Mitigating Risk and Exposure from Subsidiary Operations

Mitigating Risk and Exposure from Subsidiary Operations

Systems must be streamlined to enable the corporate sourcing organization to provide information on preferred suppliers in order to reduce the risk of supply quality.

You are responsible for risk management at the headquarters of a Fortune 1000 company. You and your team have done an outstanding job designing controls and implementing them across the company to protect your company's reputation and assets. However, you are still apprehensive about the potential risks posed by the company's smaller subsidiaries.

Unlike the head office, many of these subsidiaries are still operating on manual processes and legacy systems, inhibiting their ability to fully enforce corporate policies and processes. As a result, the activities of these small subsidiaries could pose significant potential risks to the overall company -- risks to the company's supplier quality, liquidity, financial reporting accuracy, unbudgeted spending, just to name a few.

To mitigate these risks, you must streamline and automate the mostly manual and outdated systems at small subsidiaries, in order to

  • Enable the corporate sourcing organization to automatically provide information on preferred suppliers and negotiated terms to every subsidiary, so that they work only with selected suppliers and enforce quality targets to significantly reduce the risk of supply quality
  • Enable headquarters to have ongoing visibility into cash on-hand, receivables and payables across all operations, including subsidiaries, to manage liquidity risk
  • Streamline the financial consolidation process and eliminate the back and forth of spreadsheets with subsidiaries to reduce the risk of inaccurate corporate and local financial data reporting
  • Streamline inter-company purchasing transactions with subsidiaries (from internal manufacturing and distribution sites to sales offices in various countries) and eliminate the use of spreadsheets and emails to ensure the right product gets to the right customer at the right time to reduce revenue risk
  • Implement collaborative processes such as supply/demand forecasting and budgeting with all subsidiary operations to reduce the risk of inventory liability or unpleasant spending surprises

As someone responsible for risk management, you want to ensure that these processes are automated and well implemented in order to streamline headquarters' interactions with all operations, including those with smaller subsidiaries. In short, you want headquarters to have the visibility and control it needs to reduce both operational and enterprise risk. Similarly, you want subsidiaries to support headquarters with these processes without creating any manual work for them.

Until now, such a degree of visibility, compliance and collaboration at the headquarters level has been a challenge. Your subsidiaries are running completely different enterprise systems that are not connected to the headquarters' ERP system. This makes it challenging for subsidiaries to map their processes to the ones you have designed to reduce risk. Furthermore, some of the information flow falls through the cracks when spreadsheets and emails are used to coordinate and collaborate with subsidiaries, creating increased risk. There is now an opportunity to address this issue and streamline headquarters' risk management activities. With legacy systems at some subsidiaries in need of replacement, you can help subsidiaries select a system that best meets their business and budget requirements, yet also addresses headquarters' need for visibility, compliance and coordination. But how do you help them frame the right selection criteria for a new system that fits the needs of both the headquarters and subsidiaries?

Multiple options are available, each with advantages and disadvantages. In the end, your governance and risk management model, together with the business requirements of the subsidiaries, should drive the decision. Below are three options that you may consider:

Option 1 -- Deploy the same ERP system across the company

Under this option, the corporate ERP system is deployed at every business unit and subsidiary, ensuring that the same processes and metrics are enforced across the entire company. In our risk management examples, every subsidiary would use the agreed-upon procurement terms, headquarters would be able to easily roll-up information for cash liquidity analysis and consolidation, and the entire organization would be able to easily deploy shared and collaborative processes. Such an approach would give headquarters clear visibility and control for risk management.

While some companies have implemented such an approach, especially if their business is homogeneous across the globe, this option of deploying a corporate ERP system in smaller subsidiaries or divisions comes with a set of steep challenges. The process complexity and workflows in a small, autonomous subsidiary are typically very different from those of headquarters or a large division. As a result:

  • Smaller subsidiaries are likely to get smothered by process overload
  • The cost of implementing the corporate ERP system may significantly exceed the planned budget and skills of the smaller subsidiary
  • The corporate ERP system may have to be heavily customized to meet the unique industry, functional and compliance requirements of the smaller subsidiaries

Hence, in many business environments, such an option may not be viable. Instead, some companies may be better off with a two-tier ERP approach -- the corporate ERP system is deployed at headquarters and at larger divisions, while a simpler ERP system is implemented at the smaller subsidiaries. This option is further discussed below.

