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Managing risks in airline industry
Japan and the World Economy 15 (2003) 469–479
Managing risks in airline industry$ Kichisaburo Nomura*,1 All Nippon Airways Co. Ltd., 3-5-10 Haneda Airport Ota-ku, Tokyo 144-0041, Japan Received 15 January 2003; accepted 3 February 2003
JEL classification: L93 Keywords: Risk management; Airline insurance; Operations research
1. Social needs created by environmental change Before I begin talking about risks surrounding airlines, I would like to make a brief comment on recent ideas of risk and changes in response. First, I would point out that the social needs for risk management have been growing due to environmental change. As a result of dissemination via the Internet, the speed of information transmission has accelerated to bring about a situation where an information flood exists, including correct and incorrect information. Considering a series of information disclosure systems such as the information disclosure system regarding administrative agencies of local governments and requests for disclosures in civil actions, we must control information under the premise that there may be situations where information must be disclosed. What is important here is that we should assume accountability correctly and properly with respect to background and response according to the situation of disclosure. To assume accountability means to recognize that it is the minimum responsibility of companies, and information control is an important element of risk management. Response of consumers has also become much more sensitive. We will be severely condemned if we commit an act betraying the expectations of customers. It is only proper to recognize such responses. I must concede that companies did not listen to the voices of consumers in the past, in particular to demanding claims against enterprises because companies had been concentrating on the pursuit of profits. We, All Nippon Airways (ANA), have established a corporate philosophy in order to pursue good relations with $ The journal will publish lectures and short papers by renowned administrators, statesmen and scholars who have influenced economic policy. This paper is one of those series of policy papers. * Tel.: þ81-3-5756-5555. 1 Chairman of the Board.
0922-1425/$ – see front matter # 2003 Published by Elsevier Science B.V. doi:10.1016/S0922-1425(03)00014-8
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K. Nomura / Japan and the World Economy 15 (2003) 469–479
stakeholders, including customers and shareholders, society and employees, and are making our best efforts to conduct business based on our customer creed of ‘‘security’’ and ‘‘reliability’’. Lastly, enhancement measures for corporate governance are also required. According to the views of the courts in the recent cases, it was judged that board members are legally obliged to build internal control systems. This means that corporate governance and internal control are two sides of the same coin in terms of management supervision and that without internal control, no corporate governance exists.
2. Reform of risk consciousness Enterprises, including ANA have so far basically coped with risks on a case-by-case basis. Individual response sounds better, but the problem is that it achieves only partial optimization and not total optimization and that there have potentially been remaining risks that have gone unrecognized. With respect to risk financing, we only have hedged risks that have been covered by insurance policies to the extent they are provided by insurance companies. Risks suitable for insurance are disaster risks and risk measures actually implied disaster measures. A portion of damages caused by a large-scale disaster is covered under an insurance policy. However, planning has not been made in advance as to how to efficiently cope with damages caused by a massive disaster and to recover business within a short period of time. Companies have a tendency to accept a situation in which they expect that the majority of companies will disappear if companies in Tokyo suffer massive damage from a large-scale earthquake disaster. For a company to survive, I believe it is necessary to build a enterprise-wide risk management system, taking into consideration business risks and strategic risks which are not covered by insurance. This requires that employees understand everyday risk management without exception. It is also necessary to take measures for emergency management in the case of risk actualization and other measures based on business continuity planning, which take into consideration large-scale disasters, etc. as such. We are required to develop both a department and appropriate human resources acting as internal checks since it is important to identify risk, assess the impacts and consider the hedge mechanisms. This is a fundamental point of view of risk management, which does not start with an initial insurance perspective.
3. Integrated risk management Fig. 1 shows the process of implementing integrated risk management. First, we have corporate strategies and business targets, which each company develops. The next step of risk management is to clarify, analyze and assess the risks. In doing this, it is important not only to probe disaster risks but also to clarify and appraise risks related to corporate businesses, including the business process, corporate strategy development process and decision-making process. In the integrated risk management system, we will place
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Fig. 1. The process of implementing integrated risk management.
priorities on the risks thus analyzed and assessed and conduct day-to-day control by making plans for effective response implementation. It is anticipated that we cannot manage every risk at 100 percent. This will be reflected in our corporate strategies and business targets subsequent assessments by carrying out checks and reviews in the risk management department or by way of internal audits. By repeating the said series of processes each year, we will be able to maintain continuity and realize effective risk management even if the managers or management organization has been changed, as we build an appropriate institutional knowledge bank of successful risk management capabilities and organizational responses.
