Posted: February 15th, 2022

Understanding the Economic Risks

3. Economic risks 700

Economic risks are defined as risks that are related to the financial wellness and health of a nation, region, or the world at large. Economic risks are highly concerned with how well players in economies, in this case, industries, interact with the economy and are thus able to deliver on their objectives. In their study, Cimadomo et al (2018) pointed out that economic risks are often macro-environment aspects, which means that the player firms or industries cannot control their occurrence. Further on, the researchers observed that when nations get into economic crises, their industries are affected, in that the effects on the economies therein pass to the industries’ operations, with the firms therein often being forced to allocate more finances to unplanned operations. Assessing the steel industry, Tcha (2019) pointed out that steel raw materials are often sourced from different locations or geographical regions. Thus, an economic risk occurrence in one region could affect the manufacturer’s overall success. It is worth the mention that it is highly unlikely for multiple regions to be experiencing economic stability at once. 

The occurrence of economic risks exposes players to higher tariffs, bankruptcy, and poor-performing business environments. Thalassinos and Thalassinos (2018) observed that economic risks are mainly the effects of poor policymaking, imbalanced money flows in economies, and features such as inflation. This means that firms and industries find themselves in positions where they have to compensate for the economic misgivings. Gajjara and Parmar (2020) studied the effect that the ongoing coronavirus disease of 2019- COVID 19 has had on industries. The researchers observed that the pandemic has affected nations’ financial health and their industries therein. Alongside the covid 19 pandemic, there have been constant 21st-century revisions on international tariffs, trade terms, and conditions. As more nations are moving toward being more self-sustainable, particularly in manufacturing, so do they present new challenges to foreign dealers. For instance, in a nation that is aiming to bolster its steel production capacity and which seeks to support local manufacturers, it is likely to charge higher taxes and tariffs on foreign firms which draw raw materials or supply finished products to such countries. This has an adverse effect on the industries and their supply chains as it contributes to the firms channeling monies to what they were not initially intended for. 

Economic risks can also be broken down into more particular risks, as will be briefly discussed below. The first broad category is interest and exchange rates risks. Exchange rate risk, as was conceptualized by Gadanecz, Miyajima and 

Shu (2018) refers to a company suffering higher pay rates to cater to domestic markets’ low-performing currencies. Thus, such companies are forced to pay off higher amounts of money, with the margins experienced possessing the propensity of contributing to firms’ losses or reduced earnings. On the other hand, interest rates risks are risks that are caused by how recipient firms interact with interest rates by banks and lending financial institutions. For instance, if a company had allocated ten million dollars toward its financial instruments repayments, alterations in the economies’ terms could see the company forced to take similar value instruments at a higher cost, say twelve million. The additional cost, despite the value not increasing, is a result of interest rate risk, which is an economic risk. 

Economic risks lead to currency volatility, which is in turn contained in what is referred to as exposures. There are three lead exposures as will be pursued below. The first level or type of exposure is known as the operating exposure. Operating exposure is referred to as the risk that a company or economic player experiences after exchange rates exposures which subsequently affect the party’s cash flows as well as the firm value. The operating exposure is majorly felt by major players in markets or economies. For instance, if a company whose us-dollar/local currency exchange rate is 1:50 seeks to purchase goods worth one million dollars, such a firm’s value and cash flows would be affected if the exchange rate shifted downward, such as where the exchange rates plummet to 1: 53, as the company would have to pay off the three additional units, represented by inflation. The second exposure is known as translation exposure. The exposure herein refers to the effect that exchange rates in an economy have on firms’ balance sheets in terms of assets, liabilities, equities, and liabilities. The last exposure is referred to as transaction exposure. The exposure herein relates to the uncertainty to which firms operating in international markets are exposed. For instance, such firms are often not assured of stability in other regions’ economies. Thus, secondary and tertiary economies’ changes in exchange rates can eventually affect a firm. 

The transaction, translation, and operating exposure affect the steel supply chain in a number of ways, which are best contained in the downstream, upstream, and market stability realms. Where steel manufacturing industries are exposed to the types of exposure as indicated above, they could be unable to run their operations appropriately, as the risks therein contribute to a trickledown effect to the supply chains therein. As concurrent with the findings of Akbar, Iqbal, and Noor (2019), the most common depiction of affected supply chains from interacting with the exposures above entails companies having strained finances to run operations at an optimum. This, in turn, contributes to the firms reducing spending on some operational areas. It is worth the mention that some segments or operational areas have fixed costs. For instance, when operating at their highest available capacity, firms expert some irreducible overhead costs. Treating the operational costs to persistently reduced ratios eventually leads to the gradual dilapidation of resources at hand. Eventually, such firms could be unable to pay off suppliers, ship raw materials, or ship finished goods outwards. 

Lastly, economic risks could be translated from demand risks. Demand risks are risks that lead to disruptions in the expected flow of goods into a market. Factors such as the actual miscalculation of the demand therein, entry of new players into markets often see firms exposed to demand risks, which in turn contribute to firms being unstable in making supply chain decisions such as when to increase production, when to reduce the raw materials inflows and so on. Demand risks are further broken down into five categories, as will be briefly explicated below as well as their supply chain effect, with the inferences being contextually applicable to the steel industry. 

