The LOMP Class Risk Management

1. Rev 4 The LOMP ClassRisk Management Presented by: Phil Harding and Dick Dadamo

2. Risk Taking Risk Assessment - ERA Risk Management - ERM

3. Risk Taking – Dictionary Definition “Taking risks is facing some kind of peril, jeopardy, hazard, or exposure to chance of injury or loss” 3

4. Risk Taking – Why? • Why take risks? • The rewards of proactively taking a risk can outweigh the ultimate rewards of reactively doing so only because it was necessary • The upside potential by taking a risk significantly outweighs the downside loss • Nothing ventured nothing gained • Staying the same can lose the game 4

5. Risk Taking – How? • Start with a Strategic Plan the basis of all risk analysis • Look at the projects you are doing • Look at the projects you are studying • Don’t ignore things you are not doing probably the biggest risk of all

6. Risk Taking - Axiom • If it can’t help, but might hurt…avoid it! • If it can’t hurt, but might help…don’t do it but watch it! • If it can’t hurt, but will help…go for it! 6

7. Risk Taking – Myths • Going for a higher target will insure you make the real goal • Call enough people to find one to give you an out • Not risking is a safe strategy • Sharing risks reduces danger • Risking is gambling 7 7

8. Risk Taking – Types of Risks • Strategic • Competitive • Career • Marketing • Legal • Planning • Global 8 Technological Financial Ethical Human resources Products Organization

9. The Biggest Financial Risk is theSales Forecast • How does a company determine the Sales Forecast? • Customer Purchase Orders • Probability estimates of customer programs • Historical extrapolation • Backlog • Profits are the slight difference between Sales and Costs. Variances in Sales Forecasts • Amplify profit variances • Working Capital & Cash variances • The biggest Risk in any Plan is the Sales Forecast What is the correct method for Forecasting Sales for you? 9

10. Risk Taking – Market Valuation • Where is the market heading? • What is the basis for our penetration? • How well do we know our customer base? • How well do we know the customers in the market? • What will the customer response be to our entry? • What will the competition be to our entry? • Will the customer pay for our product/service 10

11. Product Marketing Risks NEW PRODUCT/PROCESS DIFFERENT MARKET NEW PRODUCT/PROCESS PRESENT MARKET Largest Risk Lowest Risk Long term Risk PRESENT PRODUCT/PROCESS PRESENT MARKET PRESENT PRODUCT/PROCESS DIFFERENT MARKET 3

12. Product Marketing Risks NEW PRODUCT/PROCESS DIFFERENT MARKET NEW PRODUCT/PROCESS PRESENT MARKET The Risk is Risking too much The Risk is Avoiding Risk PRESENT PRODUCT/PROCESS PRESENT MARKET PRESENT PRODUCT/PROCESS DIFFERENT MARKET 3

13. Product Marketing Risks Danger Signs Present Market Stick to cliché, “Don’t fix what’s not broke” We are not vulnerable in our niche We can’t afford to change Anything new will compete against our current products New Market We only need a small % of a large market to be a success There are no strong competitors, the market is fragmented If we meet our schedule completion we will be ahead of the competitors We know what the customers need

14. Risk Management Methods Risk Budget Access to Resources Review of Priorities Organize to Manage Risk Defined Milestones Define Timeliness of Risk Periodic Reports & Reviews Risk spending vs Risk Budget Plan if Risk plan is not on Target Alternative “What If” Plan Criteria for Continuing Risk Criteria for Terminating Risk

15. Risk Management – Caution • Don’t do too much too fast • Adding new and different activities • Ignoring the environment • Keeping the same ground rules • Missing the mainstream • New product, new market • Be wary of the big customer • Volume alone won’t do it • Avoid breaking Guinness records 15

16. Risk Management Actions • Minimize the impact of playing hunches • Find out if facts support your information • Be prepared to back down • Describe your hunch to people you trust • Test market your hunch • But filter the “black paint” inputs • You can’t execute risk without having a strategic plan 16

17. Risk Management For All Risk Decisions • Accept the uncertainty • Know the potential gain (upside potential) • Know the potential loss (downside loss) • Determine the significance – is the risk meaningful? 17

18. Risk Management-Plan Checks • Record breakers • Margin eaters • Responsibility • Competitive environment • Culture change needed 18 Boundary conditions Discontinuities Comparisons Rate of change Ill-defined improvements

19. Risk Analysis Methodology • Understand the present situation thoroughly • Formalize and document the risk to be taken • Carry out due diligence on the opportunity • Analyze the upside potential if the risk is even taken • Analyze the Downside loss if the risk is a failure 19

20. Risk Taking Examples

21. RISK ANALYSIS – EXAMPLE 1 Customers buy $25M Upside Potential Present Situation Sales Gross Profit Gross Margin Capacity Forecast $20M/year $6M/year 30% $21M/year $25M/year Sales Gross Profit Gross Margin Reward $25M/year $7.5M/year 30% $1.2M/year Increase Capacity CAPEX Risk Plan Customers buy $20M Downside Loss Increase CAPEX Increase Capacity Increase Sales Cash Loss Profit Less by Margin Less by $5M $5M $4M $5M $1M 5% Should the company invest in the CAPEX? 21

22. RISK ANALYSIS – EXAMPLE 2 Present Situation Upside Potential Sales PAT Market Cap Market Size $50M/year $1M/year $100M $500M/year Sales PAT Reward PAT Market Cap $75M/year $6M/year $5M/year $150M M&A Risk Plan Downside Loss Target Sales Target PAT M&A Price Accretive by $25M -$1M $25M $5M? Sales PAT Market Cap $75M/year $0M/year $90M Should the company do the M&A? 22 22