4. Effectiveness of risk management With respect to the effectiveness of risk management, the following matters are generally pointed out: (1) It assumes corporate responsibility and accountability to all of its stakeholders, such as customers and shareholders. (2) Through developing measures for risk management, profit and cash flow will stabilize. (3) Internal control systems (corporate governance) will be reinforced.
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(4) Assessment of risks and implementation of appropriate controls will be possible. (5) Risk consciousness will be raised and recognition of risk will be shared throughout the company. (6) Corporate morale will be enhanced with a synergistic effect on compliance. (7) Cost of risk will be reduced. There may be some measures for integrated risk management that will not bring about an effect soon after introduction, but I believe effects will surely be achieved over the mid and long term.
5. If risk management is misinterpreted . . . What will be the consequences of risk management misinterpretation? If we implement faulty risk management on one matter, we will actualize one risk that will trigger the actualization of other risks and a negative chain of risks will start. First, we may expect a decrease in brand force due to a deterioration in company image, a revenue decrease due to a decrease in passengers and an increase in risk response cost, etc. As incidental effects, there may be an increase in financing interest rates due to a lower rating, drop in product prices, deterioration in asset efficiency due to a review of volume of production, investment constraints and scaling down of business, etc. These factors will cause great damage to the company in both the short term and the long run. In some cases, it may lead to a situation in which bankruptcy is unavoidable.
6. Specifics of risk management 6.1. Risks surrounding airlines From now, I would like to introduce in a little more detail risks surrounding the airline industry. First of all, what is most characteristic is operational risk. Although safety has improved as a result of significant technological developments in air transport, aircraft is still a means by which we are transported by air, and we cannot deny that the possibility of an aircraft crash will not be zero. There always exists a risk that passenger survival rates will be very low if an aircraft crash should occur. Furthermore, due to the necessity for seating reservations and carrying out boarding procedures for many passengers in a short period of time, the airline industry has used computer systems from relatively early on. As it greatly depends on computer systems, once a system malfunction occurs, this greatly impacts operations. Next, I would like to refer to business strategy risk. The airline industry is a typical processing industry, which is able to operate only after making various prior investments such as purchases of aircrafts, securing flight crews, and securing airport facilities. It is necessary to place an order at least a couple of years ahead of time before the actual
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purchase of new aircrafts and the training of a flight crew requires at least 7–8 years. Therefore, if we were to err in mid and long term business planning, this would affect revenues and expenditures over a long time. Slot restrictions are extremely tight at airports in Japan, and we must take into consideration the fact that we may not be able to set up new routes, in which we can anticipate good demand or routes we would like to serve. Since aircraft is very expensive and purchased in foreign currency, we must always maintain a large amount of interest bearing debt, thus we are at risk to financing and currency exchange. Disaster risks also exist as in other industries. 6.2. Risks surrounding airlines Fig. 2 classifies major individual risks into operational risk, business strategy risk, financial risk and disaster risk referred to in the above and also classified into those according external and internal factors. What is important here is, that one risk induces another risk, in effect, a multiplier factor. The impact of terrorism still remains and it has become one of the causes putting pressure on the balance sheets of airlines. 6.3. Impact of 11 September simultaneous terrorist attacks in the USA Now, let’s look at the impact on the airline industry as a result of the simultaneous terrorist attacks in the USA, which occurred on 11 September 2001.
Fig. 2. Risk surrounding airlines.
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These attacks were a shocking incident using aircraft as the tool of terrorism. As a direct effect of terrorism, there was a great decrease in revenues due to a decrease in the number of passengers, a large increase in costs due to strengthening in security systems and appreciation of insurance premiums. As an incidental impact, airlines were forced to review service routes, layoff employees, review scales of investing in businesses, and even now such effects from those terrorist attacks still remain. From here, not only were there negative aspects, we can also point to positive aspects in that reviews were conducted with terrorist attacks as a turning point. First, risk consciousness has been changed and a review of cost structures has commenced so as to correspond to risk. Above all, I would like to indicate the efforts made with the safety improvements, allowing our customers to use our services with peace of mind. 6.4. Approach to risk management From now, I will explain risk management at ANA. Risk management of the whole company is a relatively recent innovation. Originally, ANA has made risk management only on a case-by-case basis. Each department has taken action up to this point and risk response was of a suboptimal nature and we have not taken measures in terms of total optimization. On 1 July 2002, we established a Risk Management Committee and started activities to build a enterprise-wide risk management system. We clarify major risks and determine a risk management policy and emergency response policy after making an analysis and assessment of risks, from which we build a risk management system. Basically, each department will control risks after the system is built, however, our system will enable us to coordinate via assessment of individual risks and countermeasures, comparing them with the overall risk in order to attempt maximum optimization. Not all risk management will achieve an effect right after its introduction, but I expect positive results will be produced through the implementation of audits by the risk control department and an internal auditing department and continuous efforts. 6.5. Risk map (image) This is part of the risk map prepared during the course of activities within the Risk Management Committee. If we had plotted all risks on the map, this would be extremely detailed, therefore we plotted only characteristic ones. We will develop a risk management policy, taking into consideration such indices as risk level measures and effectiveness of measures based on the risk map (Fig. 3). 6.6. Individual risk management Next, I will explain risks somewhat particular to airlines within actual business activities and risk management. Within the category of operation risk, I will cite the risk of an aircraft accident and hijacking, and risk involving procurement of fuel, price risk and risk of unavailable aircraft.
