In association with the Disaster and Development Centre at Northumbria University.

‘Minimising Risk, Maximising Value’TM

White Paper

‘A Coordinated Approach to Inward Investment’

Maitland PHyslop

Catherine Shelley

Updated 1 January 2013

Contents

Contents

List of Figures......

List of Tables......

1. Introduction.......

2. Risk Analysis.......

2.1 Why Manage Risk?......

2.2 Uncertainty......

2.3 Risk in the Domestic US Market......

2.4 Risk Management......

2.5 Risk Assessment......

2.6 The Communication process......

2.7 Importance of Risk Modeling......

2.8 Investment Risk.......

2.8.1 Introduction......

2.8.2. Background......

2.8.3. SMART Investment......

2.8.4 Why Businesses Fail......

2.9 The Model......

2.9.1. Results......

2.9.1.1. Ceteris Parabus......

2.9.1.2. Comparisons......

2.9.1.3. Overall…......

2.10. Summary.......

3. ‘Obstructive Marketing’......

3.1 People......

3.2 Product......

3.3 Place......

3.4 Price......

3.5 Promotion......

3.6 Information......

3.7 Finance......

3.8 Politics......

3.9 Competition......

3.10 Co-Operation......

4. Criteria Based Marketing Approach......

5. The Vulnerability Index.......

5.1 Defining Vulnerability......

5.1.1. Interpretation......

5.2 Results......

5.2.1 The Firms......

5.2.2. The Sectors......

5.2.3. Cross Sectional Analysis......

5.3. UKTI North East North America Forward Plan......

5.4. Overview......

6. Research Pooling......

7 . Overview......

List of Figures

Figure 1: The Risk Model------

Figure 3: Failure Rates For Investment------

Figure 4: Failure Rates For Government------

Figure 5: Failure Rates for Infrastructure------

Figure 6: Failure Rates for Workforce------

Figure 7: Failure Rates for External------

Figure 8: The Vulnerability Matrix------

Figure 9: Vulnerability Frequency Of North American Firms------

Figure 10: Vulnerability Matrix of North American Firms------

Figure 11: Vulnerability Matrix of Regional Sectors------

Figure 12: Cross-Sectional Differences in Vulnerability------

Figure 13: The Coordinated Approach------

List of Tables

Table 1: Worst Case Scenario for Ceteris Parabus Model------

Table 2: Worst Case Scenarios for Full Model------

1. Introduction.

Durham Consulting Group Limited is a professional management consultancy. Over the last few years members of the Group have worked on a ‘Coordinated Approach’ to inward investment policy, as a further development of ‘Minimising Risk, Maximising Value’. This paper describes an approach for Inward Investment from the USA to the North East of the UK. The paper concentrates on the 1990s; this is to meet a number of ethical considerations in business, academia and the USA.

The importance of Inward Investment to any Region or Local Enterprise Partnership has declined in relative terms. However, social inclusion policies still need to be concerned with attracting the right type of Inward Investment. The Risk Approach detailed here is equally applicable to looking at reducing social risks in any environment; the ‘Obstructive Marketing’ analysis helps us understand how companies will react in the future (and the statistical analysis in part is based partly on Glaser’s ‘Grounded Theory’ that has its own roots in social inclusion policies); Criteria Based Marketing is a model of how to look at social problems too; the vulnerability index has its origins in a New Jersey social problem; and Information Technology is a key to developing society in the 21st century. Thus much that is written here has a wider application.

The types of companies in the USA targeted by inward investment agencies can be broken down into five broad categories. Each category is treated in a different way so that needs can be met and full potential can be reached. A region’s unique selling points can be defined through risk analysis, and these are then promoted, using different approaches, to the five different categories.

