Introduction to risk management
The only thing we know about future is that we do not know what is going to happen. This is related to definition of risk in general.
Miles & Wilson (1998) define risk as being an exposure or a probability of occurrence of a loss. Risk can also be viewed as having a positive effect. PMBOK (2004) defines risk as an uncertain event or condition that, if it occurs, has a positive or negative effect on business objectives.
Risks have a huge influence on the success or failure of business. However, risks cannot be avoided, but they can be managed. They must be managed by applying effort to their reduction or elimination. Not all risks need to be eliminated. They are sometimes sufficient to reduce the project’s exposure to a level that is acceptable to the project. Risk management costs time and effort, but the impacts can be significant. Without risk management, the chances of danger of failure will be high.
Effective strategic risk management can minimise of weaknesses within organisations causing damage. However, effective strategic risk management tools became harder to implement as business operations grow, become more complex, and operate in multiple locations.
Risk management is increasingly recognised as being concerned with both positive and negative aspects of risk. Potentially, there are the opportunities for benefit or threats to success as a result of risk.
Risk in financial climate arises through countless transactions of an economic nature, including sales and purchases, investments and loans, and various other business activities.
Therefore, risk management can provide a solution to making individual and company less in danger. Identifying strategy for risks as soon as possible is particularly important.
There are common approaches to risk which take alternative action when risks exposure, removal as insure risk, measure opportunities to risk may occur and make plan to control and acceptation of risk.
According to Mills (2001), the systematic approach makes the risks clear, formally describing them and making them easier to manage. In other words, systematic risk management is a management tool, which requires practical experience and training in the use of the techniques.
Appropriate responses to risk must be prepared to all the risks that would significantly affect the strategy or returns of the company if they were to occur.
Background of McDonald
According to McDonald (2010), McDonald is the world’s largest chain of quick service restaurants organisation in the world, serving tens of millions of customers daily worldwide.
There are more than 30,000 restaurants in 120 countries worldwide.
According to McDonald’s Corporation Annual Report (2009), revenue has reached a record more than US$20 billion and US$6.8 billion income and 390,000 employees.
McDonalds operates according to four values which are quality, service, convenience and value. Part of organisational culture is the quality of the food and service wherever the branch is located. The good reputation of the company and the expectation of an excellent service no matter which branch people eat is a marketing strategy of McDonalds. McDonalds set a standard applicable to all branches worldwide. However the company also gives a way for innovation by allowing the branches to integrate culture into food and service increasing market share.
McDonald’s tries to operate on a cost leadership basis by offering low priced goods with higher profit margins. Most of the efficient strategies adopted by McDonald’s associate with this strategy of low cost.
Since McDonald’s operates in 120 countries on 6 different continents, they offer different food selections because of different needs in each country, due to religion, diets, and resources of each individual country. This flexibility and knowledge allows McDonald’s to achieve global targets and compete with the other competitors. It shows that the company predict customer needs and handled well to risk.
The PESTLE analysis of the macro environment
According to BADU (2002), many of organisations’ success or failure, profit or loss, growth or decline depends on how well they respond to macro political, economic, social, technological and regulatory changes which is the external macro environment.
Johnson & Scholes (2005) support that the external factors can be divided into six categories which political, environment, social, technology, environment and legal. These external factors usually are out of the organisation’s control and sometimes present themselves as threats.
The macro environment analysis is usually the first step of a strategic analysis. It is sometimes referred to as an external analysis or a PESTLE analysis. In other words, it can be analysed with the many different factors in an organisation’s macro environment by using the PESTEL framework.
The purpose of the macro environment analysis is to identify possible opportunities and threats in the industry as a whole that are outside the control of the industry.
According to Kotler (1984), the macro environment consists of the larger societal forces that affect micro environment. The micro environment, on the other hand, consists of the forces close to the company that affect its ability to serve its stakeholders.
