September 8, 2007

The Upside
How to Turn Big Threats into Growth
Breakthroughs

Prepared for:
MMC Riyadh Seminar

C O N F I D E N T I A L | www.oliverwyman.com
 Increasing risk and volatility

© Oliver Wyman  www.oliverwyman.com 1

 Risk

Human
Hazard Financial Operating Strategic
Capital

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What questions should you ask about strategic risk?

ƒ What are the big risks that can damage my business?

– Risk is just an expensive substitute for information

ƒ Can they be turned into competitive advantages?

– Your greatest growth opportunities are your

greatest risks - reversed

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Widespread impact of strategic risk

ƒ Strategic risk is rising, and the market is unforgiving

ƒ While extreme volatility of earnings, expectations, and stock price has been inherent in tech
companies, these characteristics are now infecting even the bluest of blue chips – very powerful
companies operating in relatively stable industries.
ƒ Worse, those characteristics are infecting even the very best and smartest companies, iconic
“great managers” running “great business models” (Wal-Mart, Dell, etc.).
ƒ In this higher-risk environment, companies need to improve their skill at strategic anticipation and
increase the resilience of their business designs. Some leading companies have successfully
challenged conventional wisdom, growing their profitability and value alongside relatively low
betas.
ƒ Specific strategic risk events have impacted a wide variety of companies and industries; while
leaders have responded in less than a year, others have yet to respond.

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S&P: High-to-low quality ratio

A-ranked stocks C-ranked stocks

35% 35%
31%
30%
30% 30%

25% 25%
23%

Percent of total
Percent of total

20%
20% 20% 18%

15%
15% 14% 15%
12%

10% 10%

5% 5%

0% 0%
1985 1990 1995 2004 1985 1990 1995 2004

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Procter & Gamble took five years to recover from 2000 market value drop

$160

$140

$120

$100
$BB

$80

$60

$40

$20

$
1997 1998 1999 2000 2001 2002 2003 2004 2005 2007

Note: Market capitalization drop calculated from 99Q4 to 00Q3.

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Other blue chips have taken even longer to recover lost ground

McDonalds Deutsche Bank

$80 $80

$60 $60

$BB
$BB

$40 $40

$20 $20

$ $
1996 1998 2000 2002 2004 2006 1990 1992 1994 1996 1998 2000 2002 2004 2006

Siemens Merck
$100 $250

$80 $200

$60 $150
$BB
$BB

$40 $100

$20 $50

$ $
1995 1997 1999 2001 2003 2005 2007 1990 1992 1994 1996 1998 2000 2002 2004 2006

Note: Market capitalization drop calculated from 99Q4 to 00Q3.

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Strategic risk management: Three modes

I II III

Anticipate/ React fast LAG

ready before it
happens

0 months 80 months

ƒ Most companies are neither in Column I (they don’t practice Strategic Risk Management),
nor in Column II (they’re not organized to move fast).
ƒ The vast majority are in Column III (many with dangerously long response times).

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Response lags

Event Player Response time

GM/Toyota Hybrid GM 84 months and counting

Wal-mart/Target Wal-Mart 72 months and counting

Blockbuster/Netflix BB 58 months

Barnes & Noble/ Amazon B&N 36 months

Motorola/Nokia 00 Motorola 36 months

WSJ.com, YFinance WSJ ~20 months

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 “Reversing” risk

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Oliver Wyman and strategic risk: April 2005
In early 2005 we began to publicly share our thinking about how companies can better
manage strategic risk.

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The Upside: Released May 2007
Drawing on interviews, client work, and other research, we have published a new book
to help companies reverse risk and discover the “upside” in strategic risk.

Synopsis

ƒ Most companies do not have effective tools for addressing

strategic risks (versus operational and financial risks).
ƒ Our research has catalogued seven categories of strategic risk
and specific countermeasures to mitigate each risk within
those categories.
ƒ A growing number of companies are turning negative risk
energy into a huge opportunity for future growth.
– Designing their business in ways that increase returns and
reduce risks

Case studies . . .
ƒ Toyota Prius, Apple iPod, Coach, Tsutaya, Target, Netflix,
Continental AG, Air Liquide, and others

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The Upside explores practical tactics to counter and find opportunity in risk

Strategic risks, countermeasures, and growth

Extreme risk Countermeasures Growth upside

Technology shift ƒ Double betting ƒ Double bet to surprise the other guy

Brand collapse ƒ Continuous measurement ƒ Build the strongest brand in your

ƒ Reallocating brand investment business

Unique competitor ƒ Early warning system ƒ Avoid the gorilla; be the gorilla in a
ƒ Shift in business design different space