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Fig. 3. Risk map (image).
I will also touch upon cost structure in somewhat more detail, and the difficulties of cost control, and compliance. 6.7. Operations risk (aircraft accident, etc.) The greatest risk for airlines is operation risk and specifically speaking, an aircraft accident. Once a large-scale aircraft accident, not only are there many sacrifices but the airline loses both business and social credibility and becomes an airline rejected by customers. Compensation for passengers and aircraft damages, and damages to third parties on the ground would be covered by aviation insurance to a certain extent. But, for example, as for domestic services, loss of income as a result of a decrease in passengers, which is expected to exceed 100 billion yen the year after an accident, is not covered by insurance. There is also a risk that passengers will decrease even if an accident or terrorist act occurs to aircrafts of airlines other than ANA. Therefore, it is very important to prepare, during normal times, a plan for recovery to prior financial level before an accident occurs. Our company has completed revision of a quick response manual, based on the premise that an aircraft accident has occurred and the following build-up of a system. We are also
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preparing for emergency response planning and business recovery planning responding to a large-scale earthquake disaster and accidents by establishing Business Continuity Planning. 6.8. Operations risk (emergency response) As I mentioned before, in the case of an aviation disaster, it is very important how quickly we conduct relief efforts for injured persons and their families. Therefore, let me explain a little about our emergency response system, assuming accidents and hijacking. ANA controls operations 24 h a day by the Operation Control Center (OCC). If any irregulality occurs, it will be first reported to OCC and the Operations Director who, in overall charge of the Center, puts the emergency response system in motion. This emergency response system is contained in the emergency response manual which is prepared in the case of accidents or hijacking, which dictates the system for smooth implementation of decision-making, response at an accident site and response to passengers in the case of an accident. Also, we have set up a full-time emergency response facility as well as providing education and training to 1200 employees, who have been selected as assistance personnel. And we have arranged a system so that they respond quickly as members of the emergency response system to inquiries from customers, care of families and public relations. We have also confirmed the contents of the manual by conducting simulation training one or more times a year as well as providing class room educational training to assistance personnel every year. As this manual contains only responses to direct impact of an accident, however, we are now establishing Business Continuity Planning to sustain the company and recover from an emergency situation as soon as possible, describing how to flexibly respond to a decrease in customers after an accident. 6.9. Operations risk (fuel) The next risk is risk related to fuel, wherein, there is both a procurement risk and a price fluctuation risk. If an event occurs in which we cannot load fuel, as it will directly affect operations, the procurement risk is very serious. Therefore, with respect to procurement of fuel, in addition to the ordinary form of ‘‘delivery at loading’’ (this is a form in which ownership of fuel is transferred to an airline at the time of loading of fuel on the aircraft by the fuel supplier), at particular large airports, we purchase fuel kept in a tank so that we will be able to load fuel that we own in case of an emergency. If we are unable to load fuel at a certain airport, it is advantageous to employ tankering for maintaining operations. This is a method that entails loading of fuel, at the time of departure at the said airport, sufficient for a round trip flight or for volume until receiving the next fuel supply. We are devising various methods so that operations will not be suspended, including the method for transferring fuel from one plane to another.