Firstly, the macro economic environment analysis will identify trends such as changes in personal disposable income as rises in living standards or the general level of demand, rises or falls in interest rates, unemployment rates and inflation. According to Luffman & Sanderson (1988), the economic environment consists of the current and future state of key economic variables used to describe wealth, purchasing power, savings and consumption, together with government economic policy deployed to affect those variables. For examples, Gross National Product (GNP) or disposable income are key determinants of demand. The distribution of income in society provides opportunities for organisations to separate product or service offerings in terms of levels of disposable income. The rate of inflation and government policy towards it can really affect consumers’ attitudes to consumption. As a result, company strategy in the economic environment can be not simply threat for organisation, but opportunities for improvement that company can do better.
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Moreover, Tchankova (2002) states that the economic environment usually is hardly influenced by the political environment in a single country, but the globalisation of the market creates a market that is greater than a single market and needs to be considered separately. Although a particular activity of the government can affect the international capital market, the control of the market is impossible for a single government. Examples of sources of risk generated from the economic environment in global are economic recession and depression and current exchange rate.
McDonald could suffer in country where the economy of the respective states is hit by inflation and changes in the exchange rates.
Secondly, the macro political and legal environment analysis will identify changes in government, or a change in government policy. As a result, legislation will be made such as minimum age discrimination and disability discrimination and minimum wages. Moreover, political decisions can impact on many essential areas for business such as the environmental regulations, the employment laws, trade restrictions and tariffs, political stability for internally and externally and decision making structures.
Luffman & Sanderson support that Government at both national and local levels can affect companies not only on a day-to-day basis through laws, policies and its authority, but also at a strategic level by creating opportunities and threats.
Furthermore, Tchankova states that the political environment is a more complex and important source of risk in an international aspect. The difference in the ruling system raises different attitudes and policies toward business. For example, foreign investment might be confiscated, or taxation systems might change significantly, which will hurt the investor’s interests. The political environment can present opportunities as well.
McDonald is the international operations which greatly influenced by the government policies such as regulations and new legislations for tax, trade, product safety, health care and labour.
Thirdly, the macro technological environment analysis will identify changes in the application of technology. It is related with the application of new inventions and ideas such as the development of the internet or websites as McDonald company business marketing tools.
Luffman & Sanderson support that the technological environment is compounded of the impact of science and technology in product and process innovation. Technology can improve quality, reduce costs and lead to innovation. These developments can benefit consumers as well as the organisations providing the products and service.
Fourthly, the macro social and cultural environment analysis will identify trends in religion, beliefs, behaviours, values and standard such as changes in lifestyles like more women going out to work, changes in tastes and buying patterns. Furthermore, the number of part time workers and attitudes and diverse working environment are also related with changes in society.
The speed of change in the social environment may be slow, but its effects are unstoppable.
Generally, the company’s strategies need time to evaluate the corporate response to social changes.
Besides, Tchankova states that the changes in human behaviour and state of social structures are cause of risk. The level of employee and loyalty to the organisation determine to a large extent the success of the organisation. At the same time the changes of culture create opportunities.
Lastly, the macro environmental analysis will identify factors such as natural disaster or global warming. For example, volcanic eruption that occur few weeks ago impact on many industries including airline, farming and insurance because of volcanic ash. Also, McDonald recycle standard is result of environment analysis. Oxford University Press (2007) supports that with the weather and climate changes occurring due to global warming and with greater environmental awareness this external factor is becoming a significant issue for firms to consider.
Micro environment analysis
This environment influences the organisation directly. According to Beamish & Ashford (2005), simple approach to this analysis will be to break it down into 5 elements which are business, customers, suppliers, stakeholders and competitors. These are internal factors close to the company that have a direct impact on the organisations and strategic planning.
