First, it is necessary to consider a taxonomy of enterprise risk, that is the range of components which constitute enterprise risk. The figure below summarises the framework of specific enterprise risk, without considera- tion of the risk filtered from higher levels. Once more Miller (1992) is an initial source for an appropriate classification. His classification is modified to take account of other treatments in the relevant literature.
As the figure suggests there are three different components of ‘core’
enterprise risk – the operational, financial and behavioural components.
These are defined in such a way as to make this risk specific to the enter- prise, comprising all aspects of the operation of an enterprise; however, the template deliberately minimises the overlap with the types of risk already discussed, notably industry risk.
The nature of the enterprise determines the risk components. For example, for a bank or credit institution credit risk is an obvious and important component of operational risk. In this case, creditworthiness is an attribute of the service or product provided by the bank. The cred- itworthiness of the bank is itself an issue relevant to those borrowing from the bank. Even more important for an enterprise is its ability to borrow, both in terms of availability of funds and the price of those funds. The credit rating of an enterprise is an important determinant of the cost of its capital and indirectly of the price of its shares. There is an enormous literature on credit risk and a whole range of different ways of measuring such risk.
The first component, operational risk, can be broken down into various sub-components – labour, input supply risk, and production risk. The first refers to the problems posed by a possible change in the attitudes and morale of the enterprise’s labour force. These may be manifested through a sudden onset of strikes or the appearance of poor labour morale causing a high rate of absenteeism or labour turnover.
The motivation of the labour force is a critical element in determining both productivity levels and changes in those levels over time. The capacity of the enterprise to innovate and keep ahead of its competitors reflects the empowerment of its labour force. This applies at all levels of the enterprise. Risk arises from an unexpected and unanticipated change in that labour context, which might result from a change in the aims of the trade unions operating within the enterprise or from the reaction of workers to a change in government legislation relating to working conditions. It might even be a reaction to a change of strategy formulated by the managers.
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Operational risks Labour risks
Input supply risks
Production risks
Liquidity problems
Credit problems
Agency problems or self-interested actions
Actions which damage reputation Deficiencies of skill or experience
Problems with collectibles
Deteriorating credit rating Poor structure of assets and liabilities Finance risks
Behavioural risks Labour unrest High labour turnover or absenteeism
Raw material shortages Quality changes Spare parts restrictions Teething problems with new technology Machine failure Other random production factors Enterprise Risk
Figure 10.1 A typology of enterprise risk
The second operational item refers to both qualitative and quantita- tive problems with the supply of raw materials, components or even necessary equipment. This refers to the situation of specific suppliers. A supplier can get into difficulties for a host of reasons outside the control and even knowledge of the relevant enterprise. Often it is argued that vertical integration allows control over such suppliers and a reduction in this kind of risk. There are industry supply problems and problems of supply specific to the relevant enterprise.
The third operational item refers to the technological problems which arise when new technology is introduced, although technolo- gical difficulties also arise when existing equipment fails. The latter is probably more unusual than the former. It is impossible to anticipate all the problems created by the application of a new technology.
Teething problems are very common. The individual capacity of enterprises to master particular technologies varies. The residual sub- component has particular reference to services which have different operational modes from manufacture and in which the operational items have a different role.
The financial risk component can be broken down into two main components – liquidity and credit risk, but with the latter viewed from the perspective of the borrowing enterprise. It comprises those dif- ficulties which arise from either a limited supply of liquid assets to meet immediate obligations or from a limited ability to borrow, often wors- ened by the existing structure of assets and liabilities. A change in market liquidity, that is the ability to convert certain assets into cash, may be the source of the trouble. Much of the analysis of risk in the existing literature focuses on these elements. Liquidity risk is commonly separated out as an independent risk type.
The final component comprises agency problems, actions which can damage reputation or actions which reflect a lack of experience in the labour force, notably the managers of the enterprise. They arise because it is impossible to anticipate the way in which specific conflicts of interest arise between different stakeholder groups. There is a continuous process of negotiation over the distribution of both risk and value to these groups. Whatever is done gives signals to all the stakeholders concerning the economic health of the enterprise.
Not all contingencies can be anticipated, nor can the response to such contingencies by the relevant stakeholder groups. Some actions involve sudden changes in reputation.
Each of these components of risk affects an enterprise in a different way. They reflect the nature of the organisation, its history and current personnel. They are for that reasons highly idiosyncratic. The same exercise can be carried out for any project undertaken by the relevant Enterprise and Project Risk 173
enterprise. An enterprise, unless it is a conglomerate, has core activities and core products. Any project is likely to be in the core area. The tax- onomy discussed above is directly relevant to any such project. The situation is more complicated for a conglomerate, since the relative importance of different elements in the taxonomy is likely to differ from business unit to business unit.