Risky Business

By its nature, risk pops up where companies least expect it. But those who anticipate the worst-case scenarios, and act swiftly when they do hit, generally weather them better than those caught completely unprepared.

Some risk is unavoidable but extremely obvious, such as damage from a weather-related catastrophe like last summer's drought or Hurricanes Sandy and Isaac. The latest storm's impact on retailers' sales is still being tallied, but those forced to closed their doors are expected to report lower quarterly sales.

Other risks are far more difficult to detect, such as cyber liability from hacking, identify theft or other privacy breaches. New regulations also can pose a risk, as Sunland Inc. learned in late November when the U.S. Food and Drug Administration exercised its new authority to suspend, without the need for court approval, the company's registration at a peanut butter plant involved in a September salmonella outbreak linked to 41 illnesses. Retailers and CPGs alike are bracing for more new rules related to health care, wages, food safety and labeling. Just about any mandated change carries a cost to the business.

While rare, food contamination is the biggest risk manufacturers and retailers face on a regular basis, experts say, because the impact can be fatalities that leave a permanent scar on a company's reputation. What quickly became the largest beef recall in Canada's history started Sept. 3 at the U.S. border when inspectors detected E. coli in a routine test of product from XL Foods. The contamination would be linked to 18 illnesses, and the company was widely criticized for being slow to respond. "It took two weeks for the CEO of the company to actually make a public statement. It took seven days before they issued a press release," and the delay hurt the company's reputation, says consultant Tim Ragan of CE Strategies in Ottawa, Canada. In late October, Greeley, Colo.-based JBS took over management of the Brooks, Alberta, plant, while subsequent inspections identified more problems.

Risk is easy to understand after the fact, but when profits are under pressure, many companies don't make risk prevention a priority, says Shanton Wilcox, North American lead of logistics and fulfillment at Capgemini Consulting in New York City. "When budgets are obviously tightening, it takes a very strong executive with some recent [crisis] experience" to invest in risk mitigation, Wilcox says.

Still, "more companies are experiencing more events on a more regular basis," Wilcox says, including many stemming from the supply chain. Supply chain disruptions spurred a 465 percent increase in economic losses from 2009 to 2011, and adverse weather was the top cause of disruption, according to a study by Capgemini Consulting and Penn State University.

Supply chain disruptions often have a ripple effect. About 29 percent of risk events stemmed from a subcontractor, Wilcox says. Regardless of the cause, disruptions often impact public perception and the company's stock price. As a result, 44 percent of survey respondents said they plan to increase their attention to supply chain risk and mitigation, but finding the funds is often a challenge.

Board members of public companies have identified risk management as a top area in need of more attention, according to the 2012 BDO Board Survey of corporate directors of public company boards. The survey shows two-thirds of the board members perceive their liability risk as a director has increased.

To identify potential hazards as decisions are made, many companies are bringing in enterprise risk experts, says Rick Shanks, national managing director of the food system, agribusiness and beverage group at Aon Risk Solutions in Kansas City, Mo. A risk expert can identify areas the retailer or CPG manufacturer might not otherwise consider and offer suggestions for mitigating the risks. "We help them develop a risk map, which will come up with the top 45 risks," Shanks said. Then, the expert can develop a plan for mitigating them or transferring the risk with insurance.

1. Food Safety

Food safety risk is magnified because it's often accompanied by reputation risk, Shanks says. That's one reason Oregon-based Beaverton Foods has added a Safe Quality Food process that goes beyond Hazard Analysis and Critical Control Points to involve the entire enterprise, says Domonic Biggi, chief executive of the manufacturer of horseradish, mustard and dressings. The company puts workers through training and mock recalls and routinely asks to see suppliers' paperwork. "It's a lawsuit-happy culture we live in," he says.

2. Corruption and Bribery

News of the government investigation into Walmart's alleged bribery of Mexican officials has brought the topic into the limelight. One-third of public companies' board members cite corruption and bribery as the greatest fraud risk in the September 2012 board survey by Chicago-based accounting and consulting firm BDO USA LLP. Among the two-thirds of directors whose companies conduct international business, more than half reported dealing with foreign officials. Many said the compliance risk related to bribery of government officials has risen during the past two years.

