Risk Management Strategy - Biotechnology Investment - Essay Example

Topic: Risk Management Strategy Name Course Name Instructor’s Name Date Risk Management Strategy Case Study: Biotechnology Investment Introduction Risk management strategy refers to a set of operations that are aimed at identifying, analyzing and controlling the occurrence of risks in an organization. It consists of the activities that continuously assess the risk identification methods and improving them based on the changing actions of an organization. Small enterprises conduct risk management, but the complexity increases when the organization expands in size. Risk assessment refers to the process through which risks are recognized and studied (Hillier, Grinblatt, and Titman, pp. 365-401). Risk assessment is very important because the organization identifies the activities that are likely to cause risks, and thus mechanisms can be formulated to protect the organization from such risky outcomes. In most organizations, the management team is the one responsible for conducting risk assessment but in other organizations a risk management team is appointed whose role is entire to deal with risks and protection procedures (Chang et al, pp. 26-28). To start up a biotechnology company, it is important to understand the risks involved are large, and there is a high likelihood of uncertainty. As a result, it is important that these companies during their early stages they should study all the environmental factors that affect their growth, the people involved in their investment and above all it is crucial to conduct strategic planning to determine the direction of the organization and the anticipated growth and changes in the business environment (Tsai and Erickson, pp. 49–53). The pace that an organization sets at the early stage of its establishment becomes a blueprint that is used for the future trends of the investment, and this will also help in determining the risk factors and product development. The main objective of biotechnology companies during their startup period is to ensure that they have a positive Net Present Value in terms of revenues and market returns. It is necessary to understand that biotechnology industry is viewed differently in comparison to the pharmaceutical industry. This is because this industry uses living organisms or products obtained from these organisms for commercial use. There are various trends in the biotechnology industry. Some include, due to fact that the market has reached its maturity stage, then the growth is slow and gradual, more consolidation companies are being established, the medicines are now being personalized, the industry has accepted the nanotechnology for diagnosis and medicine administration and lastly there is an increasing need for the drug safety. Types of Risks Real options in an organization refer to the technique through which investment and operations are delayed or adjusted so that the organization has enough time to resolve an undesired occurrence. These options protect the organization from risks and also help the firm to determine the likely causes of these risks. The real option is different from other approaches to risk assessment because it is the only method that focuses on the positive side of a risk. This method uses the fact that some risks are beneficial, and they may lead to the success of the organization. This method is built on two aspects, the ability of the concerned parties to understand the likelihood of a risk to occur and their willingness to change their actions to counter the occurrence of such a risk (Wang and Yang, pp. 823–831). The following are the types of risks that may be experienced by an organization as explained by Triantis,(Triantis, pp. 65-68). The first category of risks is technological risks (Apergis, p.359-365).This usually occurs in the research and development and operation phases of the business lifecycle. For the case of biotechnology industry, technological uncertainty is a major cause of reduced output. New technologies may lead to failure especially at the operation stage. For the valuation of the biotechnology investment under study, it may be affected if any new technology is to be introduced whose cost may alter the estimated amount. The other category is economic risks (Korneychuk, pp. 126-130).This risk occurs due to changes that are experienced by costs of production such as when the price of raw materials increases or in case of revenues when demand reduces. Economic risks may be affected by competition and in some cases the Gross National Product of the country. Since the investment is at the start-up stage, the economic risk may affect the valuation process because the production cost may be higher than the anticipated value. Financial risk is one of the major causes of uncertainty in business enterprises (Turner, pp. 5-10).Financial risk may be experienced in terms of interest charged to the organization or the value of the assets. Almost every firm faces the financial risks due to competition in the global market and the risks that are experienced in the financial market. Since the biotechnology investment is at the early stages, the financial risk may not affect it, and thus the valuation process is not likely to be influenced by the financial risk. The other risk is the performance risk (Schmitz et al., pp. 108–123).These are risks that result from the connection between buyers, sellers and other shareholders. This is the kind of risk that results from a certain party in an organization failing to meet the requirements or responsibilities. For instance, the buyers may breach the terms of credit leading to a lot of debts being written off. This puts an organization at risk of failure. Similar to financial risk, performance risk affects an organization at the maturity stage. At this stage, this kind of uncertainty may not be experienced but it should be accounted for in the valuation process. This risk is more of a prediction hence funds should be allocated to it. The other risks faced