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It is natural that we transact business with multiple fuel suppliers so that a failure in a transaction with a particular company will not affect the entire operation at one time. With respect to price fluctuation risk, we purchase future options gradually 2 years prior to the actual purchase and determine to risk hedge the purchase price, making a comparison with the SPOT price at the time of purchase. 6.10. Operations risk (unavailable aircraft) Next, as to the risk of unavailable aircraft, this is a risk in which nonconformity was found in a certain model of aircraft and that type of plane is grounded until the said nonconformity is resolved. It is also called ‘‘grounding risk’’ as the said plane is parked on the apron. In fact, as a result of the Air France Concorde accident, planes of the same type were unavailable for operation for about a year. In the case of foreign airlines, some airlines have attempted to reduce maintenance and personnel expenses by unifying the model of aircraft they operate. But it is inevitable that they will suffer fatal damage if operations of aircraft of the same model of airline become impossible for a specific period of time. To avoid such circumstances, operations through diffusion of models of aircraft to a certain extent will be preparation for unexpected circumstances. It is also necessary to pay attention to the size of aircraft in addition to diffusion of aircraft models. In Japan, as there is a problem of slot shortages due to operation restrictions at airports or inadequate runways numbers, we have no choice but to solve this problem through allocation of large aircraft for operation of routes with great demand. If we operate with only large aircraft, vacant seats will significantly increase with routes of moderate or low demand. Therefore, retaining a balanced feet of aircraft, consisting of large, medium and small sized aircrafts to respond to demand and airport restrictions flexibly, will lead to a reduction in business planning risk. Now, ANA retains large size aircraft (B747, B777), medium size aircraft (B767) and small size aircraft (B737, A320 and A321) by one-third, respectively. 6.11. Cost control Now, I would like to refer to corporate risk a little. The airline industry is a typical processing industry, which gains revenues by boarding passengers after making initial and prior investments, including aircraft, spare engines and parts, airport facilities, training of flight crews and mechanics, assignment of airport attendants, reservation systems, etc. The cost structure has been highly fixed. Also, as the ratio of taxes and public charges such as airport usage fees including landing fees, air navigation facilities and aviation fuel taxes are high, it is very difficult to liquidate costs. We are promoting continuous reform, aiming at a cost structure that enables us to cope to a certain extent with a situation in which operating revenues exhibit significant variability.
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6.12. Compliance Compliance is one of the pillars of an internal control system and without a business in compliance, there is a risk that we will be forced to withdraw from the market. At ANA, we have established a group corporate policy and a six-Point Action Plan to realize our policy. We are now developing ANA Group Activity Standards in conformity with our compliance system (ethics and consciousness of compliance with law), referring to the Charter of Corporate Activity established by Japan Business Federation. Together with this, we will aim at developing a consciousness of compliance for every officer and employee and carry this out by preparing a Q&A casebook to offer specific explanations.
7. System of ANA 7.1. Build-up of internal control system I have explained so far individual risks somewhat particular to airlines. As I said before, ANA is now preparing a full-scale operation of functions of risk management, compliance and internal audits from this April. In terms of corporate governance, as we have reinforced some of the check functions of directors, I will now explain this somewhat. First, we have normal check functions of auditors. At present, auditors conduct business audits of each office annually to check corporate activities. We also invite outside directors to attend board meetings and assume check functions. In addition to the above, our management advisory committee consisting of six to seven outside experts has been regularly exchanging opinions on financial conditions and corporate problems. We will aim at reinforcing the management system by building an internal control system in addition to the existing system. 7.2. Set up of various conferences and committees At ANA, we have set up various conferences and committees in order to make expeditious decisions, and also to solve various issues and problems. There are eight conferences and committees with systems implemented to assist the board of directors and carry out expeditious business enforcement. These consist of: Management Committee, which discusses the basic strategy of ANA Group, Risk Management Committee, which develops policies of risk management and its implementation, IT Strategy and Governance Committee, which develops and promotes strategy concerning information systems, Environment Committee for the promotion of the preservation of global environment, CS Promotion Committee for improvements in services and customer satisfaction level, Safety Promotion Committee, which implements safety measures and investigations and audits for prevention of aircraft accidents, Operations Conference, which carries out measures and improvements for more efficient and effective operations of aircrafts and Aviation Security and Emergency Response Planning Committee, which
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implements aviation security measures, including prevention of hijacking and emergency responding measures in case of an aircraft accident, etc. I have talked about the general theory of risk management and risk management of airlines. However, the risk management system of ANA has just started. The greatest risk is the consciousness of employees and it is most important that each officer and employee retains a consciousness of risk management in day-to-day business activities. All officers and employees, including myself, will make best efforts to receive the further trust of our customers and allow them to fly feeling secure. I truly ask that you fly with All Nippon Airways.
