Accounting for Armageddon
Analyzing “What-If” Scenarios With Your Banker
Scott Ellyson knows all about the difficulty of planning for global “what-if” scenarios, trying to anticipate and plan for worst-case circumstances where a company’s business successes—and its reputation—can change in a matter of moments.
Ellyson is founder and CEO of Atlanta-based East West Manufacturing, a privately held firm established in 2001 that could well have this tag line: “We go to China (and other emerging market countries) so you don’t have to.”
Indeed, the company, which refers to itself as a “domestic offshore manufacturer,” works with a broad array of large and small companies to manufacture their products in China—and now Vietnam. It provides cradle-to-grave service so that these multinationals and mid-sized companies never have to set up their own facilities in these countries, hire their own local employees, deal with local politics and laws, or do any of the other tedious things that go with working directly in countries outside of the United States.
In short, they need never establish nor maintain their own “footprint.”
“Of course, thousands of companies in recent years have wanted to work in China, either for the purpose of sourcing cheap labor, [or] much more recently, accessing the Chinese business community and consumers directly, hoping that Chinese nationals would have an interest in their products and services,” says Ellyson, whose client list includes Thermopro, Inc. in Duluth, GA; Webb Supply Co. in Euclid, OH; IEC in Oklahoma City; Carrier Great Lakes in Lithonia, MI; and the Pump House in Nottingham, U.K.
Companies turn to Ellyson because they simply want to avoid the hassle of dealing directly with a country where the political, legal and business climates remain opaque, continuing to confound corporations of all sizes. East West takes the Chinese and Vietnamese conundrum out of their hands, while also doing everything it can to protect their global reputations, knowing that’s their most important asset. “Making sure that we protect their reputations is first and foremost on our minds.”
Ellyson has believed for years that even the most complex products—medical and other precision instruments, for instance—can be produced in China, and has pushed that agenda from the get-go.
What he never anticipated: aggressive Chinese government action in terms of setting minimum wage standards, while dismissal of existing employees remains next to impossible. After the government-issued decrees on wages and the workplace, Ellyson found his factories looted, as labor costs rose substantially. “It was a real eye-opener to just how exposed the company was to arbitrary pronouncements from Beijing,” he recalls. “We decided we needed to better manage our risks.”
East West did not abandon China, and maintains all of its operations there; it simply decided to do a little bit of geographic risk management. As a result, it moved some of its operations to Vietnam and has also considered setting up shop in Africa and Brazil. “Our successes continue, but now we look at everything much more in terms of ‘what-if’ scenarios,” says Ellyson.
The Lunacy Of Global Risk
If Ellyson—a pioneer of making things work in countries where things generally aren’t considered “workable”—is having difficulty planning for the ‘what-ifs’ of the future, it’s a sure bet others are.
“Today everybody’s thinking about the “what-ifs” more intensely than ever,” says Henry Good, the former U.S. risk manager for German-based multinational Rohm & Haas and now head of his own independent consultancy, Global SIRC (Strategic Insurance Risk Consulting), based in Naples, Florida. “You see that manifested overnight from an insurance perspective. When looking outside the U.S., there are two questions that are relevant: Is whatever we are doing abroad insurable at all? And if it is, can we afford that insurance? Is it too expensive to buy?”
Good understands that most corporate executives and regulators today are concerned about “mega risks” that they face at home and abroad: Is “Bank X” or “Bank Y” too big to fail, for instance, and if so, what will the consequences be along the food chain? What if the Euro continues its disintegration—the “Euro zone” along with it?—or what if China’s growth continues to slow? Or India’s, so that the BRICS countries (Brazil, Russia, India, China, South Africa) no longer seem capable of pushing global growth aggressively and saving the industrialized world from itself?
What’s also needed, Good argues, is intensive examination of risk at the individual corporate level. For example, U.S. companies operating in Asia, where tsunamis threaten physical plants and offices at any time, need to consider whether they can purchase sufficient business interruption insurance and what it will cost. These are the kinds of questions not only multinationals but mid-sized companies and smaller ones in particular must be asking he points out, because they are less able financially than a multinational to survive the damage and rebuild.
The question is, are they? Size matters—and its unacceptable for smaller organizations to shrug off these potential threats by saying they have neither the staffing muscle nor in-house financial expertise to devote to these issues as the global economy continues languishing.
U.S. companies need to be doing this contingency planning even if they have no overseas business at all, experts agree. Saying they can’t do so internationally is specious. Contingency and business continuity planning and staffing should already be in place for their domestic needs; looking abroad is simply an extension of what these companies should be doing already for the U.S. Both domestically and internationally, the risk-related issues they face are basically the same.
