Dealing with dangers abroad: as companies "go global," and particularly when setting up in emerging markets, it's critical to have clear processes and responsibilities for risk management.

• Author: Marshall, Jeffrey
• Position: Cover story - Company overview

There are many ways to try to understand global risk, but one way to spell it is clearly M-a-t-t-e-l.

U.S. toy giant Mattel Inc. found itself in full crisis mode back in August, when it was discovered that contractors and subcontractors it had hired in China to produce a number of its hit toys were finishing them with lead-based paint or had inserted tiny magnets that children could inadvertently swallow. Parents and children's' groups immediately went on the warpath, and Mattel CEO Robert Eckert was soon on television and the Internet apologizing for the lack of oversight and reassuring the public that Mattel was taking steps to handle the problem.

In early September, Mattel announced that "we have been busy testing and retesting toys before they leave factories. Our recent voluntary recalls are part of our ongoing promise to ensure the safety of your children." A key part of the effort: reinvigorated testing worldwide, with a mandatory three-stage safety check of paint used on its toys.

While the pain was primarily reputational, it also socked Mattel on the bottom line. Recall-related writeoffs of $40 million caused a third-quarter drop in profit, though only a very minor one, but in late October Mattel was compelled to do a fourth recall, this of toy boats painted in China. And, no surprise--the company is the target of shareholder suits seeking damages resulting from the board's alleged failure to handle the problems and to make timely disclosures to regulators and investors.

The entire episode is a vivid reminder of the venerable business adage: Know who you're doing business with. Even in a world with 24-7 communications, improved understanding of foreign cultures and scads of consulting help, breakdowns can still occur. The same communications explosion has virtually precluded the ability to hide or disguise problems, and once known, word of them can race like a Southern California wildfire.

Prudent risk management, then, would have companies selecting their foreign business arrangements carefully. And since the CFO is frequently the point person on enterprise risk management, expansion into new markets often puts yet another item on his or her plate. In fact, a recent survey involving IBM consultants found that 61 percent of organizations named the CFO as a leader in risk management, well ahead of the 50 percent for CEOs (multiple answers were allowed). (See "Integrated Finance Organizations Outperform Others," page 39.)

Global risk management has been nominally practiced for many years by large multinationals, but its effectiveness is often questionable. A new survey by Ernst & Young found that 56 percent of developed-market company executives responsible for risk management confessed that they had no strategy in place to manage risk in emerging markets. Even more surprisingly, given the long history of many U.S. brands in those markets, North American companies were the least likely to have a strategy in place to manage risk in emerging markets (25 percent, compared to 46 percent in Europe and 52 percent in the Far East).

"What becomes clear is risk has to be managed locally, and emerging market businesses do seem to be more active in managing across all risks than developed market businesses," says Inge Boets, global head of Business Risk Services for Ernst & Young. "Those closest to the risk are able to assess what needs to be done and take steps to reduce exposure. But they are also the least well-placed to compare performance with other markets and develop benchmark guidance."

"Companies know their own businesses very well," says Mark A. Goodburn, vice chair, advisory, for KPMG LLP. "But they have to operate within the context of the local environment, and business can move globally faster than regulation or culture. Those can be slow to change."

"With a global business, you want to be producing the best products possible, under the best circumstances possible, with the best foreign business partners possible," says Tom Travis, author of the recently published Doing Business Anywhere: The Essential Guide to Going Global (Wiley, 2007). "Do this, and you can protect your company's reputation with its most important constituency: its customers. If you don't take care of your brand and its reputation, not much else matters."

Not Just About Savings

"There has been a major shift in the reasons for investing in emerging markets," says Jim Holstein, global head of Risk Advisory Services for Ernst & Young. "Once it was all about cost savings. Now, it is about growth and the potential offered within the countries themselves. Clearly, these markets are extremely dynamic and exciting--but that also carries risk. Worryingly, a significant number of companies are still trying to work out how to manage their risks effectively."

One important resource for understanding individual country risk is the aptly named "country risk ratings" (see sidebar, "Resources for Researching Country Risk, page 36). To Goodburn, however, these ratings are "one factor" in risk analysis. "I'm not sure you should go to any agency and take...