First of all, in terms of customers, organisations should focus on meeting what customer needs and wants and providing benefits for their customers. Success of business depends on how well organisation analysis of their customer. This analysis can be the basis of organisation provides the right product at right price and to the right place at the right time. Otherwise, business strategy will be failed as a result. Customers are a major environmental factor for McDonalds. Nearly 54 billion customers served by McDonald daily basis. McDonald’s customers are mostly young generation. That’s way, company always conscious about their choice. For this reason, customers demand, their choice, what they like is impacting McDonalds.
In terms of competitors, restaurant industry is extremely competitive. McDonald is one of them and very successful company. They are doing everything in their power to make sure that they attract to their customers. Therefore, competitor such as KFC and Burger King analysing and monitoring is critical if an organisation is to maintain its position within the market. As the competition increase, there are more advantages to the customers. As a result, McDonald is up to date with customer taste and preference.
Also, employing the proper staff and keeping these staff motivated is a vital part of the strategic planning process of an organisation. Training and development are essential, particularly in service sector, in order to gain a competitive advantage. McDonald has maintained a huge commitment to their employees and their training, which includes making available to all entitled employees and a consistent management and training programme.
In terms of supplier, Beamish & Ashford states that supplier relationships are a further critical component to the success of any organisation. It is important to many organisations to ensure consistent supplies in order to meet consistent demand for their product ensuring competitive and quality products for an organisation. Therefore, supplier analysis is essential. As a result, organisation must review some factors such as costs, quality, warranty, financial stability and the relationship suppliers have with competitors.
For example, increasing beef prices will have affect on the strategy of McDonald. Prices may be going up as a result.
In terms of stakeholders, they are individual or group that can greatly influence the performance of the company. Stakeholder’s support makes company successful. They have in turn certain expectation from the company. Therefore, to analysed stakeholder expectation is fundamental.
According to Beamish & Ashford, the role of stakeholders in any organisation seems to have an increasing influence in which organisation can do business.
Shareholders are one of typical stakeholders who require a certain level of return which means it is important for any organisations to focus on making decisions that satisfy and maximise this return. Satisfying shareholder needs may result in a change in strategy employed by an organisation. McDonald’s stakeholders are individuals or groups that have an interest in the organisation and how it operates. McDonald take into account the needs and requirements of stakeholders.
In addition, microenvironment also provides organisations possible threats in the market place that would reduce their profit or rate at which consumers purchasing their products. One of those threats is that consumers use as a substitute to their products. These threats usually come from competitor organisations.
Global company and risk management
Brindley (2004) suggest that global competition, technological change and the continuous search for competitive advantage are the primary motives behind organisations turning towards risk management approaches in the international chain industry. Furthermore, the increase in economic activity at the global level encourages business organisations to seek a competitive advantage by accessing new markets and expanding their operations. According to Porter (1990), the term competitive advantage refers to the strategies that allow successful companies to create profits in their sector of economic activity which is main objective and goal of most organisations.
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Dalgleish & Cooper (2005) support that organisations manage their operations on a day-to-day basis and risk management does not naturally add value to this activity. Its application is, however, becoming more focussed with organisations identifying a sense of purpose and making proper use of the assessments. This has resulted in its adoption within the internal control systems of organisations in making informed decisions, improving communication with the board and improving their understanding of the risks and controls within the business.
Therefore, risk identification is the first stage in any organisation’s risk management. It is a base for correct future work of the organisation with regards to developing and implementing new programmes for risk control. According to George (2009), risk management is the process of planning, organising, directing, and controlling resources to achieve given objectives.
Brown (2000) recommends that boards or responsible directors should consider the key risks and assess how they have been identified, evaluated and managed, and assess the effectiveness of the system of internal control. As a result, directors should have responsibility for all aspects of control and a duty to establish a strong system of risk management, designed to identify and evaluate potential risks in every aspect of the business operation. Risk management is fundamental process in every organisation, which includes control systems to inform managers that organisation has being exposure to risks, and guarantee that strategic risk management is properly implementing.