3. Regulatory and Governance Risk

Among governance regulations, 51 percent of directors surveyed said the whistleblower bounties the Securities and Exchange Commission enacted in 2011 have undermined their company's own internal anti-fraud programs. Most governing boards rely on the chief executive officer and chief financial officer to assess and mitigate risk, while one-third of the directors surveyed said their companies employ a chief risk officer.

New regulations such as food labeling carry the financial burdens of reconfiguring labels and marketing materials as well as the risk of mislabeling an item. Most food recalls are due to mislabeled ingredients, which can pose a health risk to consumers with food allergies. As the companies opposing California's defeated Proposition 37, which would have mandated labels on products containing genetically modified ingredients, pointed out, every new rule comes with the threat of litigation.

4. Real Estate Risk

In a challenging economy, retailers have learned the risk of poor location choice and changing market dynamics the hard way. "If you open up in a bad location where you've made a mistake on the demographics, that's a risk," says Al Ferrara, director of retail services at BDO USA. Many retailers shuttered or sold underperforming stores in 2012; Delhaize America in January announced it would close 113 Food Lion, seven Bloom stores, six Bottom Dollar Food stores and a Tennessee distribution center, for example.

5. Market Risk

New competition also can blindside conventional players. Retailers saddled with debt or expensive leases could find themselves at a disadvantage. "If you over-leverage supermarkets, you're in trouble," Ferrara says. "When the competition knows you're hurting, what do they do, they go right at your jugular," Ferrara says.

CPGs also are at risk of what Ragan calls "the Walmart effect" of squeezing suppliers for low prices. Suppliers become beholden to the giant because it's too big of a customer to lose. "You introduce a fairly strong incentive to start cutting corners," Ragan says.

6. Enhancing Competitive Advantage

Volatility in commodity, energy and labor costs can disrupt the supply chain. To help control costs, some companies are turning to electronic bidding services, such as Phoenix-based Intesource, which works with Harris Teeter, Meijer, Rite Aid and other retailers to find the lowest-cost suppliers through an online auction system. By adding transparency to the price negotiations, the incumbent supplier will lower its prices 55 percent of the time, says Brian Miller, vice president of services at Intesource. "Any time costs are increasing and consumers are feeling pinched and starting to become more frugal, our service becomes more popular," Miller says.

7. Inventory Management

To mitigate the risk of excess inventory from new product introductions that flop, corporate trade firm Active International will buy the inventory from the CPG company in exchange for handling its media placement, says Bill Georges, president of sales and operations at the Pearl River, N.Y.-based company. "If there is a distribution channel available to us, we will sell it" and use the proceeds in the media at an advantageous rate. For the CPG, the assurance of getting some value for their overstock product helps to encourage additional new product development.

8. Loss and Fraud

But inventory is also subject to loss, and supermarkets reported a loss rate of 2.54 percent in 2011, outpacing retail stores in general, according to the National Retail Security Survey. About 44 percent of supermarket loss stemmed from employee theft, 33 percent was attributable to shoplifting, 10 percent was due to administrative error and about 6 percent to vendor fraud, Progressive Grocer reported.

A Silver Lining

Resilient companies can emerge on the other end of a crisis stronger, Ragan says. Maple Leaf Foods endured a Listeria crisis in August 2008, but acted swiftly to shut down the plant and recall all 220 packaged products made there, not just the ones linked to the outbreak. "Consumers will respond to companies that take risk and responsibility really seriously and communicate that," Ragan says.

But the company might not have shored up its controls without a crisis. "Until those breakages happen, it's hard to convince a management team that we should spend more at auditing. It's a tough thing to sell," Ragan says. "You start to sound like Chicken Little if you say the sky is going to fall in."

The best strategy for preventing a crisis is to develop solid relationships with vendors and partners, then verify their products and services, Ragan says. "Trust but verify. That's a really good motto for the supply chain. Yes, I trust them, but I need to verify."

Freelance journalist Ann Meyer, who serves as senior editor of Retail Leader, also has written for the Chicago Tribune and Crain's Chicago Business. She is president and CEO of L3C Chicago L3C.