HOW HIGH-PERFORMING COMPANIES HARNESS OPPORTUNITIES THROUGH SRM SRM 401 Wednesday, April 18 This session is hosted by RIMS Strategic Risk Management Development Council.
PANELISTS Carol Fox, ARM Director of Strategic and Enterprise Risk Practice RIMS Dr. Mark L. Frigo Ph.D., CPA, CMA Director, The Center for Strategy, Execution, and Valuation and Strategic Risk Management Lab DePaul University - Kellstadt Graduate School of Business Brenda Boultwood Former Chief Risk Officer Constellation Energy (now Exelon Energy Corp) 2
Setting the Context for SRM: Value Creation or Value Protection? 1. How does the organization intend to create shareholder and stakeholder value? 2. How does the organization intend to protect shareholder and stakeholder value? Risk = an uncertain future outcome that can either improve or worsen our position 3
AGENDA What is Strategic Risk Management? RIMS Strategic Risk Management Framework Strategic Risk Management in High Performing Companies As a core competency The strong resilient organization Return driven strategy Who s doing it well Constellation Energy s SRM approach Strategic Risk Assessment Process from DePaul University s Strategic Risk Management Lab Questions 4
What is Strategic Risk Management? Strategic risk management ( SRM ) is a business discipline that drives deliberation and action regarding uncertainties and untapped opportunities that affect an organization s strategy and strategy execution. 5
RIMS SRM Framework 6
Who s Doing It Well? STRATEGIC RISK MANAGEMENT IN HIGH PERFORMING COMPANIES 7
Findings: The Five Reasons ERM Fails Strategic Risk Management Lab DePaul University 1.Risk management is not connected or integrated with strategy and strategy execution. 2.Risk assessments are focused on the wrong risks, not focused on strategic risks ( 80/20 rule ). 3.Risk management is not executed as a continual and repeatable process. 4.Risk management silos create barriers. 5.Risk management is not viewed as value-added. (ERM is often under-resourced and under-networked.) Strategic Risk Management is not a core competency 8
Strategic Risk Management as a Core Competency Harvard Business Press 2009 9
Company A or Company B Which has managed strategic risks and opportunities better? Company A Company B Copyright Dr. Mark L. Copyright Frigo 2011 - Do 2012 not Risk copy and or redistribute Insurance without Management express written Society, consent Inc. of All Dr. rights Mark reserved. L. Frigo. Used with permission. 10
Company A or Company B Which has managed strategic risks and opportunities better? Copyright Dr. Mark L. Frigo 2011 - Do not copy or redistribute without express written consent of Dr. Mark L. Frigo. Used with permission. 11
The Strong Resilient Organization What can we learn from High Performance Companies? Return Driven Strategy Framework Describes the strategic activities necessary to create shareholder value Strategic Risk Management Framework Describes the interrelated risks of an organization and how they impact shareholder value Copyright Dr. Mark L. Frigo 2011 - Do not copy or redistribute without express written consent of Dr. Mark L. Frigo. Used with permission. 12
Return Driven Strategy Understanding the Rise and Decline of Companies and Business Units High performance isn t permanent. Every high-performance company we studied faces the risk of fading. Some have already begun to fade in either returns or growth or both. In every case, the reasons for fade can be charted to how the tenets of Return Driven Strategy were neglected or could not be executed. Meanwhile, the rise of these companies performance and the sustainability of high performance can be attributed to attention to these tenets. Companies with mediocre or poor performance demonstrate significant gaps in their business models when viewed through the lens of Return Driven Strategy. Copyright Dr. Mark L. Frigo 2011 - Do not copy or redistribute without express written consent of Dr. Mark L. Frigo. Used with permission. 13
Consider the case of Adidas Group 14
Adidas Group Annual Report Corporate Risk Overview 15
The LEGO Group ERM has evolved over the past 4-5 years Most risk management, we have had for years We added strategic risk management late 2006 Strategic Operational We defined and implemented a consolidated ERM reporting from 2007 Legal ERM Employee Safety We defined our risk appetite, and reporting up against that in 2008 Financial IT Security Hazard 16
The LEGO Group Risk Management Preparing for Uncertainty Active Risk & Opportunity Planning (AROP) Enterprise Risk Management Monte Carlo Simulations With a 40% average growth of profits 17
Who s Doing It Well? STRATEGIC RISK MANAGEMENT AT CONSTELLATION ENERGY (NOW EXELON ENERGY)* * Case Study based on legacy Constellation Energy practices 18
About Constellation Energy Wholesale Competitive Supply: NewEnergy Retail Competitive Supply: NewEnergy Generation: Generation Group Transmission: BGE Distribution: BGE Constellation Generation Group Approximately 11,430 megawatts of owned, low cost, efficient generating capacity throughout the United States and investments in nuclear fleet Constellation NewEnergy Leading supplier of innovative energy products and solutions to wholesale and retail electric and natural gas customers in competitive markets across the country Baltimore Gas and Electric Transmission and distribution utility for more than 1.2 million electricity customers and 700,000 natural gas customers in Central Maryland 19