23. RISK ANALYSIS – EXAMPLE 3 Present Situation Upside Potential Sales 1st year PAT 1st year Sales 2nd year PAT 2nd year $12M/year -$1M $15M $1M Sales PAT Forecast $10M/year $0M/year $11M/year New Product Risk Plan Downside Loss Sales 1st year PAT 1st year Sales 2nd year PAT 2nd year $10M -$1M $11M $0M R&D Cost Sales 1st year Sales 2nd year Gross Margin $1M $1M $4M 30% Should the Product Development be committed? 23 23 23

24. Risk of Relocation – Example 4 • Benefits and Reason for Relocation • Closer access to Customer Base • Availability of Resources • Labor, Management, Supply, etc. • Lower Labor cost • Lower Operating Cost • Freight, Utilities, etc. • Lower Income Tax • Lower Cost of Regulations • Upside Potential • Increase in Revenue (now & future) • Lower Operating Cost (now & future) • Increase in Profit (now & future) • Downside Risk • Increase in Wages (Risk of Unions) • Increase in Rent • Increase in Utility Cost • Increase in Taxes • Increase in Regulatory Cost • Increase in Freight • Increase in Insurance • Environmental Risk • Amortization of One Time Costs • Moving Cost • Lost Productivity & Revenue • Employee Terminations • Hiring New Employees • Equipment Repair & Replacement General Risks & Uncertainties Are Loans required, Is cash available? Culture of Organization Key People, okay to move or not? Recovery Time for Upside Potential to exceed One Time Costs

25. Sales Shortfall Risk – Example 5 • Analysis • Review assumptions of original forecast, change if required • Which products or product lines are slipping? • For the products in question is there a seasonal trend? • Is this a one customer or many customer problem? • Are customer/s selling another product instead of yours? • Is the problem a loss due to competition or customer demand? • Have the opportunities planned lost forever? • Upside Potential • Will pricing help you get back on line? • Lower prices on slipping product line • Raise prices of other products • Build into inventory since customer demand is likely to increase • Downside Risk • Reduce operating Costs to be in line with lower Sales • Contingencies • How to increase production if costs are reduced but demand increases • How to deploy excess inventory if customer demand does not increase

26. Risk EXAMPLE 6 Case study: the service division will lose over $28 million in the next five years • Risk in a BIG Company • Two division managers cooperating • Seeking help in other parts of the company • Raising prices unilaterally • Field personnel on customer matters • Replacing marginal equipment – free • RESULT – profits in 3rd quarter out!!

27. Risk Taking – Keys • Timing • Market evaluation • Realistic goals • Key elements 27 27

28. Contingency Planning – the “What Ifs” • Beware that most agreements are structured for success • Should have agreement on default actions • Should include “what ifs” – if certain elements of the plan or agreement aren’t met • Build a file on problems and the actions taken • Everything takes longer than you think 28

29. Consultants Approach to ERM Enterprise Risk Management • Risk: whatcan adversely affect the achievement of Company objectives. • Loss of value or • Sub-optimization of gain • Enterprise Risk Assessment (ERA): • A key step to the overall ERM program to understand the Company’s overall risk profile • A structured, dynamic approach to risk identification, assessment and prioritization • Enterprise Risk Management (ERM): • A process involving the board of directors, management and other personnel, applied in strategy setting and across the enterprise to proactively identify, respond to and manage risks

30. Enterprise Risk Assessment - Process Overview Risk Identification Risk Monitoring and Reporting Risk Prioritization Risk Mitigation and Action Planning -Risk interviews with key management /personnel and selected Board members (18 interviews with management; 4 interviews with Board members) -Risk survey with management -Risk assessment workshop with executive management -Completed “deep dive workshop on 1 of the 2 pilot risk areas -ERM program and reporting protocol being developed benchmark budget regulations environment “Deep Dive” risk action planning workshop for two pilot risk areas • Risk assessment results • Risk Matrix • Internal Audit Plan initial risk list risk list & rating criteria Risk assessment workshop risk survey ERA Risk Framework

31. Putting a “Value” on Risk The tables on the following two slides are used to identify the impact and vulnerability of identified risks on the Company. • Impact - $ value significance • Vulnerability - likelihood of occurrence These value ranges are used to assign a risk ranking score to the risks identified during the interview process.

32. Risk Rating Factors - Impact Impact: “If the risk were to happen within the next 12 months, how significant would it be? How much could it hurt the Company?” NOTE: When evaluating the potential impact of a risk, select the highest (worst case) impact threshold exceeded and assign the corresponding impact level. (Example: If a risk has a MEDIUM financial impact but and a HIGH reputation or regulatory impact, select HIGH. )

33. Risk Rating Factors - Vulnerability Vulnerability: “If the risk were to happen within the next 12 months, how vulnerable is the company?”

34. Risk Framework with Risk Assessment Results Desired State: Present State: Chart II: Illustrative Risk Map of companies under a more mature state of risk management Create a list of specific risks and place a value on the impact and vulnerability of each risk. Chart I illustrates these risks, identified as 1 to 44 for a specific company. The red zone contains The high priority risks that need to be mitigated. Note that the risks seem to line up into an approximate Slope, implying that the high impact risks have not been Worked on by the company. This is a very typical phenomenon. H H 1 1 2 5 5 7 2 10 8 8 13 3 3 8 8 15 6 4 16 18 17 13 9 11 37 19 39 28 40 Impact Impact 41 41 43 43 44 44 Chart II presents an illustrative risk map typically representing the risk profile of companies under a more mature state of risk management. Note that a number of risks, although still high in impact, have a lower to more moderate vulnerability. L L H H Vulnerability Vulnerability