Risk Management: Operational and Financial Risks

Introduction

All organizations are open systems and are hence influenced by many external factors. With increasing globalization and the resulting competition, the effects of risk on the organization are tremendous. Risks can be operational or financial or both. Operational risks involve both production and marketing risks. Most organizations now have a special risk assessment and risk management team to eliminate or reduce the effects of risk. Risk management is now a subject of study under the head of Enterprise Risk Management.

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Mr. Brown – Senior Manager (Marketing), California Organics (April 25th, 2008): Our Company is a leading producer and supplier of organic farm produce. What started off as a small farming operation in 1975 has now grown into a professionally managed organization with a staff strength of more than 200 people. The company grows its crops using only organic methods and does not use pesticides or non-organic fertilizers. The farm and the headquarters are located in California and distribute its products to groceries in our state and the border towns in the neighboring states of Nevada and Arizona. Because of rising levels of health awareness, more and more people are turning towards organic foods and hence the future of our company looks very bright.

We sell our products mainly to small retail and medium-sized groceries in these areas. It does not cater to supermarkets because of the low prices offered by them. Produce is delivered through a network consisting of 10 delivery trucks. The food is packed in such a way that food that will ripen at the earliest is delivered to nearby shops while those that will take longer are delivered to shops in more distant places.

Risk Assessment: All departmental heads including myself are a part of the crisis management team of the company with our CEO being the team leader. All members of the team have been provided with a crisis management document. The salient points of the document are given below. The area of operation is agriculture and all risks associated with this type of activity can be included as potential risks for this company also.

  1. Production: Optimum agricultural production is dependent on many factors such as weather, availability of irrigation facilities, and organic fertilizers. The company uses ladybugs instead of pesticides to ward off pests. Risks due to weather include unseasonable rains, excess or no rains, floods, cyclones, forest fires, etc. A study of past weather records in the area will be helpful in assessing average weather patterns. The Company has enough water sources to irrigate the land for a period of six months in case there is no rainfall. Organic fertilizers like compost and animal waste are available throughout the year.
  2. Storage: The Company has storage facilities like warehouses and cold storage facilities. A failure in the distribution system can cause problems in storage because the available cold storage facilities can accommodate the production of not more than two days. Because of their inherent nature, certain products cannot be stores for a period of not more than one week without being spoilt.
  3. Distribution: Even though the network of the company is efficient and the number of trucks is adequate to handle the business, a breakdown may cause serious losses to the company. This is because the entire product life is limited to a maximum of two days without refrigeration after which it will be spoilt. None of the company trucks have refrigeration facilities. The storage facilities of our clients are also a factor in keeping the company produce as fresh as possible.
  4. Market: The prices of agricultural produce are subject to availability. A glut in general production will bring down the prices also which will bring down the earnings and profits of the company. Being an organic producer, our prices are high when compared to non-organic products and demand will depend on the general health of the economy. Payment for our goods has not yet been a problem area for the company.

Enterprise Risk Management: The risk assessment team had given us the above possible risks that may be faced by the company. The risk management team has already done or plans to take up the following steps to manage the above-mentioned risks. Work on the enlargement of catchment areas has been undertaken and once finished the company will have enough water to last for a year with no rainfall. Additional cold storage facilities have been ordered. Crop insurance for protection against natural calamities has been taken. A separate department for maintenance of our fleet has been formed.

Tuesday, Aril 15th 2008

A mix-up due to a mistake on the part of the delivery department had caused a serious problem in our delivery schedules. The matter would have become a major embarrassment and caused financial loss but for the timely action taken by my team at the marketing department. The delivery department had just promoted a worker to the post of supervisor in charge of delivery. His job is to assign delivery orders to truck drivers so that correct delivery may be made. The period of crisis happened near the Christmas season when usually large orders had to be executed. This resulted in additional strain on all departments especially the delivery department. Occasionally the company policy allows the purchasing department to buy produce from neighboring farms to meet the increased demand. This time this practice was resorted to and about 20% of the orders were sourced from outside. The resulting rush caused the new supervisor to give wrong delivery orders to six of our ten delivery trucks. An assessment showed that the following problems had taken place:

  1. All our nearby buyers who were to get ripe or near ripe produce got goods that would ripen only after 3 days. Buyers started to call the marketing department about the mix-up and demanded that alternative measures be taken to supply fresh produce. Otherwise, they would resort to buying from our competitors.
  2. Our buyers situated at distances found that when they took delivery of the goods on April 17th, most of the goods had turned rotten. They took the same steps as our nearby buyers.
  3. Our quality control department failed to identify some inorganic produce that inadvertently got included in the products that we purchased from outside to meet the demand. The administrative office receives a call from the lawyer of a consumer who had supposedly fallen ill due to consuming these particular items of produce. He threatened us that he would file a lawsuit against the company for malpractice. He also added that he would sue for damages to the tune of $500,000 for causing ill health to his client.

Quantifying risks: The risk management team had quantified the risks as follows.

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  1. Wrong delivery: The tolerance level determined by the company is 5% for wrong deliveries in nearby areas and 2% in faraway markets. The probability for such risks happening is 1 wrong delivery per 100 trips. In reality, the wrong delivery percentage stood at 60% since six trucks made the wrong deliveries.
  2. Quality of outsourced products: The tolerance level given for quality and genuineness of organic foods outsourced is fixed at 1%. The probability of inorganic food being purchased has been estimated at 1%. On analysis, it was found that the actual instance of delivery of inorganic food laced with pesticides happened only once in the past five years.

Steps were taken by our company and our department in particular for solving the crisis

A day of wrong deliveries caused by an error of the delivery department had caused a lot of problems for the marketing manager. It appears that the problem was caused by giving wrong delivery orders to the truck drivers by a newly posted supervisor. Angry suppliers had called up the marketing department to complain of the error and demanded alternate arrangements for the delivery of goods. Watchful competitors took advantage of the situation and offered to deliver goods to our buyers at reduced prices. The news about the pesticide content was covered widely in the local media resulting in a loss of image for the company.. The marketing staff had to bear the whole brunt of the problem since they are the link between the company and its customers.

Recovery measures: The crisis management team had a meeting on the afternoon of April 15th and decided that it was no point in recalling the all trucks and hence no action was taken in this regard. Trucks that were supposed to deliver to faraway areas (but sent to nearby buyers) were recalled and the goods were kept in storage to be delivered within the next two days to our nearby markets. So the produce in those trucks was saved. But the value of spoilt produce was estimated to be around $150,000. As of April 20th, 2008, our department with the help of responsible officials from other departments has begun to undertake a massive public relations program. We have almost completed meeting all our buyers personally to sort things out. Most of them have agreed that this was a freak incident and that they would remain our customers. We calculate that we lost or would lose 20% of our customers. The CEO along with our marketing and public relations heads visited the lawyer of the aggrieved consumer. His lawyer contacted the client and a meeting was arranged at the house of the aggrieved. The company settled with him for $100,000 before a suit was filed. A press conference was convened and the media was given a satisfactory explanation without disclosing any facts that may harm the company’s image.

Mr. Gordon, CEO, California Organics: The unexpected crisis in our company has woken us up from our relative complacency. We have alerted all our departmental heads to be more vigilant in the future. Additional delivery system checks were introduced to prevent such instances of wrong delivery and lack of organic certification of our suppliers. Quality checks of the outside produce we buy were made more exhaustive. A retraining program for all staff in all departments is scheduled to begin on May 2nd, 2008. The supervisor who was the cause of all the problems was let off with a warning. The crisis management team and our marketing department have been complimented for their deft handling of the situation.

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