According to Jorion & GARP (2009), financial risk includes market risk, credit risk and operational risk. Market risk is the risk of losses due to movement in financial market prices or volatilities. This usually includes liquidity risk which is the risk of losses due to the need to liquidate positions to meet funding requirement. Liquidity risk is not amendable to formal quantification. Credit risk is the risk of losses due to the fact that counterparties may be unwilling or unable to fulfil their contractual obligations. Operational risk is the risk of less resulting from failed or inadequate internal processes, system and people or from external events.
Financial risk is that a company will not have sufficient cash flow to meet financial obligations. Wikipedia (2010) supports that financial risk is the additional risk a shareholder bears when a company uses debt in addition to equity financing. Companies that issue more debt instruments would have higher financial risk than companies financed mostly or entirely by equity.
Therefore, the financial risk management process must not be involve avoidance of risks, but designed at identifying and managing these risks instead.
For example, according to McDonald, McDonald’s restaurants worldwide, contribute 7% of global profits, making the UK a very important financial market for McDonald’s shareholders. Each individual McDonald’s restaurant is structured as an independent business, with restaurant management responsible for its financial performance. McDonald’s financial reporting and management accounting ensures the best financial position for the company now and for the future.
According to Monetary Authority of Singapore (2006), market risk refers to the risk to an organisation resulting from movements in market prices, in particular, changes in interest rates, foreign exchange rates, and equity and commodity prices.
The market risk strategy should first determine the level of market risk the organisation is prepared to assume. This level should be set with consideration given to, among other factors, the amount of market risk capital set aside by the organisation.
The organisation should develop a strategy that balances its business goals with its market risk appetite.
Accessing to all current operative cash flows and to all financial transactions is indispensable for complete risk management. In order to determine and control risks, the information from these two sources needs to be brought to together.
Currency exchange rate risk for McDonald
According to Mathur & Loy (1984), in a world of increased uncertainty about the future value of exchange rates and increased visibility of foreign exchange gains and losses, it is not surprising that global companies have become more concerned about minimising foreign exchange risks. Exchange rate risk may strongly affect firm’s profitability and it can be hedged. Once a company becomes involved in international trade, it consequently becomes subject to foreign exchange risk exposure.
In other words, because of the increased globalisation, exchange rate has become an important source of risk for an organisation operating in international environment.
McDonald is international franchise fast food restaurant. Lashley & Morrison (2000) support that franchising business format has become an established global enterprise trend within the service sector. They indicate further that franchising has become a mature industry in the USA and well established in the UK.
According to Edwards (2006), the reasons why company is going for international are build more brand and shareholder value, add revenue sources and growth markets, reduce dependence on home market and leverage existing corporate technology, supply chains, know-how and intellectual property.
However, certainly, some risks are exposure for those reasons. Exchange rate risk is one of them which unavoidable for global company.
According to FinancialCAD Corporation (2009), in 1967, McDonald’s opened its first foreign country franchise in Canada. Today, more than 65% of total revenue is derived internationally, as more and more restaurants are opened in countries outside the United States, with increasing McDonald’s foreign exchange and interest rate risks. McDonald is challenged with managing these risks as hedging the interest rate and foreign exchange risks for operations based in foreign countries is complex. As a result, McDonald’s warned their investors of the potential changes in currency exchange rates to impact company profits, but that the company has tried to reduce these risks.
FinancialCAD Corporation continously states that the McDonald financial markets group is responsible for hedging the balance sheet and income statement against foreign exchange and interest rate risks, while funding the growth of global operations. They often fund assets locally, but in many markets this is challenging. The assets are funded by more than $8 billion in debt, with over 50% of the debt denominated in a foreign currency.
According to Abor (2005), foreign exchange risk is the risk that an entity will be required to pay more or less than expected as a result of fluctuations in the exchange rate between its currency and the foreign currency in which payment must be made. Foreign exchange risk is commonly defined as the additional variability experienced by a multinational corporation in its worldwide consolidated earnings that results from unexpected currency fluctuations. It is generally understood that this considerable earnings variability can be eliminated partially or fully at a cost, the cost of foreign exchange risk.
