How to Manage Economic Risk More Effectively
15 May 2020 3:51 pm
In the second blog in our series on PESTLE risk monitoring, we look at the "E"—Economic—and the role economic factors play in terms of the supply-chain and third-party risks organisations face.
Economics is at the core of every business. Defined as the production, consumption, and movement of wealth, economic factors have a significant influence over how successful, sustainable, and profitable an organisation is. But if things go wrong, economic risks can disrupt supply chains and destroy businesses. Let's look further at the types of economic risk and examples of how companies have mitigated their own economic risk and built business resilience.
Economic factors affecting business
Economic risk factors can be broken down into macro-economic and micro-economic factors. Macro-economic factors are ones involving the management of demand in an economy. Governments use interest rate control, taxation policy and government expenditure as their main mechanisms for managing macro-economic factors.
Micro-economic factors are smaller scale factors based on how people spend their incomes.
Interest rates, exchange rates, recession, inflation, taxes, and changes in demand and supply, can all pose a threat to the future survival of companies. Below, we look at three of the most significant economic risk factors, and how they can influence businesses.
Interest rates — Interest rate risk is relevant for any organisation that has any interest-bearing asset, such as a loan or a bond. The specific economic risk lies in the possibility of a change in the asset's value resulting from the variability of interest rates. Clearly, this is a significant area of risk for banking institutions, but it can also impact on any organisation using loans as part of their business strategy.
Exchange rates — Exchange rates can be complex and volatile, and they will have an impact on all business activities involving export or import. Changing exchange rates might affect how much a company has to pay its international suppliers, therefore affecting profit margins.
Recession — An economic recession (of whatever scale) has the potential to change the purchasing attitude of customers, which might force companies to drop their prices or change their business pan altogether.
Understanding economic risk is an essential component of sustainable business growth and smart decision making. Here are some case studies of how companies have considered their own economic factors, and identified and mitigated their specific risk factors.
Jessops: Adaptation to recession and market change
2008 saw the UK economy fall into recession. Over the following years unemployment rates increased, and many employers were forced to cut wages, leading to consumers having less disposable income to spend. This had a huge effect on the retail industry, and Jessops, a British photographic retail company reported declining sales on many of their camera and hardware products. Fortunately, the margins on services such as photo and imaging remained stable, and therefore, to minimise risk and improve profit margins Jessops focused attention on making its imaging business the market leader.
Another important economic influence on a business is change in market competition. Jessops faced increased competition from online photo printing companies and supermarkets offering lower prices.
Jessops responded to these economic risks with a more diverse, multi-channel strategy. Customers can now order images and gifts in instore and online, with a responsive call centre to support online services to draw on Jessops' longstanding expertise in the industry. The company has also increased its product portfolio. These responsive actions have enabled Jessops to obtain a competitive advantage, increasing its resilience to any future economic risks.
IKEA: Response to macroeconomic change
The macroeconomic climate and consumer spending power is one of the most significant factors affecting IKEA's, and other retailers', performance. The global financial crisis of 2007 – 2009 is a stark reminder of the impact that external economics can have on businesses. However, the impact of the crisis was felt less by IKEA in comparison to many other businesses due to the cost leadership strategy of the business which included looking at economic risk of its supply chain and its core business activities. Although IKEA had to eliminate 5,000 jobs, their volume of sales dropped by only 1 percent by the second quarter of 2009.
Amazon: Management of currency exchange rate and tax risks
There are many economic factors that directly affect the growth prospects and stability of Amazon's business, such as taxation and inflation rates, overall and industry-specific economic growth, unemployment levels and changes in currency exchange rates. In 2016, net sales from international business accounted for 32 percent of Amazon's revenues. Therefore, the business is subjected to elevated currency exchange risks. Changes in foreign currency exchange rates negatively impacted net sales by $636 million, $5.2 billion, and $550 million for 2014, 2015, and 2016 respectively.
In June 2017, U.S. President Donald Trump spoke of a necessity to introduce 'internet tax', specifically referring to Amazon. This instance can be referred to as an illustration of potential implications of economic factors, namely taxation on Amazon.
To mitigate these risks Amazon is diversifying its portfolio to spread the impact of exchange rates and taxation.
Economic risk and the impact on supply chains
Without effective management of economic risk within your operations and within your supply chain, you put your current and future business under threat. Increasing near real-time awareness into economic and market trends, potential legislative actions and other factors allows you to respond proactively to mitigate risk. How can you achieve better visibility into economic risk? Ensure you have a risk monitoring solution to rely on.
Designed as a cost-effective, off-the-shelf solution, LexisNexis Entity Insight helps organisations implement third-party monitoring— tailored to their specific risk considerations—to identify economic and other PESTLE risk factors across global news and market intelligence.