Integration into Strategic Planning Process Assessment Articulation Action What risks can I take? How much risk can I take? RISK APPETITE Strategic Plan Capital Allocation Risk Control Risk Identification Risk Assessment Results Who is willing to take the risks? Risk Balancing Risk Limits When do we take the risk? Management Committee Agrees on Risk Appetite Management Committee Agreement on Strategic Direction Business Dreaming Session Business Unit Articulation of Viable Initiatives Risk Management Highlights Potential Risks of Offerings Business and Functional Groups Assess Controls Functional support areas play a critical role in evaluating a company s strategic risks 20
Integration of Risk Management into the Strategic Management Process SRM guarantees a strong performance between risk management, finance and strategy 21
Risk Capital Framework Capital Capital Adequacy Adequacy Text Show balance sheet is consistent with target credit rating and Company s risk appetite Potential use in discussions with rating agencies Text Pricing & Profitability Text Price all risks taken Compare profitability of investments using a coherent metric Determine true value added Identify portfolio synergies Performance Measurement & Measure performance relative to risk taken by / allocated to businesses and individuals Identify risk-adjusted value added 22
Pricing Risk in Customer Transactions Retail and Wholesale Gross Power Margins 23
Appropriate Risk Pricing Drives Financial Performance Business Financial Metrics Gross Margin/Earnings Cash Flows NPV IRR Business Growth Metrics Corporate Financial Metrics EBIT/Earnings per Share Return-on-Equity FFO as a % of Net Income OpEx as a % of Gross Margin Credit Rating Company Performance Corporate Risk Metrics Capital Adequacy Liquidity Adequacy Economic Value Added/RAROC Credit Exposure RnF@Risk Business Risk Metrics Transaction RAROC Risk Adjusted IRR Business Portfolio RAROC VaR/GMaR Credit/Liquidity Risk Metrics Return on VaR Risk-based metrics complement the financial metrics and help protect the company against adverse events by measuring potential losses, capital and liquidity adequacy. Risk adjusted returns help to incorporate risk charges into transaction pricing 24
C o n t r o l G r o u p s K e y C o n t r o l s LINES OF DEFENSE B u s i n e s s C y c l e s Risk Liaisons Risk Liaisons Risk Liaisons B u s i n e s s S e g m e n t s Business is the First Line of Defense in Risk Management Corporate Enterprise- Perspective & Business-Aligned Risk Management Portfolio Analysis 1 Transaction Analysis Portfolio Management and Trading Limits Generation Retail BGE Wholesale New Product Review Risk and Control Self-Assessments Control Environment Credit Review Asset Management & Development Intensive Business Customer Relationship Intensive Business Market Optimization Intensive Business Credit Workout Risk Measurement Risk Monitoring and Reporting Validate/refine strategy Risk Mitigation Risk Factor Identification Business Strategy and Planning Capital Business Process and Execution Policy Continuous Evaluation Reporting Oversight of Risk Integrated Risk Assessment Limits Procedures Analysis Risk Systems and Standards Re-allocate capital/limits Fraud Risk 2 Risk Management Market Risk Credit Risk Operational Risk Risk Capital Liquidity Risk Strategic Reputation Policies and Procedures Financial Performance Risk Legal Regulatory Compliance Environmental Audit SOX NERC Middle Office Risk Metrics 3 Corporate Audit Liquidity Evaluation Control testing 9-month rolling audit plan Process & control consulting 25
Findings from DePaul University s Strategic Risk Management Lab STRATEGIC RISK ASSESSMENT PROCESS 26
Strategic Risk Assessment: A First Step for Improving Risk Management exploit opportunities Frigo and Anderson, Strategic Risk Assessment: A First Step for Improving Risk Management and Governance Strategic Finance (December 2009): and Frigo and Anderson, Strategic Risk Management-A Primer for Directors and Management Teams (2011). Used with permission. 27
Integrated in Strategy Setting Source: Frigo, Mark L. and Richard J. Anderson, Strategic Risk Management: A Primer for Directors and Management Teams (2011). Used with permission. Create and Protect Shareholder and Stakeholder Value Financial Strategic Objectives Improve Productivity Profitable Growth from New Technologies and Services Increase Value from Existing and New Customers Organizational Efficiency and Leverage Customer Strategic Objectives Cost & Quality Leadership Develop Technologies to Improve Cost & Performance Deliver Highly Valued Solutions Customer Focused Strategic Themes 1- Operational Excellence 2-Create Value with Technology 3-Grow High Value Customer Relationships 4-Organizational Alignment Internal Process Strategic Objectives Reduce costs Improve quality and costs continuously Eliminate non-value added processes Risk Management: Liability for Failures Disciplined Investment in New Technologies Drive Packaging Technology Leverage Technology Licensing Risk Management: Protect IP Improve Pricing Discipline Enable Rapid New Product introduction Leverage an Open Collaboration Technology Transfer Model Risk Management: Protect Customer Information Communication and Teaming Information Sharing Roles and Alignment Risk Management: Strategic Risk Assessment Risk Management: ERM Initiative Capabilities and Growth Strategic Objectives Develop Balanced Scorecard and Strategy Maps Organizational Alignment Create a High Performance Culture and Infrastructure Retain and Develop Critical Talent Develop Strategic Risk Management Skills and Culture Develop Leadership and Execution-Driven Culture Enable and Encourage Continuous Learning and Knowledge Sharing 28
Integrated in Strategy Execution 29
Thank You Wrap Up Questions Please explore RIMS ERM Center of Excellence www.rims.org Key Takeaways 30