Companies are exposed to foreign exchange risk if the results of their projects depend on future exchange rates and if exchange rate changes cannot be fully anticipated.
According to Madura (2003), companies are generally exposed to three types of foreign exchange risk which are transaction (commitment) exposure, economic (operational, competitive or cash flow) exposure and translation (accounting) exposure. Transaction risk occurs where the value of existing obligations are worsened by movements in foreign exchange rates. Economic risk relates to adverse impact on equity or income for both domestic and foreign operations because of sharp, unexpected change in exchange rate. Translation risk is also related to assets or income derived from offshore enterprise.
Foreign exchange risk can be managed in various ways. There are techniques used for hedging against risk. According to Prindl (1976), hedging can be defined as all actions taken to change the exposed positions of a company in one currency or in multiple currencies. Clark, Levasseur, & Rousseau (1993) argue that hedging refers to the technique of making offsetting commitments in order to minimise the impact of unfavourable potential outcomes. The risk manager’s choice of the different types of hedging techniques may be influenced by costs, taxes, effects on accounting conventions and regulation.
Foreign exchange risk is mainly managed by adjusting prices to reflect changes in import prices resulting from currency fluctuation and also by buying and saving foreign currency in advance. The main problems firms face are the frequent appreciation of foreign currencies against the local currency and the difficulty in retaining local customers because of the high prices of imported inputs which tend to affect the prices of final products sold locally.
Investing in a foreign stock market is equivalent to investing in two assets: foreign stocks and foreign currency. Therefore, the return-risk outcome of a foreign investment can be separated into contributions from the local market factors and the currency factor. The currency impact on the return outcome can be positive or negative, and can be a substantial part of the total return.
According to Fatemi (2000), the objectives of risk management include minimise foreign exchange losses, reduce the volatility of cash flows, protect earnings fluctuations, increase profitability and ensure survival of the firm.
Conclusion and Recommendation
Risk taking is essential for any organisation in the global environment. Therefore, organisations need to understand the nature of the risks they meet and prepare to manage them appropriately.
Evaluating significance by estimating potential damage and possibility of events is often not an exact science, and sometimes based on best guesses.
However, monitoring and managing significant exposures of risk is vital in globalisation of today business strategy as many factors in our environment are changing with extreme speed.
McDonald is one of the biggest and most successful international franchise companies in the world. The research indicates that the way of how company manage risk is outstanding compared to other global companies. Burger King has just imitated what McDonald has done for risk management. Excellent risk management might be the best reason that McDonald has become successful business in the field. In other word, it is hard to find unmanaged area to be in risk in organisation.
As a result, well prepared risk management of company and flexibility for changing environment are bringing to organisation benefits.
However, there are some unanticipated other risks still may occur. For example, McDonald’s size of business could be obstacle of effective hedging.
International service organisation such as McDonald must consider the opportunity cost of international expansion. Being more flexible and international expansion might be a benefit to get wider market customers. On the other hand, this might cause of taking risks. It therefore certainly requires a thorough analysis of the factors such as the details on key current economic environment for the country, the main competitors, demand characteristics and trends, contribution of the project to shareholder value, the level of risk and potential difficulty for the organisation.
Moreover, the company need to consider that competitors are not just other fast food chain restaurant. It means that company should put lots of effort for analysing other companies. For example, variety of more relevant menu can be developed.
Furthermore, the research indicates that the company should be well aware of importance that steady rise of profitability and share price. Therefore, company manage for financial strength by reducing capital spending and using the money remaining after capital expenditures to pay debt and return cash to shareholders.
The research also shows that changes in exchange rates generally impact the outcomes negatively. That is why it needs to be managed properly.
Therefore, global organisation management must consider commitments for innovation and flexibility to enhance positive risk management effects.
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