strategy & risk management -role of ia - iaaia hock kee (cg board... · turning lack swans into...

Turning Black Swans Into Opportunities… Strategy & Risk Management

-Role of IA

By

Wee Hock Kee

Managing Partner, CG Board Asia Pacific, Malaysia

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Reality

Are your existing GRC frameworks helping business/operations staff advance the dialogue?

The time may come when the fundamentals of your business are about to change

It is not what you know that matters; it is what you don’t know that

makes the difference between winning and losing

Your business is boundaryless and is not an island in and of itself

Sooner or later, there will be a crisis that will test your company

Management and directors are struggling with delineating between risk

management and risk oversight

Five Realities for Every CEO and Board

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VISION, LEADERSHIP AND RISK AND GOVERNANCE

90:1090:10-- Neil Armstrong First man in the moon Neil Armstrong First man in the moon 30:30:30:10 Jeff 30:30:30:10 Jeff ImmeltImmelt GE CEO Discipline GE CEO Discipline John Collins Good to Great John Collins Good to Great –– humility & humility & discipline discipline 40:60 Dato’ Sri 40:60 Dato’ Sri IdrisIdris JalaJala Minister in PM’s Minister in PM’s department control and divine intervention department control and divine intervention

4 CG BOARD ASIA PACIFIC

Space risk management and space governance “Governments must take the lead in reviewing how risk assessment for flying over conflict zones are made” – Tony Tyler Head IATA

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Rest Assured: What Keeps AC Up At Night?

• IT Risk and Emerging Technologies

• Risk Management

• Legal/Regulatory Compliance

• Growth, Strategy and Innovation Risk

• Audit Committee Effectiveness

Source: Tone at the top KPMG Audit Committee Institute Survey on AC Members

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BOD- Reviewing and Adopting a strategic plan for the company

“The role of the board is to review, challenge and approve management’s proposal on a strategic plan for the company. The board brings objectivity and breadth of judgment to the strategic planning process as they are not involved in day-to-day management of the business. The board should satisfy itself that management has taken into account all appropriate considerations in establishing the strategic plan for the company. The board is also responsible for monitoring the implementation of the strategic plan by management. “

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BOARD- Recognize and Manage Risks

The board should determine the company’s level of The board should determine the company’s level of risk risk tolerance tolerance and actively and actively identify,identify, assessassess and and monitor monitor key key business risks to safeguard shareholders’ investments and business risks to safeguard shareholders’ investments and the company’s assets;the company’s assets; Case studies :Case studies : GSK scandal in China GSK scandal in China –– was the board aware of the illegal was the board aware of the illegal payments to doctors? payments to doctors?

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Black Swan

“The black swan theory or

theory of black swan

events is a metaphor that

describes an event that is a

surprise [to the observer],

has a major effect, and

after the fact is often

inappropriately rationalized

with the benefit of

hindsight”

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Executive Perspectives on Key Global Risks in 2014:

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IMF SEES LOWER GLOBAL GROWTH, EUROZONE STAGNATION RISK , WORLD FACES RISKS FROM RUSSIA-UKRAINE, MIDDLE EAST CRISIS AND EBOLA OUTBREAK SOURCE: EDGE FD RISK EXPOSURE TO AILRINE?

AIRLINE CORE RISKS

1. Strategic risk 2 financial risk 3 operational risk 4 hazard risk

1

2

4

3

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HOW FAST YOU COULD RECOVER FROM A DISASTER?

It is the damage that puts you behind your competitors

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CRUCIAL TO IMPROVE PRODUCTIVITY AS CAPITAL AND RESOURCES ARE NOT FREELY AVAILABLE AS IN THE PAST WITH . THE MOST IMPORTANT DELTA FOR GROWTH WILL BE AN IMPROVEMENT IN PRODUCTIVITY SOURCE:EDGE FD

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BUSINESS CHANGES AND IMPACT ON CONTROL

PwC Global CEO Survey

Do you anticipate a major change at your company in the following areas next 12 months?

1. Customer strategies – 31%

2. Managing talent – 23%

3. Organizational structure- 22%

4. M&A, JV or strategic alliance- 22%

5. Technology investment – 21%

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ERM Maturity Level

+ Adapted from the Capability Maturity Model framework developed by Carnegie Mellon University, 1993.