Managing risks in airline industry$ Kichisaburo Nomura*,1 All Nippon Airways Co. Ltd., 3-5-10 Haneda Airport Ota-ku, Tokyo 144-0041, Japan Received 15 January 2003; accepted 3 February 2003
JEL classification: L93 Keywords: Risk management; Airline insurance; Operations research
1. Social needs created by environmental change Before I begin talking about risks surrounding airlines, I would like to make a brief comment on recent ideas of risk and changes in response. First, I would point out that the social needs for risk management have been growing due to environmental change. As a result of dissemination via the Internet, the speed of information transmission has accelerated to bring about a situation where an information flood exists, including correct and incorrect information. Considering a series of information disclosure systems such as the information disclosure system regarding administrative agencies of local governments and requests for disclosures in civil actions, we must control information under the premise that there may be situations where information must be disclosed. What is important here is that we should assume accountability correctly and properly with respect to background and response according to the situation of disclosure. To assume accountability means to recognize that it is the minimum responsibility of companies, and information control is an important element of risk management. Response of consumers has also become much more sensitive. We will be severely condemned if we commit an act betraying the expectations of customers. It is only proper to recognize such responses. I must concede that companies did not listen to the voices of consumers in the past, in particular to demanding claims against enterprises because companies had been concentrating on the pursuit of profits. We, All Nippon Airways (ANA), have established a corporate philosophy in order to pursue good relations with $ The journal will publish lectures and short papers by renowned administrators, statesmen and scholars who have influenced economic policy. This paper is one of those series of policy papers. * Tel.: þ81-3-5756-5555. 1 Chairman of the Board.
0922-1425/$ – see front matter # 2003 Published by Elsevier Science B.V. doi:10.1016/S0922-1425(03)00014-8
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K. Nomura / Japan and the World Economy 15 (2003) 469–479
stakeholders, including customers and shareholders, society and employees, and are making our best efforts to conduct business based on our customer creed of ‘‘security’’ and ‘‘reliability’’. Lastly, enhancement measures for corporate governance are also required. According to the views of the courts in the recent cases, it was judged that board members are legally obliged to build internal control systems. This means that corporate governance and internal control are two sides of the same coin in terms of management supervision and that without internal control, no corporate governance exists.
2. Reform of risk consciousness Enterprises, including ANA have so far basically coped with risks on a case-by-case basis. Individual response sounds better, but the problem is that it achieves only partial optimization and not total optimization and that there have potentially been remaining risks that have gone unrecognized. With respect to risk financing, we only have hedged risks that have been covered by insurance policies to the extent they are provided by insurance companies. Risks suitable for insurance are disaster risks and risk measures actually implied disaster measures. A portion of damages caused by a large-scale disaster is covered under an insurance policy. However, planning has not been made in advance as to how to efficiently cope with damages caused by a massive disaster and to recover business within a short period of time. Companies have a tendency to accept a situation in which they expect that the majority of companies will disappear if companies in Tokyo suffer massive damage from a large-scale earthquake disaster. For a company to survive, I believe it is necessary to build a enterprise-wide risk management system, taking into consideration business risks and strategic risks which are not covered by insurance. This requires that employees understand everyday risk management without exception. It is also necessary to take measures for emergency management in the case of risk actualization and other measures based on business continuity planning, which take into consideration large-scale disasters, etc. as such. We are required to develop both a department and appropriate human resources acting as internal checks since it is important to identify risk, assess the impacts and consider the hedge mechanisms. This is a fundamental point of view of risk management, which does not start with an initial insurance perspective.
3. Integrated risk management Fig. 1 shows the process of implementing integrated risk management. First, we have corporate strategies and business targets, which each company develops. The next step of risk management is to clarify, analyze and assess the risks. In doing this, it is important not only to probe disaster risks but also to clarify and appraise risks related to corporate businesses, including the business process, corporate strategy development process and decision-making process. In the integrated risk management system, we will place
K. Nomura / Japan and the World Economy 15 (2003) 469–479
471
Fig. 1. The process of implementing integrated risk management.
priorities on the risks thus analyzed and assessed and conduct day-to-day control by making plans for effective response implementation. It is anticipated that we cannot manage every risk at 100 percent. This will be reflected in our corporate strategies and business targets subsequent assessments by carrying out checks and reviews in the risk management department or by way of internal audits. By repeating the said series of processes each year, we will be able to maintain continuity and realize effective risk management even if the managers or management organization has been changed, as we build an appropriate institutional knowledge bank of successful risk management capabilities and organizational responses.
