In the current economy, high inflation, supply chain disruption, labor shortages and other trends are driving higher risk across sectors. Companies using a traditional enterprise risk management playbook might evaluate risks according to two criteria: probability and severity. Each risk is evaluated discretely, as if it were operating independently of others. But risks don’t manifest discretely – they combine. One risk that may be assessed as low-impact on its own could trigger other risks and, together, form a high-probability, high-severity risk cluster.
As the economic landscape evolves, companies that focus on systemic risks instead of discrete risks will have greater resilience, drive value, and increase stakeholder trust. Companies that plan to weather economic storms must invest, strategically, in the top “risk emitters” – areas that affect and influence the greatest number of other risks.
Focusing on the consumer goods sector, KPMG recently undertook systemic risk modeling using its patented Dynamic Risk Assessment methodology. Combining qualitative and quantitative data, Dynamic Risk Assessment takes a differentiated approach to gaining insights into clients’ risk environments by addressing risks’ propensity to interconnect with each other. The result is a deeper understanding of the risks organizations face in today’s changing, complex world.
Economic upheaval shifts the risk landscape
Globally, we are currently experiencing a massive macroeconomic shift from a previously more stable period of globalization, democratization, deregulation and privatization. Around the world, nationalism is on the rise. Consumers and regulators are scrutinizing the impact of companies’ environmental, social and governance (ESG) commitments. The Internet age is evolving with the development of the metaverse. Just-in-time supply chains are being replaced by localized manufacturing and the re-establishment of inventory levels and related financing.
This shift changes the risk dynamic profoundly. In a period of tumult, the past no longer informs the future. Indeed, it misrepresents the future.
During periods of globally accepted and adopted economic convention, such as the past 40 years of globalization, risks exhibit cyclical behavior – even if it is profoundly volatile. This gives risk some predictability and allows organizations to model risks more precisely. But in our current environment, companies need a new playbook.
Evaluating risk in the consumer goods sector
KPMG’s risk assessment revealed that, in traditional risk modeling, the most probable discrete risks in the consumer goods sector are input cost or inflation risk, talent, and cybersecurity. Evaluating the risks for discrete severity, cybersecurity comes out on top, followed by geopolitical forces and complacency or incumbency.
A company could try to mitigate each risk discretely, but that would be to try to win each battle, as opposed to the bigger war. Instead, companies must focus on risk emitters. For the consumer goods sector, the top risk emitters are technology, digital, organizational agility, brand, understanding the local customer, cyber, and complacency.
Acknowledging that one risk can trigger another, our assessment painted a new picture: Looking through the lens of non-discrete risk clusters, we identified two clusters for the sector: strategic and operational. The strategic cluster includes cyber; digital; technology; organizational agility; decentralized automated organizations (DAOs); building, sustaining, and advancing the brand; and understanding the local customer. The operational cluster comprises currency volatility, input cost/inflation risk, and price inelasticity.
If any individual risk in either of these two clusters is triggered, it will spread to the others to produce an aggregate risk. They are therefore expected to be present simultaneously, with the aggregate severity surpassing the most severe individual risk. Most of the risks that form the two clusters would not have been identified as high-threat risks using traditional enterprise risk management, as their propensity to trigger other risks would have remained unassessed.
Interpreting the operation of the wider network, including the clusters identified, we can identify long-term systemic risks that could impact companies in the sector’s future performance. These pose the most severe, systemic longer-term performance impediments to the sector.
For the sector, the top long-term systemic risk is technology, followed by companies’ ability to adjust – rapidly – to the changing circumstances and, thirdly, their ability to capitalize on digital developments. All the other risks identified are linked, directly or indirectly, to these risks, rendering the industry predisposed to them in terms of overall longer-term vulnerability. They also represent the industry’s safeguards to future performance and sustained shareholder value: focusing investment on technology and digital transformation, as well as supporting innovation rather than complacency or incumbency, are the key ingredients for future sustained performance.
By understanding the interplay and interconnectivity of risks combined with the economic environment, companies can better prepare for future risks and exposures. In this regard it is vital to obtain an informed understanding of future, even unprecedented, risks. These risks will unfold to eventually impact valuations, results, and disclosures in the financial statements.
Attacking individual risks as they arise will not protect a company in times of economic upheaval. Companies that evaluate systemic risk by recognizing how risks interconnect will be better positioned in the years to come, increasing stakeholder trust and organizational resilience.
Allan Colaço is Global Audit Sector Leader, Consumer & Retail, KPMG LLP (US). Andries Terblanché is Global Lead of Dynamic Risk Assessment, KPMG Group Services (Pty) Ltd.