Option 2 -- Deploy a two tier ERP approach with simple data integration between headquarters and subsidiaries

In this option, the company implements a corporate ERP system at headquarters and larger divisions, and a simpler, easier to use system that is better suited to the local financial and regulatory requirements and lines of business at smaller subsidiaries. Additionally, there is a layer of simple transactional data integration (or rollup) between the two levels of ERP systems. The most popular scenario under this option is rollup of financial data from the subsidiary system to the corporate ERP system to enable financial consolidation for fiduciary and management reporting at headquarters. This example is often seen in an environment where the subsidiary runs its operations at an arm's length from headquarters or when headquarters is a holding company with several independent and autonomous entities, each with its own business model. The primary role of the integration between the two ERP systems is to enable financial consolidation of the information from the subsidiary to headquarters.

However, this approach is not sufficient if headquarters and the subsidiary need to collaborate or coordinate their activities more closely for risk management, as is the case for many of the examples discussed earlier in the article. As a result, by implementing such an approach, the company would still need to depend on manual processes for liquidity forecasting, making corporate sourcing terms visible to subsidiaries, demand/supply forecasting, etc., which would impede their ability to manage risk.

Option 3 -- Deploy a two-tier ERP approach with process integration between headquarters and subsidiaries

With this option, the company implements a two-tier ERP model, but the integration between the two ERP systems tiers goes beyond simple data consolidation discussed in the previous section. It integrates business processes, such as procurement, collaborative budgeting/planning and liquidity analysis, across the two systems. This approach is ideal for scenarios where headquarters and subsidiaries need to coordinate activities or collaborate with each other.

For example, one of the key processes defined at the beginning of this article was liquidity analysis and forecasting at headquarters to identify and proactively manage liquidity risk. This is critical for companies when their working capital requirements must be managed carefully or when they have strict creditor covenants to meet. In such a scenario, every subsidiary and operating division needs to capture its current cash position, accounts receivable and payables, as well as recurring payments and provide a cash/liquidity forecast to headquarters. At headquarters, the treasurer's office captures its own cash position, receivables and payables, checks the completeness of data from subsidiaries and operating divisions, and consolidates all the information to create an overall liquidity forecast. Headquarters then drives specific actions with subsidiaries, such as transferring funds into certain subsidiaries from HQ or from other subsidiaries.


Figure 1 -- Liquidity forecasting scenario

In corporate governance models where headquarters and subsidiaries collaborate around activities such as budget planning or supply/demand forecasting, have common functions, such as shared finance or HR services, or have common processes which require coordination, such as in liquidity forecasting or corporate sourcing, Option 3 with process integration between headquarters and subsidiaries is the best way to implement a two-tier ERP model. When process level integration is available out-of-the-box (pre-integrated), it becomes extremely cost-effective to deploy such an option.

Summary and Recommendation:

As outlined above, there are several approaches for providing the visibility headquarters needs to coordinate and collaborate with subsidiaries to manage and reduce risk. Option 1, a single ERP system may not always be the best approach, especially if subsidiaries have very different business models, economics or other business requirements. A two-tier ERP model is the right option for such scenarios. Option 2 supports light data integration between the two ERP systems, enabling you to effectively implement a two-tier ERP model for subsidiaries that operate very independently or only need to provide financial data for consolidation to headquarters. However, if some level of cooperation between headquarters and subsidiaries is required in their supply chain operations, shared services, or collaborative planning activities, then Option 3, two-tier ERP with process level integration, is the best approach. This option enables subsidiaries to implement a system that meets their business and budget requirements, provides them the flexibility to innovate and compete effectively in their local markets, while meeting the visibility, control and coordination requirements of headquarters for risk management.

Sheila Zelinger is Vice President of Portfolio Marketing at SAP.

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