4. Effectiveness of risk management With respect to the effectiveness of risk management, the following matters are generally pointed out: (1) It assumes corporate responsibility and accountability to all of its stakeholders, such as customers and shareholders. (2) Through developing measures for risk management, profit and cash flow will stabilize. (3) Internal control systems (corporate governance) will be reinforced.
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(4) Assessment of risks and implementation of appropriate controls will be possible. (5) Risk consciousness will be raised and recognition of risk will be shared throughout the company. (6) Corporate morale will be enhanced with a synergistic effect on compliance. (7) Cost of risk will be reduced. There may be some measures for integrated risk management that will not bring about an effect soon after introduction, but I believe effects will surely be achieved over the mid and long term.
5. If risk management is misinterpreted . . . What will be the consequences of risk management misinterpretation? If we implement faulty risk management on one matter, we will actualize one risk that will trigger the actualization of other risks and a negative chain of risks will start. First, we may expect a decrease in brand force due to a deterioration in company image, a revenue decrease due to a decrease in passengers and an increase in risk response cost, etc. As incidental effects, there may be an increase in financing interest rates due to a lower rating, drop in product prices, deterioration in asset efficiency due to a review of volume of production, investment constraints and scaling down of business, etc. These factors will cause great damage to the company in both the short term and the long run. In some cases, it may lead to a situation in which bankruptcy is unavoidable.
6. Specifics of risk management 6.1. Risks surrounding airlines From now, I would like to introduce in a little more detail risks surrounding the airline industry. First of all, what is most characteristic is operational risk. Although safety has improved as a result of significant technological developments in air transport, aircraft is still a means by which we are transported by air, and we cannot deny that the possibility of an aircraft crash will not be zero. There always exists a risk that passenger survival rates will be very low if an aircraft crash should occur. Furthermore, due to the necessity for seating reservations and carrying out boarding procedures for many passengers in a short period of time, the airline industry has used computer systems from relatively early on. As it greatly depends on computer systems, once a system malfunction occurs, this greatly impacts operations. Next, I would like to refer to business strategy risk. The airline industry is a typical processing industry, which is able to operate only after making various prior investments such as purchases of aircrafts, securing flight crews, and securing airport facilities. It is necessary to place an order at least a couple of years ahead of time before the actual
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purchase of new aircrafts and the training of a flight crew requires at least 7–8 years. Therefore, if we were to err in mid and long term business planning, this would affect revenues and expenditures over a long time. Slot restrictions are extremely tight at airports in Japan, and we must take into consideration the fact that we may not be able to set up new routes, in which we can anticipate good demand or routes we would like to serve. Since aircraft is very expensive and purchased in foreign currency, we must always maintain a large amount of interest bearing debt, thus we are at risk to financing and currency exchange. Disaster risks also exist as in other industries. 6.2. Risks surrounding airlines Fig. 2 classifies major individual risks into operational risk, business strategy risk, financial risk and disaster risk referred to in the above and also classified into those according external and internal factors. What is important here is, that one risk induces another risk, in effect, a multiplier factor. The impact of terrorism still remains and it has become one of the causes putting pressure on the balance sheets of airlines. 6.3. Impact of 11 September simultaneous terrorist attacks in the USA Now, let’s look at the impact on the airline industry as a result of the simultaneous terrorist attacks in the USA, which occurred on 11 September 2001.
Fig. 2. Risk surrounding airlines.
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These attacks were a shocking incident using aircraft as the tool of terrorism. As a direct effect of terrorism, there was a great decrease in revenues due to a decrease in the number of passengers, a large increase in costs due to strengthening in security systems and appreciation of insurance premiums. As an incidental impact, airlines were forced to review service routes, layoff employees, review scales of investing in businesses, and even now such effects from those terrorist attacks still remain. From here, not only were there negative aspects, we can also point to positive aspects in that reviews were conducted with terrorist attacks as a turning point. First, risk consciousness has been changed and a review of cost structures has commenced so as to correspond to risk. Above all, I would like to indicate the efforts made with the safety improvements, allowing our customers to use our services with peace of mind. 6.4. Approach to risk management From now, I will explain risk management at ANA. Risk management of the whole company is a relatively recent innovation. Originally, ANA has made risk management only on a case-by-case basis. Each department has taken action up to this point and risk response was of a suboptimal nature and we have not taken measures in terms of total optimization. On 1 July 2002, we established a Risk Management Committee and started activities to build a enterprise-wide risk management system. We clarify major risks and determine a risk management policy and emergency response policy after making an analysis and assessment of risks, from which we build a risk management system. Basically, each department will control risks after the system is built, however, our system will enable us to coordinate via assessment of individual risks and countermeasures, comparing them with the overall risk in order to attempt maximum optimization. Not all risk management will achieve an effect right after its introduction, but I expect positive results will be produced through the implementation of audits by the risk control department and an internal auditing department and continuous efforts. 6.5. Risk map (image) This is part of the risk map prepared during the course of activities within the Risk Management Committee. If we had plotted all risks on the map, this would be extremely detailed, therefore we plotted only characteristic ones. We will develop a risk management policy, taking into consideration such indices as risk level measures and effectiveness of measures based on the risk map (Fig. 3). 6.6. Individual risk management Next, I will explain risks somewhat particular to airlines within actual business activities and risk management. Within the category of operation risk, I will cite the risk of an aircraft accident and hijacking, and risk involving procurement of fuel, price risk and risk of unavailable aircraft.