The categories are:

1)Regular UK Investors – this is the group of companies that has more internationally mobile investment than any other. They vary slightly from year to year, but are presently about 25 in number. These are all Original Equipment Manufacturers (OEMs);

2)Major Multinational Corporations (MNC’s) – this is the group of companies that is likely to have some form of mobile FDI project running. There are currently 39,000 companies who trade abroad, and of those, approximately 630 who have regular, mobile, inward investment projects worldwide. Most of these are OEMs. These two groups alone account for 50% of the FDI in the UK. (Source: PWC 1997 onwards);

3)Small and Medium sized Enterprises (SMEs) – there are over 10 million of these within the USA. These companies go abroad in support of OEMs, or to establish themselves as a foreign subsidiary in their own right. They do this by establishing independent presence, buying an existing company abroad, establishing licensing deals, or establishing inventory positions of some description. Another method is through Joint Ventures (JVs) or mergers.

In order to be efficiently marketed, this group needs to be broken down into a more manageable size. This is done through a ‘Criteria Based Marketing Approach’ (Section 4) which brings the ten million companies, of whom only 0.1-0.5% are involved abroad, into a more manageable sized group (Source:US Export Assistance, 1997, 1999).

4)Current Investors – there are currently 280+ of these firms. Approximately half of the new jobs from inward investment come from this group. However, it is not possible to deal with all these companies at once and therefore prioritization is required. This is carried out through the ‘Vulnerability Index’ (Section 5);

5)University JV’s – This concerns matching universities and research authorities in the north eastern region of England with those in the US who have complementary research programs in action. This results in integrating funds, increasing the budget and taking advantage of economies of scale and shared knowledge.

This approach,especially when combined with efficient use of Information Technology, resulted in an improved Inward Investment performance for the North East region of England, and provided increased job opportunities and economic potential for the region and its residents (Thereby fulfilling some of the strategy aims and social criteria for the region).

This paper will outline each of the category approaches taken by the North East, and will illustrate how the different approaches managed to encompass the different firm structures and optimize the budget constraints. There is such a vast array of firms present in the US that it is impossible to approach each one of them, considering both budget and manpower constraints.

Furthermore, this paper will illustrate that the North East was (and to an extent remains) an extremely competitive region, was (and is) very attractive to FDI, holding the lowest risk in Europe and with the least probability of being subjected to ‘Obstructive Marketing’. Included also is advice for the preservation of this position and how it can be improved further in order that the North East maintains its competitive standpoint indefinitely.

It should be noted that some of these approaches have been used previously, and some of the research is new:

  • The Risk Model has been set up previously by the North East[1], but has now been modified and tested with new data, which is presented within this analysis;
  • The understanding of ‘Obstructive Marketing’and ‘Criteria Based Marketing Approach’ have been used over the last few yearsand have both helped to generate results;
  • The ‘Vulnerability Index’ is new, but initial feedback is favorable.

2. Risk Analysis.

The region’s unique selling points could be presented to any company in order to illustrate the benefits to them of investing in the North East of England rather than an alternative location. The NorthEast devised a risk model, using DMT software, which portrays the regional risk associated with inward investment.

2.1 Why Manage Risk?

Risk modeling is a relatively new tool in business planning. Risks, however, are not a new occurrence. They have been present since the dawn of man. Neanderthals and cavemen would have considered the probability (in metaphoric terms) of the risk of getting killed or injured by fierce animals in certain areas whilst out hunting. Similarly, humans today consider the probability of, e.g., being involved in a road accident on a cold, icy winter’s day. These probabilities represent the likelihood of a risk turning into an actuality. These kinds of assessments are considered every day; the available options, and factors such as cost, convenience, and pleasure are taken into account before a decision is made, intuitively or otherwise.

A formal definition of the expression of risk can therefore be stated as: ‘The probability of adverse effects associated with a particular activity’.

The weather has been the subject of risk modeling for a considerable length of time. The Greeks attempted it, but their lack of knowledge failed to result in accurate estimations; Aristotle did not even believe that wind was air in motion. However, a succession of notable achievements by chemists and physicists of the 17th and 18th centuries contributed significantly to meteorological research and weather predictions. The formulation of the laws of gas pressure, temperature, and density by Robert Boyle and Jacques-Alexandre-César Charles; the development of Calculus by Isaac Newton and Gottfried Wilhelm Leibniz; the development of the law of partial pressures of mixed gases by John Dalton; and the formulation of the doctrine of latent heat by Joseph Black. These are just a few of the major scientific breakthroughs of the period that made it possible to measure and better understand previously unknown aspects of the atmosphere and its behavior.

