Hierarchy of Corporate Needs and ERM
In psychology 101 class you heard about Maslow’s hierarchy of needs, They are:
- Physiological Needs
- Safety Needs
Corporations have needs as well. The needs of firms is similar to the needs of the people in the firms.
Hierarchy of Corporate Needs
Growth of Value
The ERM process can help companies to satisfy these needs. In ways that no other business management process will. This is true for all businesses, but it is particularly true for financial services businesses like insurance and banking where every transaction can have a significant element of risk for the firm.
- For a business to exist, it must have something that it can sell to some market.
- ERM is usually thought of as “the Sales Prevention Department”. But ERM can be instrumental in planning the sales process. But let’s come back to that after discussing the other corporate needs.
- Once a firm has mastered the ability to produce or otherwise provide something that some market will buy, they need to figure out how to deliver that product or service at a cost lower than the price that the market will pay. This is a combination of managing costs and convincing the market of the price that the product/service is worth.
- In businesses like insurance or banking, the fundamental transactions of the business involve risk taking in a way that is different from most other businesses. Making a profit ultimately means getting the price right for risk and properly managing the risk so that it rarely gets out of hand.
- That is the prime territory for ERM – evaluating and managing risks. So to satisfy this second need of corporations, at least for the corporations in the risk business, ERM is needed.
- Without ERM, profits are hit or miss for firms in the risk business.
- Once a business has a product that they can reliably sell to a market and has figured out a way to reliably deliver that product at a profit, then that business has value. And the third need becomes important; Security.
- This is the case not just for companies in the risk business, but for all types of firms. Once they get used to making money, there is a strong need to keep that happening.
- But there are many, many things that can go wrong and put an end to that profitable business. As a general class, we call those things RISKS.
- So risk management is applied by firms to deal with those things that might go wrong and end the stream of profits – separately, risk by risk as management becomes aware of those risks.
- Enterprise Risk Management provides a different approach, and one that should appeal to those who are fundamentally interested in the security of the firm. While risk management seeks to prevent outsized losses from one cause or another, ERM seeks to manage outsized losses from ANY and ALL sources.
Growth of Value
- Once a business has Sales, Profits and Security the focus shifts. And it shifts to growing the value of the firm.
- Some firms focus on growing their value by making more of the sales that they mastered at the outset of their existence. Others seek to grow value by increasing their efficiency and increasing the profitability of their business. A few are able to focus on both at the same time.
- However, the value of the firm, by some reckonings is the present value of future earnings. Those future earnings can be higher because sales grow or because profits per unit grow. But that future will be discounted by the market. Discounted for both risk and for time.
- Since Risk is a major component to value, growing value means managing risk. SO we are again back to ERM. ERM helps management to see the trade-offs, the risk reward trade-offs, that will influence value.
- And so, back to sales. What you find when you look to manage value with ERM is that it helps you to see the value of sales. And what you see will be that different sales have a different impact on the value of the firm.
- So ERM can halp to guide the sales planning process, shedding light on which sales to plan to grow the most and which to limit.
So ERM can play a major role in the achievement of all four of the main Corporate Needs.