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Fig. 3. Risk map (image).
I will also touch upon cost structure in somewhat more detail, and the difficulties of cost control, and compliance. 6.7. Operations risk (aircraft accident, etc.) The greatest risk for airlines is operation risk and specifically speaking, an aircraft accident. Once a large-scale aircraft accident, not only are there many sacrifices but the airline loses both business and social credibility and becomes an airline rejected by customers. Compensation for passengers and aircraft damages, and damages to third parties on the ground would be covered by aviation insurance to a certain extent. But, for example, as for domestic services, loss of income as a result of a decrease in passengers, which is expected to exceed 100 billion yen the year after an accident, is not covered by insurance. There is also a risk that passengers will decrease even if an accident or terrorist act occurs to aircrafts of airlines other than ANA. Therefore, it is very important to prepare, during normal times, a plan for recovery to prior financial level before an accident occurs. Our company has completed revision of a quick response manual, based on the premise that an aircraft accident has occurred and the following build-up of a system. We are also
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preparing for emergency response planning and business recovery planning responding to a large-scale earthquake disaster and accidents by establishing Business Continuity Planning. 6.8. Operations risk (emergency response) As I mentioned before, in the case of an aviation disaster, it is very important how quickly we conduct relief efforts for injured persons and their families. Therefore, let me explain a little about our emergency response system, assuming accidents and hijacking. ANA controls operations 24 h a day by the Operation Control Center (OCC). If any irregulality occurs, it will be first reported to OCC and the Operations Director who, in overall charge of the Center, puts the emergency response system in motion. This emergency response system is contained in the emergency response manual which is prepared in the case of accidents or hijacking, which dictates the system for smooth implementation of decision-making, response at an accident site and response to passengers in the case of an accident. Also, we have set up a full-time emergency response facility as well as providing education and training to 1200 employees, who have been selected as assistance personnel. And we have arranged a system so that they respond quickly as members of the emergency response system to inquiries from customers, care of families and public relations. We have also confirmed the contents of the manual by conducting simulation training one or more times a year as well as providing class room educational training to assistance personnel every year. As this manual contains only responses to direct impact of an accident, however, we are now establishing Business Continuity Planning to sustain the company and recover from an emergency situation as soon as possible, describing how to flexibly respond to a decrease in customers after an accident. 6.9. Operations risk (fuel) The next risk is risk related to fuel, wherein, there is both a procurement risk and a price fluctuation risk. If an event occurs in which we cannot load fuel, as it will directly affect operations, the procurement risk is very serious. Therefore, with respect to procurement of fuel, in addition to the ordinary form of ‘‘delivery at loading’’ (this is a form in which ownership of fuel is transferred to an airline at the time of loading of fuel on the aircraft by the fuel supplier), at particular large airports, we purchase fuel kept in a tank so that we will be able to load fuel that we own in case of an emergency. If we are unable to load fuel at a certain airport, it is advantageous to employ tankering for maintaining operations. This is a method that entails loading of fuel, at the time of departure at the said airport, sufficient for a round trip flight or for volume until receiving the next fuel supply. We are devising various methods so that operations will not be suspended, including the method for transferring fuel from one plane to another.