Industry economic ƒ Change compete/collaborate ratio ƒ Collaborate more in order to differentiate

squeeze more

Customer shift ƒ Proprietary information ƒ Three-year lead

ƒ Fast, cheap, continual experimentation

Project risk ƒ Realistic determination of the true odds ƒ Risk control system
ƒ Smart sequencing
ƒ Stepping stone method
ƒ Develop excess options
Market stagnation risk ƒ Early warning system ƒ Growth system: Upward spiral
ƒ Demand innovation

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Strategic risk management incorporates new ways of anticipating and managing
risk

Traditional risk tools Strategic risk tools

(Hazard, financial)

ƒ Insurance ƒ Knowing the Odds

ƒ Re-insurance ƒ Early Warning Systems
ƒ Prevention programs ƒ Countermeasures
ƒ Credit scores
ƒ Collateral
ƒ Capital allocations
ƒ Hedging/derivatives/counterparties

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 Our approach

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Our approach to ERM: Oliver Wyman’s value proposition

ƒ Industry-leading thinking and research on how companies can reverse strategic risk
ƒ We have a solid framework AND we understand your business
– Not only do we conduct management surveys and interviews to catalog the risks your organization sees,
but we bring in our industry experts to assess global trends, anticipate and estimate risks you will likely be
facing
ƒ Enables greater Board/senior management visibility and understanding of strategic risk and financial
implications, as well as links between ERM and strategy
ƒ Cost-effectiveness of fixing today vs. at the time of crisis (cents vs. dollars), and identification of valuable
quick hits
ƒ Process engages and mobilizes management on risk, identifies comprehensive set of risks for focus, forces
management to assess size and probabilities, and work against the feeling that “we can’t do anything about
it” or “that’s just the business we’re in”
ƒ Process brings together cross-functional groups with linked responsibilities to address common risks and
organizational roadblocks
ƒ Move beyond a “checklist” mentality of risk management to explore strategic alternatives
ƒ Shift to a comparable risk-return decision-making process, within an integrated and common framework
ƒ Adaptable to client needs: Depending on degree of sophistication of current risk infrastructure, can
emphasize integrated risk identification and mitigation, risk sizing and trade-off modeling, and/or capability
development

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We have a clear approach to risk assessment and capability development

ERM infrastructure development

1.1 1.2 1.3

ERM framework and
ERM governance
risk classification Risk reporting
model 3
definition

Implementation
plan
Enterprise risk mapping and mitigation planning

2.1 2.2 2.3

Risk prioritization
Risk identification Risk quantification & high-level
mitigation planning

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High-level description of work steps
1.1 ERM framework definition
ƒ Review current stage of
enterprise risk management
ƒ Develop ERM vision statement,
particularly around objectives,
anticipated results and ownership
2.1 Risk identification
ƒ Identify the main risks
– Financial, hazard,
operational
– Seven major strategic
categories
ƒ Conduct major functions’ survey
and selected interviews with
senior managers
ƒ Leverage Oliver Wyman industry
expertise
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1.2 ERM governance model
ƒ Research on ERM governance
models
ƒ Design ERM related
organization, management
system and processes
ƒ Recommend ERM related KPIs
ƒ Scorecards for evaluating
corporate performance
2.2 Risk quantification
ƒ Quantify the magnitude and
likelihood of major risks
ƒ Develop the detailed risk profile
for each major risk
1.3 Risk reporting
ƒ Define the risk reporting contents,
structure and responsibilities
ƒ Develop the ERM guide book
ƒ Develop the risk database
prototype 3 Implementation plan
ƒ Develop implementation plan
including timeline, milestones,
key decision points, resource
requirements and
implementation ownership
2.3 Risk prioritization & high- ƒ Adjust capital decisions based
level mitigation planning on risk assessments
ƒ Ongoing risk monitoring and
ƒ Prioritize major risks based on management
probability and severity and
develop overall risk map
ƒ Identify and assess “upside”
alternatives, business design
changes
ƒ Develop the high-level risk
mitigation action plan to eliminate,
reduce or counter key risks
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 Strategic risk framework

What can I do?