The first category is referred to as demand shortfall. Demand shortfall occurs when a firm forecasts that certain goods will be demanded, up to particular extents or levels, but the market households do not record such demand indices. This leaves the producer with excess goods at hand. This can affect the supply chain as producers would naturally lower production in the subsequent rounds. However, the market could seek more goods under the underproduced lines, thus resulting from supplying chain hitches. The second category is referred to as latent demand. Latent demand can be viewed as the unavailability of goods in a market, where the consumers cannot obtain specific goods despite producers distributing them to the market. Latent demand, as conceptualized by Nagata et al (2021), causes reputational damages to producers, and it is often coupled with price and distribution mismatches, as the sellers could take advantage of the demand exceeding supply or price ranges to hoar goods and therefore make more profits. Latent demand is closely linked to the supply chain in illustrating producers’ weaknesses in distributing goods optimally and commanding uniform pricing in markets. The third category is known as seasonal demand, where the demand surges upwards at certain times and plummets in clothes. The seasonal demand risk possesses the propensity of prompting producers to make uninformed decisions, which simulate higher demand for products, while in actual sense, there will be lower demand levels. Seasonal demand is two-pronged, with both scenarios being disadvantageous to firms. The first scenario is when firms expect higher demand in certain seasons and then end up producing more to cater to the imagined increased demand. However, the market thereafter demands fewer units than produced, thus leaving the firm with excess inventory. On the other hand, firms speculate lower demand, with the demand exceeding the supply. The fourth category is known as excess demand. This occurs when there is more demand than a company can supply. Multiple scholars have studied the effect of excess demand, with both positives and negative inferences emerging therein. Inferences are mainly on reputation, branding, and pricing. Proponents of excess demand feel that excess demand signals higher market confidence, and the producer can therefore determine their prices more ably. On the other hand, those opposing excess demands opine that excess demand could dent firms’ reputation and is highly likely to prompt consumers to consume competitors’ products. The fifth category is referred to as demand volatility. Demand volatility is often recorded when there are rapid surges in demand for a product followed by demand collapse. This affects producers’ supply chain as the producers could often make rash decisions which could eventually hurt their businesses. 

 

 

 

 

 

 

 

 

 

 

 

 

 

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Logistics risks 

Logistics risks are among the highest-rated risks which contribute to supply chain lags, failures, and challenges. Logistics refers to moving a product from one area to the other. As noted earlier, for manufactured goods to move in both the upstream and downstream realms, there ought to be proper channels that enable the manufacturers to draw the products from one area to another. Logistics risks are further broken down into three categories, namely: transportation risks, inbound delivery risks as well as lead time risks. Each of the categories will be explicated below. 

Transportation risks 

Steel manufacturers rely on certain criteria to choose which mode of transport to use in delivering raw materials to production sites as well as shipping the goods from the production sites to the consumers. For instance, one steel manufacturer could seek to fulfill urgent orders, which are highly valuable. Such a manufacturer could, for instance, utilize the air mode of transport is not only transporting the raw materials but also the finished products. The context above could be contrasted by another player whose orders are more flexible and which have longer time provisions. 

Transportation risks are associated with the mode of transport that a manufacturer chooses. In their study, Tliche, Taghipour, and Canel-Depitre (2020) observed that manufacturers seek to avoid some scenarios in the downstream and upstream realms of their supply chains. The researchers observed that one of the scenarios that manufacturers avoid is the non-delivery of the products on time, either inwards or outwards. Also, manufacturers often reduce the probability of damage eventualities occurring when products are in transit. 

Under the air mode of transport, one of the highest costs that manufacturers incur is transportation costs. Due to cost constraints, steel manufacturers are likely to use the mode of transport only when it is extremely needed. Some of the risks associated with air transportation of goods and raw materials are aircraft being prone to adverse weather conditions as well as aircraft being prone to mechanical problems while in transit. However, it is worth the mention that air transport is by far the safest mode of transport, compared with the other modes as will be discussed below. 

The second mode of transport is sea transport. This involves large-scale vessels and ships. Steel manufacturers often use sea transport where they source their raw materials or ship finished goods to areas separated by seas, in what is otherwise known as intercontinental commerce. Sea transport is a cheap mode of transport and is therefore suitable for voluminous quantities shipping. However, sea transport has some downsides, with the biggest being that the mode is slow. Thus, the mode of transport is only suitable for manufacturers who have long timelines. Transportation risks that are common in literature and associated with sea transport are deep water piracy and the regular occurrence of various physical eventualities such as typhoons and tornadoes, particularly in some areas and regions. 

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The third mode of transport is road transport. Road transport is the most common mode of transport in steel manufacturing. This is particularly supported by the fact that in most nations that produce steel, a high percentage of consumption is internal. With a majority of nations producing steel having effective road networks, manufacturers often use such networks to ship raw materials and finished goods. In the event that the raw materials are shipped by seaways or finished products are to be shipped through the seaways, the manufacturers utilize road transport to ship the raw materials and finished products to manufacturing sites and from manufacturing sites, respectively. Despite the fact that road transport is highly efficient and is not as costly as the fastest mode of transport- air transport, road transportation is averse to some risks, including vehicles being most likely to be involved in accidents, as well as roads being vulnerable to natural occurrences such as earthquakes and storms which could render such roads impassable. 

 

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