Learn about and see examples of direct and indirect risks, including financial market, operational, and counterparty risks. Learn why indirect risks are important and what the differences between indirect vendor and indirect competitor risks are.
- Sometimes it's not the devil you know, but it's the devil you don't. Direct financial market risks are the devils that corporations usually know very well while indirect risks can be the devils they don't, but those indirect risks need to be recognized, measured, and monitored just as closely as direct risks a company faces. You need to be able to identify direct and indirect financial market risks including risks from currencies and physical commodities and you need to know that these risks can originate from a vendor or a competitor.
Direct risks are those that a company sees day to day both physical and financial. Let's consider a US-based auto manufacturer. As a direct financial risk, a US-based auto manufacturer selling goods into Europe is certain to be aware that a stronger Euro would help the company sell more cars into Europe, but a weaker Euro would hurt sales. That's a direct risk, a direct currency risk, that the company sees everyday. As a direct physical commodity risk, consider that this auto manufacturer buys steel to manufacture car chassis.
The auto manufacturer is directly exposed to steel prices. It knows that higher steel prices would erode the profit margin of selling cars. That auto company sees that direct commodity risk every single day. Indirect risks are those that a company does not see day to day, but they can also be currency and commodity risks. As an indirect currency risk, a US-based auto manufacturer may not sell anything into Japan, but that does mean it isn't exposed to moves in the Japanese Yen.
If the Yen weakens against the dollar, a Japanese competitor could lower its car price in dollar terms to receive the same number of Yen. In this way, the Japanese car price would be lower, presenting an indirect risk to the US auto manufacturer. This is a specific kind of indirect risk. It is an indirect competitor risk. It is also very different from a direct risk like selling cars into Europe and worrying about the value of the Euro. This exposure to the Yen is something that a company does see everyday and may not have given much thought to.
Another indirect risk that a company might not give much thought to is indirect commodity risk. An example of this would be if that auto manufacturer buys tires from a vendor. Those tires are made from rubber. If that tire vendor does not manage its rubber price risks, an increase in the price of rubber could drive up the price of tires that the vendor then passes through to the auto manufacturer. In this way, the auto manufacturer is indirectly exposed to high rubber prices.
This indirect risk comes through a vendor. Without understanding its vendor supply chains and how its vendors manage or do not manage their risks, companies can be exposed. Now that we've talked about direct and indirect risks, can you name some of the direct currency and commodity risks your company faces? What risks does your company face day to day? And can you think of indirect risks your company faces from competitors who may be able to more favorably price their goods or services if currency rates move? What about your supply chain? Do you know about your indirect vendor risks? Do you know how your vendors manage the risks? Do yo know how your vendors' vendors manage their price risks? These are second and third order supply chain risks.
They can be indirect and easy to miss, but missing them could be costly.
Jason Schenker of Prestige Economics discusses nine types of corporate risk, including financial and nonfinancial risks. He explains the difference between direct risks that companies face constantly, as well as indirect risks that usually come from vendors, competitors, and counterparties. Then he covers how risks are typically resolved, either by elimination (divestiture or acquisition), transfer (hedging or insuring), offset (creating a natural hedge), or ownership (keeping the exposure). Finally, he reviews how corporations can actively measure and monitor risk by appointing dedicated risk managers, officers, and committees.
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- Understanding risk in corporations
- Risk management process
- Nine different types of corporate risks
- Financial market risks
- Direct and indirect risks
- Risk management solutions
- How corporations actively manage risk