[IMGCAP(1)]Every company in every industry faces some degree of risk. But some risks are greater than others, particularly sensitivity risk (related to external factors like commodity prices and competition), which accounts for about half of all risk incurred by any company.
These external threats cause companies’ costs and returns to vary widely from year to year, which may pose difficulties for accounting professionals with clients in high-risk industries. Because volatility is out of their control, accountants will have to anticipate relevant changes and advise clients on how to mitigate risk, such as through new products or building regulation into pricing.
To determine overall risk, IBISWorld uses a proprietary model that looks at each industry’s unique structural, growth and sensitivity risk. These scores are measured on a nine-point scale, with one representing very low risk and nine representing very high risk. IBISWorld analyzed more than 1,000 US industries and identified 10 with the highest levels of sensitivity risk.
These volatile markets present opportunities for accountants to proactively advise existing clients on how to hedge external risks, establish credibility and build relationships, as well as equip them with the insight necessary to secure new business.
Farming and Food
The cotton farming industry exhibits the highest sensitivity risk in the United States. Cotton farmers derive 85 percent of their revenue from exports, so the strength of the U.S. dollar is the single largest contributing factor to the high risk score.
During the five years up through 2013, the U.S. dollar appreciated only slightly, making U.S. cotton exports more affordable on the international market. But as the United States climbs out of recession over the next five years, the U.S. dollar will appreciate, making U.S. cotton exports more expensive and hurting global demand. To mitigate risk, farmers must ensure that both domestic and international markets are strong and varied so that drops in demand in one market can be offset by strong performance in another.
Levels of domestic and international crop production are also significant factors for the farm product storage and warehousing industry. Unpredictable fluctuations in downstream farming industries’ outputs and trade levels determine the demand and, thus, revenue for operators in this space. Because weather patterns and exchange rates underpin farming activities, this industry is inherently volatile. To best minimize potential risk, operators should diversify their client base and not rely solely on one crop.
In addition to volatile weather (which plays a role in input availability and prices from farms), consumer tastes and spending determine the sensitivity risk of the downstream tortilla production industry. Its high score is indicative of waning consumer spending since 2008 and volatile corn prices. As shoppers cut spending on discretionary items, especially those that grew in price, the viability of tortilla production has declined during the period, increasing industry sensitivity risk. To offset some of this risk, tortilla producers should look to foreign input suppliers for backup.
The home ownership rate in the United States has declined at an annualized rate of 1.7 percent over the five years to 2013, hurting a slew of home-related industries. This drop is largely responsible for the home ownership associations industry’s high sensitivity risk score. The industry provides development, management and administrative support services to housing communities, so Americans’ shift toward renting has stifled industry growth opportunities.
Similarly, because the manufactured home dealers industry relies heavily on consumers’ home purchases, it is also characterized by high sensitivity risk. To stimulate demand during the recession, manufactured home dealers lowered prices, which slashed profit margins and revenue and profit margins, making the industry a risky one.
Household furniture manufacturers also fell victim to lower home ownership during the recession. Their situation was made worse, however, by competing imports, which represent attractive low-price alternatives to consumers. Sensitivity risk is expected to continue growing as imports become less expensive due to the appreciating U.S. dollar.
Although the furniture repair and reupholstering industry is considered countercyclical, the recent recession was so deep and widespread that spending on repairs also dropped, causing operators to suffer revenue and profit declines. The combined effects of weak home ownership and falling incomes—in 2009, per capita disposable income fell for the first time in 18 years—contributed to the industry’s high sensitivity risk score.
To mitigate risk, many of these industries’ operators can—and have—expanded their product and service offerings to capture demand in other markets. For example, home owners’ associations have taken on apartment and condo management. And as home ownership rates rebound slowly over the next five years, sensitivity risk for these industries is anticipated to lighten.
Fuel, Textiles and Lab Supplies
With the second highest sensitivity risk score, the fuel dealers industry is dependent on highly volatile prices of key inputs, such as crude oil and natural gas, which present unpredictable conditions for fuel dealers. For example, in 2011, both commodities’ prices jumped more than 30 percent, so downstream markets chose to invest in alternative energies, causing industry revenue to rise only 6.4 percent that year. To offset risk associated with a single commodity, dealers should build a network of alternative products to distribute through established infrastructure.
Like furniture manufacturers, textile mills are highly exposed to competition from imports, contributing significantly to their high sensitivity risk. With cheaper imports available to downstream markets, domestic mills have suffered revenue declines averaging 1.3 percent over the past five years. To mitigate risk from imports, domestic mills can offer specialized products, which are harder to substitute.
For the laboratory supply wholesaling industry, government budgetary cuts are a key indicator of sensitivity risk. Despite steady growth over most of the past five years, a 1.0 percent decline to $22.1 billion is expected in 2013 as the industry faces sequestration. Budget cuts threaten operators’ avenues for growth and may even eliminate some players altogether, so laboratory supply wholesalers should look to nongovernment entities to ensure that revenue streams are diversified.
Sensitivity risk can play a major role in altering an industry’s cost and profit structure from year to year. So being aware of an industry’s exposure to external factors can help accounting professionals anticipate and explain any potential change in returns to their clients, benefiting both parties.
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