Noetzold & Noetzold

Added Value and Benefits from the Opture® System

The Opture® risk management system generates added value and benefits concerning:

  • Transparency,
  • Cost reduction (risk costs),
  • Efficient steering under risk and return aspects (operational and strategic decisions),
  • Reduction of earnings volatility (operational and strategic planning), and
  • Optimal resource/capital allocation.

General Added Value

Profit and Loss statements and planning figures of companies are mostly based on cost/revenues and expenses/earnings data. The risk dimension is often neglected and management decisions are based primarily on return aspects. Experience shows that planned figures often are optimistic and include approx. 70-80% opportunity data and 20-30% risk data. As a matter of fact, volatile risk drivers (e.g. external factors as exchange rates, price volatilities, interest rates) and unexpected events can lead to diminishing profits, losses, liquidity problems, or, in the worst case, can even endanger the existence of a company. Of course, volatile drivers or unexpected events can also lead to windfall profits. In any case, the general aim should be to protect against adverse circumstances and to improve predictability into the future. The Opture® risk management system does this with the following objectives (besides fulfilling legal requirements and corporate governance objectives):

  • Integration of risk as second dimension into operational and strategic planning and decision-making process,
  • Transparency on risks in the economic/financial plan to identify potential cash burner and liquidity problems in the future ("What are the risks contained in planned earnings?"),
  • Calculation of a risk-adjusted Profit and Loss statement and cash flow statement ("How do risks affect planned earnings?")
  • Calculation of risk figures for an optimal risk mitigation and steering ("What are the characteristics of the risks, i.e. what is the VaR, RAROC, risk capital, Expected Loss for each business unit, product, P&L position, or individual portfolio?")
  • Calculation of individual scenarios and sensitivities to anticipate possible future changes ("How do planned earnings change under special circumstances, e.g. in case of a simultaneous 10% USD/EUR increase, 15% steel price increase, and 13% JPY/EUR decrease?")
  • Calculation of the risk and return position of the company, business units, subsidiaries, and products ("What is current risk-return picture, how does it compare to an optimized positioning, and what would be the strategies to optimize the current risk-return position (regional strategy, product strategy, competitive positioning, etc.)?")

Specific Added Value (Sample Cases)

Three sample cases represent specific benefits of the Opture® System:

  • Impact of Correlations
  • Risk cost reduction
  • Steering under risk and return aspects

Impact of Correlations

An automotive supplier, e.g. assembling wiring systems, encountered financial problems due to correlated risks. The management was aware of the individual risks and managed them efficiently. The reason for tremendous unexpected cash burnings were not the top 10 risks but the correlation among those risks and risk drivers. When a risk driver changed, several of the positively correlated risks occurred simultaneously (= risk bundle). The situation was a weak US-Dollar, an increase in copper prices, a strong Japanese Yen, and weak economy. The correlation of these market risks induced additional correlations among the individual risks. The sales volume decreased dramatically due to a general decline of automotive sales (economic situation) and an unrelated (uncorrelated) quality problem of the OEM (automotive manufacturer) at the main car brand. The correlated market risks with an (in this case uncorrelated) event risk generated a strong negative impact on the supplier's earnings and cash flows.

Risk correlations can have a strong impact on the consolidated risk exposure of a company. It is essential to identify and to quantify them as they build the basis for correct risk aggregation. Only integrated enterprise-wide risk management systems are able to aggregate all risks, opportunities, measures, risk drivers including all correlations.

Risk Cost Reduction

Risk cost reduction can be reached by:

  • Optimal risk mitigation and steering (e.g. management of portfolios and risk drivers instead of focus on individual risks),
  • Avoid event risks (e.g. with insurance, operational risk steering) and reduce market risks (e.g. netting, hedging),
  • Reduce capital costs due to better rating (a McKinsey survey concludes that investors are willing to pay about 20% premium for companies with optimal corporate governance and risk management).

Companies controlling their individual risks and aggregated risk exposure are able to (1.) reduce corporate risk premia (relevant when borrowing from financial institutions), (2.) value and price with risk premia (e.g. price calculation, diversification of product portfolio, diversification of customers and suppliers, contract management), and (3.) avoid potential risks by efficient risk mitigation measures.

Steering under Risk and Return Aspects

A manufacturer supplied two different products, a commodity product without any technical features and a high-tech product. Both products had nearly the same profitability. The high-tech product included special devices supplied by a big chip producer (derived risks, e.g. delivery risk, price risk, technology risk). As general supplier of these high-tech products the supplier had complete liability (product liability, quality liability, delivery liability, etc.) against their customers. In conclusion, at the same level of profit, the high-tech product had a much higher risk than the commodity product. The hidden risk costs of the high-tech product were not considered when comparing the profitability of the products or when allocating resources to the production. One of the operational steering measures was to modify the contracts with chip supplier and customer.

Conventional management under return aspects should be developed into a risk-return management, with the following benefits:

  • Focussed risk steering: accept and manage risks in areas where the company has its core competences, and steer, mitigate, diversify, hedge risks in other areas.
  • High risk demands high return: investments with high risk have to generate higher returns compared to low-risk investments.
  • Correct decisions under uncertainty: uncertainties (e.g. risks) are appropriately valued (e.g. including risk premia), unprofitable investments will be avoided.
  • Quantitative decision basis: risk valuations provide a quantitative basis for decisions under uncertainty.
  • Integration of the risk dimension: valuation under risk and return aspects offers optimization of investments, e.g. discrimination between investment alternatives at the same level of profit but different risk costs/premia, unprofitable investments will be avoided.

The Opture® risk management system calculates and delivers risk figures referring to operational and strategic plan data. With this information and the opportunity to investigate specific future scenarios the management is able to quantify decisions under uncertainty.

The risk monitoring as part of the management process tracks the development of risk values and calculates their portfolio impact. Even without modifications in the risk portfolio, risk values can evolve due to intrinsic time dependence of risks or due to volatility of external factors. The Opture® risk management system also monitors the evolution of factors and their impact on risk figures.

Back to top