Ad-hoc Fragmented Comprehensiv

e Integrated Strategic

Overarching risk

management philosophy or

objectives are not defined

Risk management

functions independently

within business units

Risk management is enterprise-

wide and encompasses all risk types

Risks are treated as a portfolio at

the enterprise level and are

correlated and aggregated across risk types and

business units

Risk management is

built into decision

making. The organisation selectively

seizes opportunity

because of its special ability to exploit risks

Risk Management: Capability Maturity Model +


Decline in core products demand

Poor acquisition merger

integration

Competitor infringement on

core product

Failure to identify asset price bubble

Destruction price war

NON TRADITIONAL ASSURANCE

STRATEGIC RISKS- 68% STRATEGIC RISKS- 68%


Undiversified partnership risk

Margin pressure Investor loss of confidence

Senior management

team turnover

Failure to extend alternative revenue sources

NON TRADITINAL ASSURANCE

STRATEGIC RISKS- 68% STRATEGIC RISKS- 68%

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DIGITILISATION -DECLINE IN CORE PRODUCT “After Kodak’s founder Eastman Kodak first started using

his patented emulsion coating machine in 1880 to mass produce dry plates for photography, Kodak dominated the world of film and photography with sales surpassing US10b in 1981. Then upon taking over as Kodak’s CEO George Fisher declared: when I arrived in late 1993, we were over committed and over extended. We were not only in the imaging business, we were also selling aspirin, paint thinner, air freshener, and a host of other things far removed from the company’s core. Our debt was astronomical by both historical and industry standards” VERTICAL GROWTH M & A RISK

M&A FRAUD –USD 1.5 b VERTICAL GROWTH

Stonewalled :Ex CEO Olympus Michael Woodford Acquisitions: Altis- disposal of industrial waste from hospitals News Chef- develops and markets microwavable dishes Humalabo- sells mail order cosmetics and health foods

CORE BUSINESS :70% WORLD ‘S MEDICAL ENDOSCOPE WITH ANNUAL SALES OF USD4B.

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Source: YahooFinance

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Reinventing Nokia -Unveils first tablet as part of Microsoft's consumer device push

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WHILE TRAFFIC IN THE OVERALL MALAYSIAN MARKET HAS BEEN UP SIGNIFICANTLY BY 20% IN 2013 AND 12% IN H1 2104, THE GAINS CAME AT THE EXPENSE OF YIELDS EBIT MARGIN DOWN 4 PPTS Q2 YTY AT 13% OPPOSED TO THE NORMAL EBIT MARGIN OF ABOVE 20%.

COMPETITION FROM MALINDO WITH STRONG BACKING FROM LION AIR AND LEVERAGING ON LION AIR HUGE ORDER BOOK WHERE THERE IS FLEXIBILITY TO CHANGE ALLOCATIONS DEPENDING ON MARKET AA WAS TO HAVE SOLD 12 OF ITS OLDEST PLANES THIS YEAR, 6 BY Q2 BUT IT DID NOT SELL ANY. ALSO IN TALKS WITH AIRBUS TO SELL 4 OF ITS NEW A320. IN SECOND HALF 2014 BUT MAY CHANGE OF HEART FOLLOWING MAS RATIONALIZATION

10 more low cost carriers entering market this year

Source: Focus Malaysia

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“MODIFIED ITS MID RANGE BUSINESS PLAN TO ADDRESS THE SIGNIFICANT CHANGE IN THE MARKET AND COMPETITIVE ENVIRONMENT OF THE MOBILE BUSINESS. THIS REVISION INCLUDES CHANGING THE STRATEGY OF THE MOBILE SEGMENT IN CERTAIN GEOGRAPHICAL AREAS, CONCENTRATING ON ITS PREMIUM LINE-UP AND REDUCING THE NUMBER OF MODELS IN ITS MID RANGE LINE-UP”

Source: The Edge Financial Daily

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ACTIVE VOLUME PASSIVE YIELD “The price war is

ending not only in Malaysia but across the region as industry players are tired of losing money. Our strategy is to keep prices low but not to sink below cost” – Tan Sri Tony Fernandes


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COMPETITION –PHILIP MORRIS DID NOT INCREASE THEIR PRICE YET “HOWEVER TO REMAIN COMPETITIVE, WE HAVE DECIDED TO REVERT TO OUR OLD PRICES”- BAT


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ANCILLARY REVENUE Extension of alternative revenue sources-courier service 50% cheaper than market. JV with R Box Asia Pte Ltd, utilizing its existing fleets (available belly space) as opposed to cargo with limited flight frequencies, their value proposition


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Single base customer risk Source: The Edge Financial Daily

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KEEP YOUR EYE ON THE TALENT QUESTIONS CAES SHOULD ASK

• What value does the organization place on human capital?

• Does the organization have an integrated approach to talent

management?

• Do company leaders play a meaningful role in the organization’s

talent management efforts?

• Do company risk assessment models consider talent

management?

• Does internal audit include talent management in its plan?