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It is natural that we transact business with multiple fuel suppliers so that a failure in a transaction with a particular company will not affect the entire operation at one time. With respect to price fluctuation risk, we purchase future options gradually 2 years prior to the actual purchase and determine to risk hedge the purchase price, making a comparison with the SPOT price at the time of purchase. 6.10. Operations risk (unavailable aircraft) Next, as to the risk of unavailable aircraft, this is a risk in which nonconformity was found in a certain model of aircraft and that type of plane is grounded until the said nonconformity is resolved. It is also called ‘‘grounding risk’’ as the said plane is parked on the apron. In fact, as a result of the Air France Concorde accident, planes of the same type were unavailable for operation for about a year. In the case of foreign airlines, some airlines have attempted to reduce maintenance and personnel expenses by unifying the model of aircraft they operate. But it is inevitable that they will suffer fatal damage if operations of aircraft of the same model of airline become impossible for a specific period of time. To avoid such circumstances, operations through diffusion of models of aircraft to a certain extent will be preparation for unexpected circumstances. It is also necessary to pay attention to the size of aircraft in addition to diffusion of aircraft models. In Japan, as there is a problem of slot shortages due to operation restrictions at airports or inadequate runways numbers, we have no choice but to solve this problem through allocation of large aircraft for operation of routes with great demand. If we operate with only large aircraft, vacant seats will significantly increase with routes of moderate or low demand. Therefore, retaining a balanced feet of aircraft, consisting of large, medium and small sized aircrafts to respond to demand and airport restrictions flexibly, will lead to a reduction in business planning risk. Now, ANA retains large size aircraft (B747, B777), medium size aircraft (B767) and small size aircraft (B737, A320 and A321) by one-third, respectively. 6.11. Cost control Now, I would like to refer to corporate risk a little. The airline industry is a typical processing industry, which gains revenues by boarding passengers after making initial and prior investments, including aircraft, spare engines and parts, airport facilities, training of flight crews and mechanics, assignment of airport attendants, reservation systems, etc. The cost structure has been highly fixed. Also, as the ratio of taxes and public charges such as airport usage fees including landing fees, air navigation facilities and aviation fuel taxes are high, it is very difficult to liquidate costs. We are promoting continuous reform, aiming at a cost structure that enables us to cope to a certain extent with a situation in which operating revenues exhibit significant variability.
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6.12. Compliance Compliance is one of the pillars of an internal control system and without a business in compliance, there is a risk that we will be forced to withdraw from the market. At ANA, we have established a group corporate policy and a six-Point Action Plan to realize our policy. We are now developing ANA Group Activity Standards in conformity with our compliance system (ethics and consciousness of compliance with law), referring to the Charter of Corporate Activity established by Japan Business Federation. Together with this, we will aim at developing a consciousness of compliance for every officer and employee and carry this out by preparing a Q&A casebook to offer specific explanations.
7. System of ANA 7.1. Build-up of internal control system I have explained so far individual risks somewhat particular to airlines. As I said before, ANA is now preparing a full-scale operation of functions of risk management, compliance and internal audits from this April. In terms of corporate governance, as we have reinforced some of the check functions of directors, I will now explain this somewhat. First, we have normal check functions of auditors. At present, auditors conduct business audits of each office annually to check corporate activities. We also invite outside directors to attend board meetings and assume check functions. In addition to the above, our management advisory committee consisting of six to seven outside experts has been regularly exchanging opinions on financial conditions and corporate problems. We will aim at reinforcing the management system by building an internal control system in addition to the existing system. 7.2. Set up of various conferences and committees At ANA, we have set up various conferences and committees in order to make expeditious decisions, and also to solve various issues and problems. There are eight conferences and committees with systems implemented to assist the board of directors and carry out expeditious business enforcement. These consist of: Management Committee, which discusses the basic strategy of ANA Group, Risk Management Committee, which develops policies of risk management and its implementation, IT Strategy and Governance Committee, which develops and promotes strategy concerning information systems, Environment Committee for the promotion of the preservation of global environment, CS Promotion Committee for improvements in services and customer satisfaction level, Safety Promotion Committee, which implements safety measures and investigations and audits for prevention of aircraft accidents, Operations Conference, which carries out measures and improvements for more efficient and effective operations of aircrafts and Aviation Security and Emergency Response Planning Committee, which
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implements aviation security measures, including prevention of hijacking and emergency responding measures in case of an aircraft accident, etc. I have talked about the general theory of risk management and risk management of airlines. However, the risk management system of ANA has just started. The greatest risk is the consciousness of employees and it is most important that each officer and employee retains a consciousness of risk management in day-to-day business activities. All officers and employees, including myself, will make best efforts to receive the further trust of our customers and allow them to fly feeling secure. I truly ask that you fly with All Nippon Airways.