Russian Frozen Chicken Case Study
We can gain a more in-depth understanding of risk management by illustrating it for an international project.
Expropriation Risk
A company had a project to export frozen chicken by oceangoing vessels from Virginia and North Carolina to St. Petersburg, Russia. The company planned to load 60- to- 80-pound boxes on pallets for ocean voyage. A problem arose because the Port of St. Petersburg had no shoreside refrigeration to allow the quick the quick unloading of an expensive reefer vessel. The company would incur significant demurrage charges (extra cost resulting from a vessel delay) if the ship wasted time in port while waited containers or railroad cars. One option was to build a warehouse, but the risk manager identified an expropriation risk. She spotted an action involving the Hotel Europa in St. Petersburg, which was partly owned by European investors. In the mid-1990s, the hotel opened a foreign bank account to handle dollar transactions. Russian banking laws prohibited such accounts. When the government learned of the account, a government agency levied a heavy fine on the hotel, causing the foreigners to lose their entire investment. Effectively, the government confiscated the hotel.
The risk manager knew she could obtain insurance from an agency of the U.S. government to reimburse the company for expropriation. At the same time, was it really an expropriation? Insurance did not seem to be the answer. Thus, the company considered buying an old (and relatively inexpensive) reefer vessel and using it for storage. It could build a refrigeration facility on a barge that could be moved if the situation became sticky. Alternatively, it could find a strong Russian partner with high-level government connections and allow the partner to accept the expropriation and storage exposure. The company found such a Russian partner.
Lesson Learned: Investigate all options for risk mitigation. Do not assume that the traditional insurance approach is the answer.
Credit Risk
So good news. The company exporting frozen chicken to Russia had a partner. This was also the bad news because it created a credit risk. How would the U.S. company ensure payment from the Russian partner? It was not realistic to demand payment in advance or to obtain a letter of credit to guarantee a future payment. The Russian partner was not able to pay for a cargo for 30 or so days after receiving it. To deal with the credit exposure, the parties agreed that the Russian partner would have to pay for one cargo before it could receive a subsequent cargo.
How did this mitigate the exposure? The stream of profits from a series of cargos was significantly larger than the funds from a default on payment for a single cargo. If the Russian partner did not deposit funds in a Western bank account by day 45 after receipt of a cargo, the ship carrying the next cargo would be diverted from Russia to a northern European port.
Lesson Learned:
Give other parties, in this case the Russian partner, incentives to help your organization mitigate risk.
Physical Security Risk
Once the Russian partner accepted the chicken in St. Petersburg, it shipped the chicken by railroad to Moscow, Yekaterinburg, and beyond. The cargo was placed in refrigerated containers that were locked and then loaded on flat railcars. On the fifth journey, one of the containers was empty when it arrived in Moscow after the three-day trip from St. Petersburg. At this point, the partner was facing risk management problem. Two strategies were discussed. The first was to purchase insurance, an idea that was quickly eliminated. Who would insure a cargo with a high chance of loss? If a Russian insurance company agreed to provide coverage, the premiums would be prohibitively high. The second was door-to-door container placement. The railroad company would place the containers on the flatbed railcars so the doors could not be opened if the locks were broken. This was the chosen strategy.
The story continues. Sometimes a risk mitigation solution does not actually solve the problem. Several journeys later, another container arrived empty. The partner realized that someone had a crane on a siding when the train stopped in the middle of the night. What else should be tried?
The problem was finally solved by placing a boxcar on the back of the train. The car was fitted with heaters and cots. It carried guards with Kalashnikov weapons. Whenever the train stopped, guards stepped out to protect the containers. It was a simple but effective risk management strategy.
Lessons Learned: Stay with it until a risk management strategy works. Sometimes it takes a few tries to get it right.
Upside of Risk
The story of guards on the train can be used to illustrate the upside of risk. The railroad security situation in Russia has improved significantly since the 1990s, when the story unfolded. Prior to the improvement, a business opportunity arose. Once the cargo was being protected by armed guards, the Russian partner could offer insurance services to third parties to protect their cargoes as well as the chicken. The partner would incur small costs for the guards but could be confident that the train would experiences no losses. We do not know whether this opportunity was ever pursued.
QUESTION
Considering the risks and the responses made by the buyer, would you have made the same choices? If not, what choices would you have made? Explain and defend your choices.