Source: Tone at the TOP IIA Global June 2013

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TO HEDGE OR NOT TO HEDGE

•”Firm believers in Modigliani and Miller’s theories would argue that companies theoretically should not hedge any risks since shareholders can diversify away any risks taken by the individual firm” OIL PRICE PER BARREL HAS DIPPED BELOW USD 100 AND EXPECTED TO GO AS LOW AS USD 90, WHAT IS YOUR ASSESSMENT ON THIS FINANCIAL RISK?

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Scorecard Performance Strategy

Source: IIARF

Mission/Vision/Strategy

Strategy Assessment Strategy Mapping

Refine Strategy SWOT Analysis

Assess Customer Needs Assess Capabilities

Strategy Maps Strategic Objectives

Performance Measures

Strategic Objectives

Performance Measures, Targets, Initiative

Innovation &

Capabilities

Internal Processes

Customers

Scorecard Refinement

Measures, Targets, Initiatives

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WITH MORE THAN 21000 STORES IN 65 COUNTRIES, IT HAS REDEFINED COFFEE DRINKING AROUND THE WORLD. THREE LATEST INNOVATIONS INNOVATING ON “OLD TECHNOLOGY” :-

1. NEW FORMATS THAT WOULD REDUCE CLIENT WAIT TIMES

2. WITH MORE PORDUCTS TO TEMPT THOSE WHO USE ITS STORES AS AN AD HOC OFFICE DURING THE DAY

3. EMPLOYING USER-DRIVEN CUSTOMISATION TO EXPAND ITS REACH AMONG GROUPS SUCH AS TEENAGERS AND TWEENS


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Rebutting claims that Apple is not innovative as Samsung, the unveiling of iOS8 and iPhone 6 and mobile payments proved critic wrong. Artificial Intelligence, the humanising of machines is the next frontier for technological advancement

Source from The Edge Financial Daily

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“AS A RESULT OF SIGNIFICANT CAPACITY INCREASE OF 48.2% OF ASK (AVERAGE SEAT KM) FROM JUNE 30,2013 AND THE NEED TO STIMULATE DEMAND TO ACHIEVE A LOAD FACTOR OF 80.4% IN THE THREE MONTHS ENDED JUNE30, 2014, YIELD AS MEASURED BY RASK (REVENUE PER AVAILABLE SEAT KM) HAS DECREASED 7% FROM 11.60 SEN IN THE THREE MONTHS ENDED JUNE 30 2013 TO 10.79 SEN IN THE THREE MONTHS ENDED JUNE30 2014” – AAX


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• Air Asia ANA Japan termination due to high operating cost

and disagreement on operating business model

• Air Asia reentry into India with Tata; Tata alliance with SIA

• Boeing 777x and Airbus A350 strategy coincides with

increase in intra-regional trade led by Asia

AIRLINE: STRATEGIC REFINEMENT/REALIGNMENT

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• SIA reconfiguration of premium economy seats- volume

and margin impact on business class seats

SQ AIRLINE SEAT RECONFIGURATION

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No orders from airlines so far this year and continuously seeking buyers that don’t yet have A380 in their fleet.


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Japan Airlines (JAL) turnround 2009, company suffered steep losses albeit it was Asia’s largest airline by

revenue

Overexposed to unprofitable domestic and overseas routes compounded by Sept 11, Iraq War, global financial crisis, SARs, bird flu health scares

Embarked on staff cuts & route cutbacks to reduce costs but not enough to stop company filing for bankruptcy

June2010, JAL entrenched in billions Yen in debt and mired in losses

JAL received 100b yen credit line from Tokyo

JAL applied for court protection under Corporate Rehabilitation Law

JAL managed to return to black; posted net profit 18.34b Yen in 3months ended June 2013

Revenue FY12 -1,205b Yen, FY13- 1,239b Yen, EBITDA FY- 12 286 b Yen, FY 13- 276 b Yen

PT Garuda Indonesia Turnround Affected by two major accidents in mid 90s & Asian financial crisis 97 and Sept 11, Bali

bombing and SARS outbreak

Garuda banned from European airspace in 07 because of safety concerns; lifted in late 2010 and resorted to debt restructuring in 2010

Turnaround started with the appointment of Emirsyah Satar in 05

He radically changed the government owned airline on operations, system & culture, opted cut routes, shrink business where flights had to be justified on bottom line

VSS 1000 out of 6500 members opted for this scheme

Cleared the real issue of the company – the lack of trust which is above other issues such as government interference in commercial decision &entrenched interest