Action plan:
Action plan to:
Percent completion
How Maximize
Risk How big? likely? Prevent Mitigate upside 0% 20% 40% 60% 80% 100%

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

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“Exposure” map

Probability Certain events

< 20% 20-40% 40-60% 60-80% 80-100% 100%

>400

300-400
Severity ($MM)

200-300

100-200

<100

Specific strategic risks for which:

= Mitigation plan in place

= No mitigation plan/risk exposure

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 Case examples
Aviation
Telecommunications

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ERM case example – Major Asian airline (1 of 4)
Our client was facing a rapidly changing marketplace, and wanted to focus managerial
attention on proactively addressing highest priority risk categories.

Client context and objectives Key components Results

ƒ One of world’s fastest- ƒ Risk identification ƒ Executive agreement on top

growing airlines, facing
significant challenges and
new risks
– Increased competition
– Fuel price increases
– Post-merger integration
issues
– Possible regulatory
changes and market
liberalization
ƒ Management team,
including CEO and CFO
wanted to qualitatively and
quantitatively assess
strategic and operational
risks, agree priorities and
proactively manage
– Interviews risks and understanding on
– Surveys how to manage
ƒ Risk prioritization ƒ Actions to address key
business risks implemented
ƒ Risk mitigation planning
ƒ Cultural mindset shift from
ƒ Organizational design and avoiding risks to proactively
infrastructure development understanding and addressing
for risk management
ƒ Foundation to build ERM into
management routine and
planning processes

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ERM case example – Major Asian airline (2 of 4)
We used a comprehensive and analytic intensive approach to identify and down select
the key external and internal risks facing the client.

Form Apply initial Conduct detailed Develop management

“laundry list” filters to focus quantification of and mitigation
of risks mgmt. attention top risks plans for top risks

ƒ Risk 1
ƒ Risk 2
Senior management
ƒ Risk 3 judgment
External market data
ƒ Risk 4 + + Internal input from
ƒ Risk 5
Inputs

Internal data, input Bus/Divisions

Business line
ƒ Risk 6 surveys from BUs/Divisions +
ƒ ... + OW expertise
+
ƒ … OW expertise
OW expertise
ƒ …
ƒ Risk 100+

ƒ Initial list of top risks (in ƒ More comprehensive ƒ Management/ mitigation

this case, twelve risks) quantification plans for top risks (in this
Outputs

case, four risks)

ƒ First-pass prioritization ƒ Further prioritization
based on initial based on severity and ƒ High-level profiles for
quantification (severity), probability (in this case, remaining risks (in this
probability top four risks) case, eight risks)

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ERM risk identification – Major Asian airline (3 of 4)
Based on internal interviews and expert judgment, we created a comprehensive view of
potential key risk areas for the client.

Key risks identified

through . . . Key risk identification

Strategic Operational
ƒ Customer value management ƒ Core business planning processes
Senior ƒ Brand strategy and execution ƒ Supplier management
management ƒ Increased international competition
ƒ Post-merger integration
interviews ƒ Industry consolidation and mergers
ƒ Operational reliability
ƒ Pricing and revenue management
optimization ƒ Human capital and talent strategy
ƒ Fit and alignment of potential strategic ƒ Information management and decision
partnerships
support capabilities
ƒ Infrastructure ability to support future growth
Survey ƒ Critical systems
ƒ Matching capacity supply with market
responses demand
Financial
ƒ Fuel price risk
ƒ Interest rate increase
ƒ Capital structure
Oliver Wyman Hazard ƒ Exchange rate fluctuations
expertise ƒ Pandemic
ƒ Cash flow risk
ƒ Accident or incident

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 Enterprise Risk Quantification– Major Asian airline (4 of 4)
We worked with the executive team to obtain agreement on which risks to immediately
address and quantified the probability and severity of the top risks.
Risk management/
mitigation planning
Risk map (client disguised) immediate priority

4.4

Core business
International
planning processes Matching competition
High capacity with
Human capital demand
and talent
Risk probability

Fuel
Operational
Maintenance reliability
3.4

Financial structure
Consolidation
Brand Strategy
Supplier-related
Moderate
Customer value
management
Safety -related
2.4

Low High
Risk Probability Scale Risk severity
5 Very High (~100%) (Annual earnings-at-risk, CNY in BN)
4 High (75 - 100%)
3 Moderate (50 - 75%)
2 Low (25 - 50%)
1 Very Low (0 -25%) Our earnings at risk quantification relied upon deep industry
expertise and tailored approaches for individual risks

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Why should you act?

Source: The New Yorker, October 10, 2005.

ƒ Strategic “hits” are a huge distraction

ƒ Threats can be growth breakthroughs

ƒ Fewer surprises every year

ƒ Save your shareholders’ money

© Oliver Wyman  www.oliverwyman.com 26