Using Economic Downturn Magnitude And Duration Forecast To Manage Your Future

Using Riskope’s Economic Downturn Magnitude and Duration Forecast to Manage your Future (Based on Nov. 2008 Forecast by Riskope) Franco & Cesar Oboni Riskope International Rational and sustainable risk management requires quantitative understanding of scenarios

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Our Lives, Corporations, Projects Can be seen as a never ending succession of cycles of growth, peace, turmoil, i.e. cycles of great changes we call crises. Fast growth can be seen as a positive crisis: in some cases it can, however, suddenly turn into a negative crisis. A crisis is a decisive moment, particularly in times of danger or difficulty.

Generic Phased Crisis Model Triggering point for the emergency plan Controlled crisis Uncontrolled crisis…may evolve to catastrophic consequences One crisis cycle (time) Event Intensity : from emergency to crisis Emergency that does not evolve into a crisis Phase 1 Potential Phase 2 Latent Phase 3 Acute Phase 4 Return Phase 1 Potential Desired Level of Service Tolerated level of disservice (minor emergency) Max tolerated disservice limit (max emergency) Crisis Catastrophic crisis

Each point of the “crisis trajectory” has:

A probability of occurrence

An associated cost (loss, consequence…could be positive or negative, but let’s focus on the negatives for the moment…)

… thus a Risk , as Risk=probability x cost of consequence.

It is in the Latency Phase that the best returns are to be expected from:

Analyzing what could go wrong, and how much it would “cost” the company: Risk Assessments

Analyzing the means to bring the risks towards a tolerable level in a sustainable way: Risk Management

Analyzing how to behave when a residual risk hits, i.e. Crisis Management

ERM excellence criteria:

Risk/reward optimization

Enterprise wide view of risks

Control processes for risks

including:

Hazard identification

Risk evaluation

Risk management and loss control

Benchmarking against predefined risk

tolerability criteria

The future lies in using Risk to weigh decisions, rather than just guiding mitigation.

Scenarios can be prioritized by their intolerable part of risk. A clear road-map becomes available for rational and sustainable RM/ERM.

* A mathematical model is used Bar graph for the Intolerable portion of the scenarios Of the 14 initial scenarios, seven are above tolerability, but only three are top attention priority.

Case Study Several mid-sized companies face the present economic downturn

Hazard Analysis

Let’s define probability and “magnitude” of the hazard of this “economic downturn”.

Crisis Forecast, November 2008

Duration Probabilities :

30% less than 1.5 years Spring 2010

80% less than 3 years Fall 2011

10% longer than 6 years past 2014

Magnitude Probabilities:

20% present situation will persist

25% significant worsening

55% critical evolution of disservice

Measure of the Depth of Recession: “loss of service and control” in the country system, for which we can build a scale as follows, by drawing examples from the past: Level 1:Persistance , or Status Quo, i.e. generalized budget cuts in the non- key services, for example starting with culture, arts, then going to education [1] ; some protests [2] . [1] cuts are already being performed in various countries, France, Italy etc. [2] also in act, Russia, Japan, etc

Significant Worsening, i.e. Level 2 & 3.

Level 2: Generalized Poverty , unemployment up to 12%, vanishing maintenance of civil systems, reduced health programs, salaries of public officers in decline, protests, criminality, and some violence [3] .

[3] already reported in some G20 countries

Significant Worsening, i.e. Level 2 & 3. (cont'd )

Level 3: Severe Impoverishment unemployment over 12%, severe reductions of public transportation offer [4] , gradual replacement of police forces with armed forces [5] , reduction of retirement plans, protests and criminality, high violence.

[4] example: reduction of RR network and service

[5] example in Italy, US, under the “war on terrorism” cover

Level 4:Critical evolution of disservice (Disruption of Order and Quality of Life), generalized rioting, wide spread criminality and sacking, and total loss of control.

Apparently some countries in the G20 group have already passed the Status Quo level, but as we are developing this study for a “theoretical” country within the group, we will not bother with these particular cases here.

Crisis Forecast, November 2008

Consequence Definition

These will be different for every client/industry or organization

Example 1: a company that builds specialty motor vehicles could have:

Reduction of 20% of routine paying services revenues, if the downturn is persistent , i.e. 2 M/yr

Reduction of 50% of overall sales if downturn worsens significantly , i.e. 5 M/yr

Reduction of 70% of overall sales if downturn has critical evolution , i.e. 7 M/yr

P C 5 M/years 0.20 0.25 0.55 Tolerable Intolerable Persistent Significant Worsening Critical Evolution 7 M/years 2 M/years Risk: 0.4 Risk: 1.25 Risk: 3.85 Intolerable: 0.07 Intolerable: 0 Intolerable: 1.53 Sometimes a risk assessment confirms intuitive “feelings”!

a company building special motor vehicles will focus it efforts to mitigate in this order:

1) Critical evolution

2) Significant worsening

3) Persistent

Mitigative scenarios, possibly including diversifying etc. will have to be studied

Example 2: a Discount Retailer

Reduction of 60% of routine services if the downturn is persistent , i.e. 6 M/yr

Reduction of 30% of overall billable if downturn worsens significantly , i.e. 3 M/yr

Reduction of 10% of overall billable if donwturn has critical evolution , i.e. 1 M/yr

P C 3 M/years 0.20 0.25 0.55 Tolerable Intolerable Persistent Significant Worsening Critical Evolution 6 M/years 1 M/years Intolerable: 0.16 Risk: 0.75 Risk: 0.55 Intolerable: 0 Intolerable: 0 Risk: 1.2 Status quo may mean, quite surprisingly, highest priority!

a Discount Retailer will have the focus it efforts to mitigate in a different order:

1) Persistent

Mitigative scenarios, possibly including a line of top quality items etc. will have to be studied

Example 3: a company that services motor vehicles could have:

Reduction of 40% of routine services if the downturn is persistent , i.e. 4 M/yr

Reduction of 60% of overall billable if downturn worsens significantly , i.e. 6 M/yr

Reduction of 30% of overall billable if donwturn has critical evolution , i.e. 3 M/yr

P C 4 M/years 0.20 0.25 0.55 Tolerable Intolerable Persistent Significant Worsening Critical Evolution 6 M/years 3 M/years Intolerable: 0 Risk: 1.5 Intolerable: 0.01 Risk: 1.65 Risk: 0.8 Intolerable: 0.24 Highest risk does not necessarily mean highest priority!

a company that services motor vehicles will have the focus in this order :

3) Persistent

Even thus the risk of the critical evolution is higher, the intolerable part of the significant worsening is more critical. Possible mitigation: advertisement and lowered prices right now!

Scenarios will be prioritized by their intolerable part of risk. Therefore a clear road-map becomes available. Transparent decision can be taken leading to a rational and sustainable RM/ERM.

Details available upon request via contact page at http://www.riskope.com These results can help building rational risk management strategies. Contact us, Franco & Cesar Oboni Riskope International