by organizations include the regulatory and legal risks. These factors pose some risk because a business must operate in a legal environment and participate in following the operation rules. For instance, changes in the tax laws may lead to negative impact on some companies and introduction of certain rules may lead to additional costs in specific organizations. Regulatory risk is likely to affect the valuation process of the biotechnology investment in Shockley’s explanation (Shockley, pp. 48-51). This is because the government and the regulatory laws may be strict on a company during the initial stages due to the maturity of the industry itself. In addition to this, the biotechnology industry is very sensitive and, as a result, the government is likely to increase the taxes to discourage start-ups. This probability has to be included in the design process (Sparrow, pp.123-127). Real and Financial Options in the Risk Management Strategy Similarities As described above, real options of risk management are aimed at identifying risky behaviors and protecting the organization from any failures that are connected to those risks. They help an organization in discovering the causes of risks (Allen, pp. 93-97).The financial option is also aimed at ensuring that the firm is operating in the direction that reduces risks while looking for ways through which the company can improve profits. These two options are similar in the early-stage research and development of biotechnology investment because they both identify risks and help in protecting the investment from those risks. There is a link between the real option and the finance option because, in both cases, there is the investment that requires financial options to start-up. This means that at the end of each strategy the finances are kept safe, and the organization is directed towards the upside in terms of profitability. This is an indication that both options have control on the finances of the investment (Campello et al., pg. 1615–1647). Differences between Real and Financial Options The real option entails using resources to detect and identify risky behaviors. Although finances are used, it is not the main concern for the organization, it is only an option. The financial option, however, is mainly concerned about the monetary value of all the sections under consideration. Financial options are therefore aimed at protecting assets like stock based on its financial value (Hirsa and Neftci, pp. 6-11). . The two options can be differentiated from the factors that affect their value. The differentiation is determined by what factors are given emphasis. The financial option focuses on factors that influence the stock such as, the current value of the stock, the exercise price, time to expiration, stock value uncertainty and lastly the interest rate. The real option, on the other hand, considers the project itself. Such factors include the present gross value, the cost of investment, the time taken until the opportunity is completed, the uncertainty of the project value and the adjusted value of the project due to risk (Christoffersen, pg. 121-134). In addition to this, the financial option is usually dynamic while the real option is static. The dynamic nature of financial option, for instance, can be described in terms of stock. In the case of the biotechnology investment, the stock will be analyzed in the category of assets (Rampini, Sufi, and Viswanathan, pp.271-296). This implies that when the stock is being brought into the premises, the price may be different from the one identified at the initial stage. In some cases, the price may even be lower. As a result, the actual price is determined at the time of acquisition. The other difference between real and financial option is determined by how the type of uncertainty is influencing the asset under consideration. Uncertainty in terms of financial options is determined based on the future prices of the stock. This uncertainty is used to evaluate the causes of downward trends, causes of low profitability level and how outside stakeholders affect the assets that are under the financial option. Real options, however, place value when projects are considered to contain some form of uncertainty. This option, therefore, brings out the need for managers claiming that if uncertainties were not present, then the managers have no value. They, therefore, add worth to an organization because they manage uncertainties and dictate change. Integrated Risk Management Strategy Integrated risk management refers to the process through which risk factors and all information surrounding it is incorporated into the strategic planning of the organization. This implies that risk management is a component of all the factors that determine the direction of an organization such that strategic planning entails pointers that should be taken by an organization to manage and tolerate risks. The reason for making risk management part of strategic management is because is some organizations such as the government or other large-scale enterprises, risks can cause a major downfall of the organization. As a result, the management has to make sure that the resources are managed wisely, projects are well coordinated and all decisions made are towards the goal of the organization. In this case, the organization needs to know in advance all the probable causes of risks and the risks the company expects to face in future. This information helps in preparation to deal with such undesired happenings in the event of their occurrence (Miller and Waller, pp. 93–107). . The best option to use is the real option. The option should focus on the projects being undertaken and ensure that they are aligned to the original plan. The reason the real option is appropriate for this case is because as stated earlier, the financial option is very dynamic in nature as opposed to the real option that is quite static. In case the risk management is involved in the strategic organization management, dynamic factors are very