Business Continuity Continues Gaining Ground
In the U.S., so-called “business continuity” is a concern getting increased attention from the ‘C-suite’ and board members—particularly post-9/11, when many companies found their IT computer back office operations destroyed because of the attacks. They had no “redundant” facilities elsewhere that could take over from their destroyed Manhattan IT centers.
More recently, business continuity (BC) has gained even more traction as issues ranging from tainted milk in China and the manufacturing of lead-based toys there to (most recently) supply chain-related interruptions caused in Japan because of the closing of its nuclear facilities have all come to the fore, potentially jeopardizing the domestic and international reputations of well-known and respected companies such as Mattel.
And those companies that want to expand overseas need to make sure they have a real understanding of the companies they’re looking at, either in terms of becoming suppliers or being acquired.
“Companies are saying their risks are bad, they really need to understand them,” says Buddy Baker, vice president and manager of global trade solutions delivery at Fifth Third Bank’s Chicago branch.
“The two questions where I see increasing interest are in terms of what I call ‘commercial risk’—that is, evaluating the financial viability of a company you’re thinking of acquiring abroad,” says Baker, who also teaches courses in global trade finance issues through his Global Trade Risk Management Strategies firm. “The ‘what-if’ here is ‘What if we acquire this firm and it turns out to have plenty of assets, but its financial viability is in doubt because it doesn’t have sufficient cash flow to meet its obligations?” Baker notes. “It may even be on the verge of bankruptcy, but that’s not obvious immediately when you look at the numbers you’re given. And, of course, that threatens, at least potentially, your own survival.”
The other question is what is called “country risk”: How likely is it that anything will happen in a particular country that might keep a company from repatriating funds, for example, or where operations might be nationalized? Some British-based companies operating in Argentina have recently had their operations nationalized in Argentina, he points out; the same problem has become increasingly de rigueur in Venezuela under the Chavez regime; and, of course, some Asian and African countries have long histories of nationalizing local operations of overseas companies and/or putting restrictions on repatriating funds. “What difference does it make if you’re earning a lot of money in a particular country but can’t get it out?” Baker asks.
Indeed, so concerned are ‘C-suite’ executives about what is going on abroad that they are asking members of their financial teams to find ways to speed their international accounts-receivables process—and, if they’re the ones on the hook, how to lengthen the payables process. Why? Concern over liquidity: They don’t want to tie up too much capital, and they’re concerned about the cash conversion cycle, reducing payables outstanding as quickly as possible.
Not A Moment To Lose
Markus Krebsz, a London-based securitization expert, former credit ratings agency executive with Fitch, consultant to the World Bank on evaluating country-specific risks and author of a new book, Securitization and Structured Finance Post Credit Crunch: A Best Practice Deal (Wiley), argues that companies can ill-afford to take a wait-and-see attitude regarding contingency and business continuity planning.
Krebsz says an enormous number of global concerns can be detrimental to cash flow, ranging from non-acceptance of goods or payment to the risk of protracted buyer default and foreign exchange exposures. For instance, Switzerland may introduce capital controls for the first time since the 1970s if the Euro disintegrates. In fact, Krebsz points out, the Swiss government is already intervening, enforcing a cap on the Euro/Swiss Franc exchange rate. And if one or two countries are advancing in these areas, he says, others are likely to follow. He’s concerned, too, about recent reports that the economic rise of the BRICS countries is slowing, meaning that firms need to monitor the impact this can have both on their business and customer base.
And that’s just the beginning. As the continuing problems in the Euro zone demonstrate, companies need to have a feasible exit strategy in case they are forced to withdraw operations from a particular country, either temporarily or permanently. They need to have plans in place to ensure that expatriate staff returns safely and their nationals are protected as well—and to ensure that local stock or inventory is secured rather than diluted in case of a regional unrest, caused, for instance, by an earthquake or tsunami. “Some of these risks can be covered by specialist insurance, others cannot, at least not at a sensible premium,” Krebsz notes. “Meanwhile, in Greece, some of the international export trade insurers such as Euler-Hermes and Coface are no longer willing to provide insurance if the buyer is based there.”
Regardless of whether a company is public or private, it borders on the negligent—unacceptable disregard of shareholder and stakeholder protection—not to be doing this kind of contingency planning now, both domestically and internationally, Krebsz says. “And don’t dismiss scenarios which at first appear to be totally crazy. Just because they are highly unlikely doesn’t mean they can’t happen or pose a significant risk to your firm if they do.”
Settling In Asia