of American International Group, Inc. For additional information, please visit our website at www.aig.com. All products and services are written or provided by subsidiaries or affiliates of American International Group, Inc. Products or services may not be available in all countries, and coverage is subject to actual policy language. Non-insurance products and services may be provided by independent third parties. Certain property-casualty coverages may be provided by a surplus lines insurer. Surplus lines insurers do not generally participate in state guaranty funds, and insureds are therefore not protected by such funds.

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Are Mid-Market Businesses Ready to Take on the World?