Economic Risk—What Is It and How to Effectively Manage It
Economic risk centers on macroeconomic circumstances that may result in significant loss for a business. These conditions include inflation, exchange rates, new government regulations and other decisions that may adversely affect profits.
When it comes to global supply chains risks, economic risk is particularly challenging to anticipate and predict. Without an economic risk management strategy, you put your business, its current profitability and its potential growth at risk.
For the most effective economic risk management strategy, you must first understand the variety of economic threats to your business.
Common Types of Economic Risk
There are many types of economic risk that businesses need to identify and manage to best defend against global supply chain risks.
- Interest rates. As with any loan, increasing interest rates can lead to reduced profits. Researching the interest rate environment of a country is a crucial step for comprehensive economic risk management.
- Minimum Wage. If minimum wage is increased, the cost of production is increased. Often, labor costs can increase but market price remains stable, leading to decreased profits.
- Market Prices. A country’s economy greatly influences market prices. When market prices decrease but production costs stay the same, profitability can be significantly reduced.
- Taxes. New types of taxes can threaten a business’ profits. When a government introduces new taxes, it can negatively impact a business’ financial performance.
- Duty Rates. Similar to taxes, an increase on import/export duties can decrease profitability.
- The Cost of Materials. An increased cost of materials is one of the economic risk factors that manufacturing businesses need to identify and manage. When the market is competitive and these costs increase, consumers still expect to pay the consistent prices, leading to a possible loss in profits.
Other common types of economic risk to be aware of include exchange rates, hyperinflation and general government regulations that can affect investments. Businesses need to proactively identify and monitor all these conditions to support a robust economic risk management strategy.
Economic Risk Examples
By being aware of the types of economic risks that threaten your organization, you can strategize future business decisions and growth to mitigate these risks. Consider these three examples of companies who have effectively managed their own economic risks to avoid supply chain and business disruptions.
Jessops: Actively Responding to Recession and Competition
When the UK economy fell into recession in 2008, unemployment rates increased, wages decreased and consumers were spending less disposable income. The photographic retail company Jessops made the business decision to focus on its imaging business, as those services remained stable despite a decline in camera and hardware sales. This responsive action minimized risk and improved profit margins for the company.
As Jessops’ competitors from online photo printing companies with lower prices came into play, the business again adjusted its strategy to obtain a competitive advantage. Its diverse, multi-channel strategy included both in-store and online image and gift orders. To support customers online, the company provided a responsive call center with industry experts. Additionally, Jessops increased its product portfolio. These adaptions enabled Jessops to become a market leader, despite the multiple economic risks.
Ikea: Building Business Resilience During the Global Financial Crisis
The global financial crisis that began in 2007 hardly impacted IKEA compared to other businesses because of its response to macroeconomic change. IKEA’s volume of sales dropped by only 1% by the second quarter of 2009. The cost leadership strategy of IKEA considered the economic risk of the supply chain and core business activities. While the company had to cut 5,000 jobs, they outperformed many other retailers despite the impact of the macroeconomic climate and decreased consumer spending.
Amazon: Diversifying Its Portfolio to Mitigate Economic Risks
Amazon faces many types of economic risks, including taxation, inflation rates, industry-specific economic growth and more. One of the greatest risks the company faces is currency exchange risk. In 2016, net sales from international business made up 32% of Amazon’s revenues. Net sales were negatively impacted due to changes in foreign currency exchanges rates by USD636 million, USD5.2 billion, and USD550 million for 2014, 2015, and 2016 respectively.
Amazon could soon be facing the economic effects of taxation. U.S. President Donald Trump introduced the concept of an ‘internet tax’ in June 2017. He spoke of this specifically referring to Amazon. In order to manage the economic risks of both currency exchange rates and taxation, Amazon is diversifying its portfolio.
How to Manage Economic Risk in Business Operations
LexisNexis Entity Insight is a fast, efficient and cost-effective solution for identifying and reducing economic risk in business operations. The tool proactively monitors local and global suppliers and third-party business partners by leveraging a wide range of market intelligence unavailable on the open web, helping you manage global supply chain risks.
This off-the-shelf solution helps companies capture an in-depth view of reputational, regulatory, financial, strategic and economic risk factors. LexisNexis Entity Insight enables users to tailor monitoring to align to their internal company policy and risk-based approach.