The authorities currently spend vast amounts of money on research and equipment in order that the weather can be accurately predicted. It poses problems to agriculture, coastal cities, military operations, travel arrangements, personal safety, etc. The cost of prediction is outweighed by the benefits of possible consequent risk minimization potential; livelihoods can be rectified and lives can be saved.

Thus, although the weather’s activity is out of human control, if information is sufficient and accurate, humans can behave so as to minimize the adverse effects it can cause. This is the essence of risk modeling, and the same notions can be applied to any area of risk management. This includes Inward Investment.

The more efficiently and accurately the risk can be analyzed, the more productive and successful the outcome will be. i.e., previously unrealized risks may have caused failure, and falsely perceived risks may have caused unwarranted fear, thus wrongly affecting behavior. Accurate risk perception will result in an efficient outcome.

2.2 Uncertainty

Stock markets dislike uncertainty; it always depresses prices. They prefer hard news, even bad news, to uncertainty. Since the earliest times, uncertainty has been the greatest problem faced by man. Man achieves by making decisions, and uncertainty paralyses the decision making process.

Some of the oldest writings known to historians are concerned with man’s wrestle with uncertainty, and over thousands of years ways have evolved in order to cope with it through a more structured and effective process. These have included sacrifices to influence the harvest, fortune telling and astrology, mutual support clubs and organizations, and more scientific means such as market research and economic modeling.

Risk management concerns itself with uncertainties about the future that cause an organization to fail. Risk management, as both a concept and an activity, has only been developed very recently, yet it is often misunderstood. It is concerned with statistics and unpredictability, yet most trained managers, even many trained scientists, do not grasp statistical behavior at an intuitive level. Often there is a subconscious tendency to confuse a minute probability of a major disaster with the occurrence of a small disaster.

The formal parts of an organization are those which are emphasized at business schools, and which potential managers therefore have knowledge of. These are the parts on which decisions are made, and over which there is control, albeit partial. These parts include the mission, organizational structure, recruitment policy, systems usage, hardware, training, procedures, etc. The managers of tomorrow are thus rarely trained to deal with uncertainty and the uncontrollables concerned. This uncertainty has the potential to add to inefficient business investment decisions.

2.3 Risk in the Domestic US Market

A more complete picture of risk includes factors over which there is virtually no control. Examples from the domestic US market include:

  • National strikes (GM 1998[2]);
  • Equipment failures (AOL 1996[3], AT&T 1998[4]);
  • Outbreaks of fire (Florida 1998[5]);
  • The weather (Du Pont and El Nino 1998[6], Canadian Ice Storm 1998[7]);
  • The existence and intentions of hostile parties (Reuters 1998[8], Avery Dennison 1998[9], McDonalds 1994-1996[10], Defending The US Against Cyber Threats 1998[11] and other Pseudo wars[12]);
  • Illness (Cook County E Coli 1998[13], Hudson Foods, 1997[14]);
  • Design limitations (Millennium Bug[15]).

These uncontrollables, each of which affect many business functions, do not just occur singly, but may arise in combination, the number of which is enormous. e.g. 75% of businesses affected by a major computer failure go out of business within 5 years[16]. Furthermore, the aforementioned examples imply that it is not only computer disasters that can severely damage companies.

However, there are countermeasures to those events that obstruct the marketing of a company’s products, which also need to be included in the business plan[17].

2.4 Risk Management

Risk management is therefore the science of understanding and reducing sensitivity to the four U’s:

  • Uncertainties;
  • Unknowns;
  • Uncontrollables;
  • Unmeasurables.

These have the potential to paralyze the decision-making process.

Understanding risk involves understanding why uncontrollable factors sometimes have to be depended upon. This occurs through an understanding of what are known as dependency relationships. As General Robert T Marsh is apt to comment: ‘dependency creates vulnerability’.[11]

Modern businesses are a rich network of interdependencies. The effects of even a single decision are complex, and widespread over both time and place. Add the four U’s, and it becomes hard to plan for maximum survivability. The only way to reduce risk is to understand the true interdependencies within the organization.

