Bolstering the Bottom Line

As the economy recovers, companies should consider allocating additional resources to improving physical risk management. Not only will this action reduce property-related risks, it may lead to a more stable financial performance.

This unexpected possibility is a key finding of FM Global’s latest research, which indicates a high statistical correlation between a company’s earnings and its risk management practices to prevent fires, natural hazards and other causes of property loss and business interruption. The correlation suggests companies with better physical risk management will produce more stable earnings. Since earnings are a key driver of shareholder value, strong physical risk management can also have a potential positive impact on stock price.

The striking statistical correlation was uncovered when FM Global commissioned Oxford Metrica, an independent strategic adviser to FORTUNE 500 companies, to conduct the research. It involved comparing and analyzing the physical risk management practices and financial performance of 520 large multinational companies with at least $1 billion in annual revenue.

The findings? Companies with best practices in managing their property risks produced earnings on average that were 40% less volatile than companies with less advanced physical risk management. The findings also underscore the strategic value of strong physical risk management — benefits beyond property loss reduction that may direct enhanced financial performance.

Oxford Metrica is no stranger to divining statistical relationships that have bearing on financial performance. The firm provided much-publicized, research-based intelligence on the Johnson & Johnson Tylenol poisoning cases in the 1980s. Its quantitative assessment correlated the impact of the crisis on the company’s brand, market capitalization and shareholder value. Other recent studies by the firm include an examination of airline crashes and their impact on an airline’s reputation and wide-ranging analyses for clients like Bank of New York Mellon, AIG and Ernst & Young.

To assess the financial performance of the study’s subjects (all are clients of FM Global), researchers analyzed the companies’ annual stock returns, risk-adjusted stock returns, total variance of stock returns, the sensitivity of stock price to general market movements and variances in operating cash flow, interest rates and earnings. These were then compared to proprietary data on the physical risks, loss history and risk quality of those companies.

As part of its loss prevention engineering services, FM Global rates commercial clients on a 1-100 scale for property risk management “best practices.” The rankings assist organizations to quantify, prioritize and benchmark physical risks for improvement. Higher scores signify superlative risk quality. Lower scores signify an increased risk of a major loss and disruption in business continuity.

Statistically, companies with strong physical risk management practices produced earnings that fluctuated by nearly 18% on average. Companies with weak physical risk management practices produced earnings that fluctuated by 31% on average, the research finds.

Such findings are significant. Given strong physical risk management practices, a more constant financial performance presents a competitive advantage over peers with less advanced physical risk management practices. Businesses with less earnings volatility also have a more predictable bottom line, allowing companies to focus more on strategic long-term planning.

Companies with strong risk management practices have a higher level of confidence in the reliable performance of their physical assets. This in turn helps those organizations make smarter decisions.

The statistical correlation between physical risk management and earnings stability is unprecedented. Nevertheless, FM Global’s quantitative research has long indicated the financial prudence of physical risk management best practices. Internal studies indicate, for example, that the average risk of a property loss is 20 times larger for companies with weak physical risk management practices than for those with strong physical risk management practices. Additionally, a location deemed to practice weak physical risk management is more than twice as likely to experience a property loss and subsequent disruption in business practices. The cost of these losses on average is considerable–more than $3 million for a company with weak physical risk management practices, as opposed to $620,000 for a company that manages its physical risks well.

In terms of specific causes of property loss, quantitative research reveals similar distressing findings. For instance, the average risk of a property loss caused by fire is 55 times greater for a company practicing weak physical risk management than for one with strong practices. The financial consequences also are much higher — more than $4.5 million in loss per location on average, compared with less than $720,000 on average for companies with strong practices.

With regard to natural disasters like earthquakes, hurricanes, tornadoes and other natural hazards, the risk of a property loss is 28 times larger for companies with weak physical risk management practices than for those with strong practices. The property loss costs follow suit — $3.4 million per loss on average for companies with weak practices, versus $478,000 for companies with strong practices.

Clearly from a financial perspective, resources allocated toward reducing physical losses are judiciously invested. The statistical correlation between physical risk management best practices and more stable earnings and greater shareholder value presents additional evidence of a positive return on investment.

Such research findings can give corporate risk managers added clout to recommend increasing budgetary allocations for physical risk improvement. For some companies, reliability in the performance of their physical assets is a component of their reputation, and the way to improve this reliability is to invest in the physical safety and security of one’s plants.

Overall, although economic conditions compel cost-cutting measures, restricting resources dedicated to physical risk management may be imprudent. The tactic may offer short-term financial relief, but it eventually may instigate earnings volatility and negative implications for shareholder value.

If you have not done so already, perhaps it’s time to consider physical risk management as a key performance indicator.

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Resources allocated to physical losses are judiciously invested. The statistical correlation between physical risk management best practices and more stable earnings and greater shareholder value presents evidence of a positive return on investment.