A note on Risk Management 1

In recent years, managers and project managers have become increasingly aware of how their organizations or projects can be buffeted by risks beyond their control. In many cases, fluctuations in economic and financial variables such as oil price, exchange rates, interest rates, and commodity prices have had destabilizing effects on corporate strategies and performance. Consider the following examples: In the first half of 1986, world oil prices plummeted by 50%; overall, energy prices fell by 24%. While this was a boon to the economy as a whole, it was disastrous for oil producers as well as for companies like Dresser Industries, which supplies machinery and equipment to energy producers. As domestic oil production collapsed, so did demand for Dresser’s equipment. The company’s operating profits dropped from $292 million in 1985 to $149 million in 1986; its stock price fell from $24 to $14; and its capital spending decreased from $122 million to $71 million. During the first half of the 1980s, the U.S. dollar


appreciated by 50% in real terms, only to fall back to its starting point by 1988. The stronger dollar forced many U.S. exporters to cut prices drastically to remain competitive in global markets, reducing short-term profits and long-term competitiveness. Caterpillar, the world’s largest manufacturer of earthmoving equipment, saw its real-dollar sales decline by 45% between 1981 and 1985 before increasing by 35% as the dollar weakened. Meanwhile, the company’s capital expenditures fell from $713 million to $229 million before jumping to $793 million in 1988. But by that time, Caterpillar had lost ground to foreign competitors such as Japan’s Komatsu. [1]

Based on the fats described above, there are few things that project managers and project members can consider in order to minimize the risk carried to the projects and control the impact of drastic price changes or other external factors on the projects:

1) The economy and the anticipations: The economy that the project is being executed in can play a vital role in future decision making. The stronger the economy the less impact can occur for the project and the team.

2) 2) The project: How much a project can be impacted from these changes and how can be mitigated is another important issue.

3) Flexibility of Investments; How flexible are the investors or the project in case they want to invest on something else.

4) The adjusted break even price; Sometimes even drastic oil price changes does not change the profitability of the project in a way the project is not feasible any more [2]

References:


1) A Framework for Risk Management, Kenneth A. Froot et.al, Journal of Applied Corporate Finance, Vol. 7.3, P. 22 – 32.

2) Managing Investment Opportunities Under Price Uncertainty: From “Last Chance” to “Wait and See” Strategies, P. Bjerksund and S. Ekern, Financial Management, Vol. 19 – No. 3, P. 65 – 69.