difficult to plan and implement. This is because in many cases, the financial plans are made and by the time the strategic plan is being implemented, the prices have already changed. This means that the process has to be repeated until the values are consistent with the current prices. This approach is very tedious and impractical. The real options, however, are not expected to change randomly and thus their implementation is in line with the overall direction plans of an organization. Thus, they are easily monitored and only altered when a risky operation or an uncertainty is identified (Meulbroek, pg. 60-64). Another reason real option will be preferable is because of the results that it produces when used in risk assessment. Consider the decision tree method of risk assessment. When using the financial and real options the values obtained will be different but the point of focus is of the nature of results produced by the two methods (Stamatelatos, Michael et al.pp.14-17). The financial option is constructed using probabilities, and thus the results obtained will be multiple making it hard to make decisions in the strategic management. On the other hand, the real option will only produce two values at each stage since probability is not used. It is easier to analyze the outcomes of decision-making. Using the real option is appropriate because the method can be adjusted to fit the optimal level needed for decision-making. Sometimes real options can be conducted at the wrong time, and this gives undesired results, in such cases, the method can be adjusted so that the outcome is desirable. This means that the process is flexible, and it can be changed to fit the needs of the organization. For the financial option, however, it is very complex and altering it may cause more harm than the way it was before. The implementation of real options is, therefore, easier because of this ability to be changed to fit the needs of an organization (Copeland and Tufano, pg. 90-99). Conclusion Risk management is a crucial element of any organization because it helps the organization to determine the cause of action. However, the method that an organization uses to assess risks may differ depending on the type of business and the preference of the management. For large organizations, the rate of risk occurrence increases with size and there is a need to manage this factor appropriately because it forms part of the day to day activities. During the start-up phase of an organization such as the biotechnology investment, risks should be assessed and managed well to ensure that they can reach maturity and meet the expected outcomes. Work Cited Alexander J. Triantis. Real Options and Corporate Risk Management. Journal of Applied Corporate Finance. University of Maryland, 2000. Richard L. Shockley, Jr., Staci Curtis, Jonathan Jafari and Kristopher Tibbs. The Option Values of an Early-Stage Biotechnology Investment. Journal of Applied Corporate Finance. Indiana University, 2002. Allen, Steve L. Financial Risk Management: A Practitioner’s Guide to Managing Market and Credit Risk. John Wiley & Sons, 2012. Print. Apergis, Nicholas. “Policy Risks, Technological Risks and Stock Returns: New Evidence from the US Stock Market.” Economic Modelling 51 (2015): 359–365. Science Direct. Web. Campello, Murillo et al. “The Real and Financial Implications of Corporate Hedging.” The Journal of Finance 66.5 (2011): 1615–1647. Wiley Online Library. Web. Chang, Chia-Lin et al. Risk Management of Risk under the Basel Accord: Forecasting Value-at-Risk of VIX Futures. Rochester, NY: Social Science Research Network, 2011. Papers.ssrn.com. Web. 1 Oct. 2015. Christoffersen, Peter F. Elements of Financial Risk Management. Academic Press, 2011. Print. Copeland, Tom, and Peter Tufano. “A Real-World Way to Manage Real Options.” Harvard Business Review. N.p., Mar. 2004. Web. 1 Oct. 2015. Hillier, David, Mark Grinblatt, and Sheridan Titman. Financial Markets and Corporate Strategy. McGraw-Hill, 2011. Strathprints.strath.ac.uk. Web. 1 Oct. 2015. Hirsa, Ali, and Salih N. Neftci. An Introduction to the Mathematics of Financial Derivatives. Academic Press, 2013. Print. Korneychuk, Boris. “Localization of Economic Risks Generated by International Sanctions.” Economic Policy (2014): Web. 1 Oct. 2015. Meulbroek, Lisa K. Integrated Risk Management for the Firm: A Senior Manager’s Guide. Rochester, NY: Social Science Research Network, 2002. Papers.ssrn.com. Web. 1 Oct. 2015. Miller, Kent D., and H. Gregory Waller. “Scenarios, Real Options and Integrated Risk Management.” Long Range Planning 36.1 (2003): 93–107. Science Direct. Web. Risk: The Interfaces of Strategy and Finance. Rampini, Adriano A., Amir Sufi, and S. Viswanathan. “Dynamic Risk Management.” Journal of Financial Economics 111.2 (2014): 271–296. Science Direct. Web. Schmitz, Björn et al. “Towards the Consideration of Performance Risks for the Design of Service Offers.” Exploring Services Science. Ed. Mehdi Snene and Michel Leonard. Springer International Publishing, 2014. 108–123. Link.springer.com. Web. 1 Oct. 2015. Lecture Notes in Business Information Processing 169. Sparrow, Malcolm K. The Regulatory Craft: Controlling Risks, Solving Problems, and Managing Compliance. Brookings Institution Press, 2011. Print. Stamatelatos,Michael et al. Probabilistic Risk Assessment Procedures Guide for NASA Managers and Practitioners (Second Edition). 2011. NASA NTRS. Web. 1 Oct. 2015. Tsai, Wendy, and Stanford Erickson. “Early-Stage Biotech Companies: Strategies for Survival and Growth.” Biotechnology Healthcare 3.3 (2006): 49–53. Print. Turner, Philip. The Global Long-Term Interest Rate, Financial Risks and Policy Choices in EMEs. Rochester, NY: Social Science Research Network, 2014. Papers.ssrn.com. Web. 1 Oct. 2015. Wang, Juite, and Chung-Yu Yang. “Flexibility Planning for Managing R&D Projects under Risk.” International Journal of Production Economics 135.2 (2012): 823–831. Science Direct. Web. Green Manufacturing and Distribution in the Fashion and Apparel Industries.  Read More