Garuda recorded USD110.8m profit reflecting 72.6% increase from 2011

Revenue FY 2011 - US 2,151m, FY12- US 3,096m and FY13- US3,473m

EBITDA FY11-US174m, FY12-US226m and FY13 US 162m

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LEAN TIME FOR AIRLINES: THE EDGE FINANCIAL DAILY 30/9/14

Traditional carriers did not have a low enough cost structure to compete with

LCCs

Intra Asia as opposed to Trans –Atlantic, 48% of global air traffic in Asia by end of decade

Intra Asia ASKs expanded by 6.5% annually between 2013 and 2104 to reach 1.7 trillion

MAS was the fastest growing airline group in Asia last 3 years, and 65% capacity expansion was concentrated on short haul network

CAPA- 80% of the 50 airlines based in SEA have not been profitable in 1H2014, many continue to lose money; surging capacity led to price war

Only 4 out of 17 publicly traded airlines or subsidiaries in SEA were profitable in 1H2014

SIA reported third straight year of declining passenger yields for FY march ending; aggressive fares and capacity injections from competitors will continue to affect yields

Yields at Air Asia slumped to a five year low in 2QFY2014 resulting in core losses of RM13.4m

Capacity rationalization – Qantas and SIA have cut capacity by deploying Boeing 777s instead of B747 and Airbus 380

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Despite roughly 6% air traffic growth in AP over next 20 years, airline profitability is expected to remain narrow for the foreseeable future

As full carriers try to bring their cost structures in line with LCCs, the latter are trying to increase their revenue by offering add-on services, at an extra charge and deploying new state of the art jets and attempting to take on longer routes, in short the difference between LCC and full service business model is steadily NARROWING

Demand for business travel is also shrinking although there will always be demand for full service carriers and premium services

One full service airline seeing recovery in corporate demand is Cathay Pacific, reported a huge jump in earnings for 1HFY2014 at HK$347m versus HK$24M a year earlier

The silver lining to all this is that demand for air travel in general across the region will grow steadily. Air coverage will deepen into more markets. More airlines will emerge, but there will be more failure amongst the start ups. There will be a brand consolidation.

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LEAN TIME FOR AIRLINES: THE EDGE FINANCIAL DAILY 30/9/14

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SWOT Analysis to Develop Strategic Objectives

Source: IIARF

Strengths & Weaknesses (Internal)

Opportunities & Threats (External)

Strategic Objectives

Performance Measures

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STRATEGY AND RISK MANAGEMENT: A TOP DOWN APPROACH

Adapted from Internal Auditor December 2011

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ERM COSO 2 FRAMEWORK

ORGANISATION RISK STRUCTURE

1. INTERNAL ENVIRONMENT

2. OBJECTIVE SETTING

RISK ASSESSMENT

3. EVENT IDENTIFICATION

4. RISK ASSESSMENT

RISK MANAGEMENT

5. RISK RESPONSE

6. CONTROL ACTIVITIES

RISK MONITORING

7. INFORMATION & COMMUNICATION

8. MONITORING

INTERNATIONAL STANDARDS FOR THE

PROFESSIONAL PRACTICE OF

INTERNAL AUDITING

OCTOBER 2012

2130. A1 – The internal audit activity must evaluate the

adequacy and effectiveness of controls in responding to

risks within the organisation’s governance, operations,

and information systems regarding the:

1. Achievement of the organisation’s strategic

objectives

2. ..

3. ..

STRATEGIC RISK RESOURCE

ALLOCATION

Percentage of Risk Failures Leading to Significant Market

Decline

Percentage of Time Spent By Audit Departments on

these Risk types in 2014 /2015 Risk Categories

Strategic

Legal and

Compliance

Financial

Operational 13%

12%

Audit departments

report spending only 6% of their

time auditing strategic risks

7%

68%

Strategic risks account for 68%

of severe market declines

THREE COMMON STRATEGY FAILURE POINTS

Flawed Business Assumptions

Management assumptions may not be rigorously tested resulting in

organizational objectives that are inconsistent with the enterprise’s

capabilities or the realities of the business environment

Business Unit Misalignment

Lack of communication or a strategy development framework for

business units can result in business unit objectives and operating

plans that fail to align to enterprise objectives

Employee Understanding

Poor communication of strategic priorities throughout the

organization can lead to a lack of understanding and belief in the

future direction of the company

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Oversight, assurance and managing risk management Oversight, assurance and managing risk management

The internal auditors offer assurance as to management’s effectiveness regarding strategic risks, the risk management function provides the techniques and methods for management to be most effective

Management led by the CEO is primarily responsible for Assessing and Managing strategic risks to allow for deeper understanding and focused action on the most significant risks

At the end of the day, the board is ultimately responsible for risk management, CAN DELEGATE CANNOT ABIDICATE

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