These dependencies can be modeled through a Dependency Modeling Tool (DMT). This approach differs from traditional risk models in that it is not prescriptive but allows an original, intuitive and graphical understanding of the risk situation to be created and then analyzed in an holistic manner.

2.5 Risk Assessment

Risk assessment is the process of evaluating circumstances in order to determine the risks which those circumstances pose. It can be seen to have four steps:

1)Identification of Hazards – determination of the presence of a ‘cause and effect’ relationship;

2)Establishment of a Relationship – What level of hazard will have this effect;

3)Analysis of Public Exposure – other factors which may also have an influence;

4)Characterization of Risk – Expressed by a number, but which has a lot more thought and judgement behind it than first meets the eye.

It does, however, have limitations. The data may be inadequate and/or incomplete, and uncertainty therefore exists with the outcome of results. This is the most difficult and controversial aspect of the whole risk analysis process; it can mean consideration of less defined factors which rely on an experts judgement. The absence of hard data itself causes uncertainty. It is thus an inexact science; even numbers come with an element of uncertainty because calculations are sometimes based upon hypothetical situations.

Risk assessments can, however, act as a tool to aid the making of good, informed decisions. They can be particularly useful when the issue is complex or technical. The fundamental advantage of performing risk assessments, despite their limitations, is that they provide a way to use numbers to compare relative risks and identify tradeoffs. They do not provide magic solutions, but will document and clarify the components of risk, leading to a more efficient and effective utilization of resources and better decisions.

2.6 The Communication process

It is easier to prevent fear than to reassure people who are afraid. Risk communication can raise the understanding of issues or actions and are successful if the public believes that it is adequately informed. Thus, the usefulness of the risk communication process depends upon the source (i.e. legitimacy) and the quality (i.e. accuracy).

2.7 Importance of Risk Modeling

Risk perceptions can be said to be important on five grounds:

1)Public policy – A public policy agenda may focus on some highly feared, but improbable threat to the market rather than some less feared, but more likely hazards due to the placement of public fears. For political reasons, the authorities have to be seen to react to the voters fears.

2)Market Processes – Unjustified fear or misplaced overconfidence by consumers can lead to serious economic distortions. Consumers behave in line with their expectations, and if these are wrong there is severe potential for the market to fail. This is the major justification for regulatory action.

3)Individual Behavior – Consumers behavior is triggered by present situations and by the social and historical context in which a risk is presented. These factors will effect how and whether this person thinks about risk, what risks are considered, and how a persons attitudes and risk perceptions are structured.

4)Evaluation of New Risk Evidence – risk perceptions constitute a filter for attending to and interpreting new data over time. Knowledge of risk perceptions may be used to improve communications in the regulatory process and to ensure proper learning over time.

5)Integrity and Trust – Since trust and integrity are major factors in the alleviation of fears, it is important to enhance the perceived integrity of the process of regulation. Failure to protect this perceived integrity will inevitably lead to the amplification of public risk perceptions.

2.8 Investment Risk.

2.8.1 Introduction.

Recent world events, and a catalogue of domestic US disasters, ranging from E Coli outbreaks to the weather, have demonstrated how prone businesses are to risk and the ‘uncontrollable’ aspects of business life. This is particularly the case for overseas investment – an environment in which domestic risks are magnified. An understanding of risk is important for making good, informed decisions, and the analysis of risk has become a much more important tool for managing business in recent times.

The reasons businesses fail are generic: finance, management, marketing, region; and particular to the business: site, raw material, infrastructure, market entry etc. Using a Dependency Modeling Tool as the basis for the Risk Model it is clear that some factors regarding Overseas Investment are more risky than others. In fact, as the risk model will later prove, the North East region of England was and is extremely competitive, actually showing the lowest risk in sixteen out of thirty variables, and the lowest overall regional and investment risk. i.e. the areas in which the region does fall down is not sufficient that another region/country can currently overtake the North East’s position.