K
  • CFE - Office_150

    By Randy Kemnitz, MS, CFP©
    Published November 2014

    Ace Hardware recently announced a partnership to franchise their name in Afghanistan (Geary, 2013). This is the first American company to open a franchise there. Ace sees opportunity but also recognizes the risks. Risk is the knowledge that something unpleasant or untoward is likely to happen. Uncertainty is not knowing when that risk may manifest itself. You can manage risk, you cannot manage uncertainty.

    The common tools to manage risk are avoidance, retention, mitigation, and transference, or a combination of these tools. Avoidance is removing yourself from the risky situation. If you don’t want to have an auto accident, then do not drive. If your company does not want to manage the risk in an emerging market, then do not enter that market. Retention is the acceptance of the risk. You know the risk is there but you accept it and any consequences it may present to you. 

    Mitigation is minimizing the cost or impact of the risk to you. Deductibles in insurance policies are an example of mitigation. You are willing to assume the risk, the amount of your deductible, up to a limit. Transference is the use of contracts, such as insurance, to pay another party to assume your risk. Your auto insurer assumes your risk of causing an auto accident. You have transferred that risk to them.

    Back to Kabul. The risks of opening a business in an emerging market are numerous, and risks of expropriation, civil unrest, and war are increased dramatically. Even the risk of employees being taken and held for ransom is more prevalent in emerging countries. Ace could have chosen to avoid these risks by not opening in Kabul. It could have retained the risks by opening there and dealing with any adverse results. Instead, what Ace chose to do is transfer the risk to their Afghani partners. The only risk Ace is assuming is damage to its reputation and is willing to assume this risk to attempt to capitalize on the opportunity in Afghanistan.

    Ace used contracts to transfer the risk. Other forms of contractual risk transference are insurance policies. The following specialized insurance contracts have been developed to help companies manage the risks of emerging markets:

    Political risk insurance is available for several different types of political risk, including:

    • Political violence, such as revolution, insurrection, civil unrest, terrorism, or war;
    • Governmental expropriation or confiscation of assets;
    • Governmental frustration or repudiation of contracts;
    • Wrongful calling of letters of credit or similar on-demand guarantees;
    • Business interruption; and
    • Inconvertibility of foreign currency or the inability to repatriate funds

    Kidnap/ransom insurance protects companies by providing resources to pay ransom demands or to extract employees.
    Difference-in-conditions (DIC) insurance is designed to fill the gaps between the coverage provided by a company master insurance policy (property or liability) and coverage provided by policies purchased locally, so that the organization has uniformity of coverage regardless of location. 

    The DIC policy has become more important as many emerging markets are exercising their sovereignty by requiring foreign companies to purchase property and liability insurance from local providers. Researchers at Harvard suggest this equates to a 33% additional tax in some emerging markets (2010). The researchers note these local providers of insurance may not be as financially stable as those here in the United States. 

    Opportunity and risk go hand in hand. As Sinatra once sang, “You can’t have one without the other.” 

    Though, you can plan for both.

     


    References
    Geary, S. (2013). Ace says Afghanistan is the place. DC Velocity, Sept. 16, 2013. Retrieved from http://www.dcvelocity.com/articles/20130916-ace-says-afghanistan-is-the-place/

    Henisz, W. & Zelner, B. (2010). The hidden risks in emerging markets. Harvard Business Review, April 2010. 1-8.

     

    Randy Kemnitz, MS, CFP©, is a subject matter expert at Kaplan University. The views expressed in this article are solely those of the author and do not represent the view of Kaplan University.

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