Back To CourseFinance 305: Risk Management
11 chapters | 85 lessons
M.B.A. Veteran Business and Economics teacher at a number of community colleges and in the for profit sector.
The turn of the last century ushered in a period of great change, and one of the biggest changes was in how we communicate. After a long and storied life, the old rotary telephone was headed for extinction. It would be replaced by email and a new kind of telephone, the cell phone. Car phones had been around for a while, but they were bulky and heavy. The new cellphones, on the other hand, were small and light, and best of all they could be carried around in a bag or pocket! The era of mobile communication was underway.
Two of the dominant players in the new industry were Nokia in Finland and Ericsson in Sweden. Both had been dabbling in mobile technology for years and were ready to assume leadership in the global market. Nokia, Ericsson and Motorola were the top cellphone makers by the year 2000.
The brain of the cellphone (and later the smartphone) was the microchip. A set of these chips is in every phone, and they tell the other components inside the phone what to do. The US was (and still is) the main supplier of these critical chips, but a sizable number were made in Japan as well.
Phillips Semiconductor was a US maker of these microchips, located in Albuquerque, New Mexico. They used a new technology to produce them. Chips were first soldered, then hundreds of them were placed on cooking trays that looked like something you bake pizzas with. The chips were baked in an oven, then cooled. The production process took place in a sterilized environment because even a speck of dust could ruin the chips.
One stormy night in March of 2000, lightning struck a power line outside of Albuquerque. The power went out at the Phillips plant and the cooling fans shut down, which caused a fire. The fire was contained quickly, though eight trays of chips were destroyed in the process. All in all, Phillips did not expect production to be offline for more than a week. Both Nokia and Ericsson bought sizable quantities of chips from Phillips, and the way each company reacted to this incident would have a big impact on their futures.
Nokia and Ericsson faced many risks in their global operations, including supply chain disruptions like the fire at Phillips. But their approach to these risks was much different.
Ericsson operated with a more traditional attitude toward risk management. In this approach, risk management was treated as just another cost center. Since risk management was not a revenue-producing area of business, management should try to reduce its cost. As a result, operating managers were responsible for the risks in their area with no overall coordination or control.
However, a new approach to risk management was developing around this time. Called enterprise risk management (ERM), it gathered all of the risks in the enterprise in one place under a 'C' level executive, who worked on developing ways to deal with them. This approach assured consistency and that best practices were followed. Risk management was now treated strategically and as a way to gain competitive advantage. One such competitive advantage was the ability to provide a product or service when competitors couldn't. Nokia was getting on board with this new way of thinking.
After the Phillips Semiconductor fire, their clients were advised that cleanup should be done quickly and that production would resume in about a week. Since no major disruption to chip supply was anticipated, Ericsson planned to wait it out.
Nokia's actions were more in tune with the new enterprise approach to risk management. They knew that one week sounded optimistic at best and more likely impossible given what it would take to restore the chip plant to the sterile conditions needed. After a few weeks passed and still no chips from Phillips, Nokia put a strategic response into action. They began contacting all of the other chip makers in the US and Japan to see if they had extra capacity. They negotiated with the ones that did to make chips for Nokia. The company was not going to wait around and let a chip shortage reduce their ability to make phones!
Ericsson, unfortunately, was left behind. By the time they realized that Phillips would be off line for quite a while, it was too late. The other chip makers had already contracted out their extra capacity to Nokia, leaving none available for Ericsson. They eventually ran out of chips, and phone production ground to a halt.
These consequences changed the structure of the cell phone industry. Ericsson lost $200 million in the second quarter of 2000. They also saw their market share fall from 12% to 9%, while Nokia went from 27% to 30%. Nokia not only protected their share but used the whole episode to gain competitive advantage over Ericsson. They could supply the phones needed to meet the exploding demand while competitor Ericsson couldn't. By 2001, Ericsson merged its cell phone business with Sony's, in part because of Sony's good relationship with Japanese chip makers. They would continue making cell phones but under the Sony-Ericsson brand. Meanwhile, Nokia emerged as the clear market leader.
As the communication landscape was changing thanks to the introduction of the cell phone, company attitudes about risk management were changing as well. Enterprise risk management (ERM) viewed risk management as a strategic tool to be used by top management.
When a chip supplier to two of the biggest competitors in the cellphone industry went offline, it affected the companies differently. Ericsson did not follow the principles of ERM and was nearly put out of business. Nokia, following ERM, contracted all of the available capacity for chips and was able to procure enough to meet production goals, despite the disruption from their main supplier. They became the industry leader.
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Back To CourseFinance 305: Risk Management
11 chapters | 85 lessons