Senior Management
A Political Minefield: The Complex Risks of Global Geopolitics
International mining company BHP owned a controlling stake of the Ok Tedi Mine in Papua, New Guinea, when it opened in the mid 1980s as one of the world's largest copper mines. The local government was a partner in the operation and the mine contributed substantial revenue to the government and landowners, as well as creating thousands of jobs. Its position seemed secure, and it seemed certain to be a tremendous asset on the balance sheet of BHP. But through a series of natural and political disasters, it turned out to be one the company's most serious liabilities.
"Anytime you undertake an international business transaction, you have as an implicit counterparty everyone who has a political influence in the country," says Witold Henisz, associate professor of management at Wharton, who teaches global policy risk in Wharton's Executive Development Program. "Anyone who has political influence has the ability to do you harm."
Anytime you undertake an international business transaction, you have as an implicit counterparty everyone who has a political influence in the country. Anyone who has political influence has the ability to do you harm.
–Witold Henisz, Associate Professor of Management; Faculty member, Executive Development Program
Political Tailings
This was a lesson that BHP learned the hard way at Ok Tedi. To deal with the mining operation's tailings — wastes that contain toxic materials such as cyanide — BHP planned to create a dam by building a retaining wall between two mountains. But in 1984, one of the mountains collapsed under the pressure of the wall — along with BHP's plan for dealing with the 180,000 tons of rock powder, silt, and water produced daily by the operation. In 1988, it negotiated to lift government restrictions and began discharging all its wastes into local rivers. This led to increases in sediment and reductions in fish populations, as well as destruction of local vegetation including those that supplied food for villages downstream.
Public concern about the environmental impact of the mining operation led to protests by activists. The protests attracted the attention of the media. Between 1992 and 1994, the news media picked up the story, publishing more than 40 articles on the Ok Tedi Mine, primarily in the Australian press. The international press picked up the stories, creating a growing public relations disaster for BHP. Local workers also filed a lawsuit against BHP, outraged that the company had hired immigrants to reduce costs. Ralph Nader and other global activists weighed in. The World Bank reconsidered its policies on mining funding and environmental compliance, later calling for the Ok Tedi Mine to be closed without delay.
By 1995, the challenges at the Ok Tedi Mine, along with the Moura Mining disaster, and grounding of the cargo vessel Iron Triangle, threatened BHP's global reputation and market position. In particular, BHP could not move forward with its planned merger with Billiton until it extracted itself from the Ok Tedi Mine. A mining project in one remote part of the world suddenly was determining the fate of the entire company.
BHP sold its ownership in the mine to PNG Sustainable Development Program Limited, clearing the way for its merger with Billiton. The mine is still running under local control, but BHP Billiton vowed never to commit to a future mining project where tailings were discharged into a river.
"What happens in Papua, New Guinea, can affect what happens on the New York Stock Exchange," Henisz says. "It starts with activists, who go to government politicians, the media, suppliers, investors, and other partners. Thinking about external stakeholders is not just charity; it is profit maximizing."
Policy Risks
Such policy risks are a significant source of uncertainty for global businesses. A World Bank study found that between 15 and 30 percent of the contracts governing $371 billion of private infrastructure investment in the 1990s were subject to government-initiated renegotiations or disputes.
Many companies are not good at managing such risks, and the costs of such failures are high. A Merchant International Group report claimed that the mishandling of non-conventional risks cost multinational companies more than $24 billion in 1998 alone. From 1995 to 1998, 84 percent of operations in emerging markets failed to meet their financial targets. This amounts to an average erosion of 8 to 10 percent of investors' total expected returns.
Another study, by PricewaterhouseCoopers, concluded that doing business in a country whose policymaking environment is one standard deviation more "opaque" than the global average results in additional costs equivalent to a 33 to 46 percent increase in taxation.
Managing Policy Risks
Policy risks are so complex and unpredictable that they are difficult or impossible to mitigate through insurance or hedging. You may be able to insure your company against fires or floods, and hedge currency risks, but you can't insure or hedge against something as amorphous as the world turning against you.
The best defense may be a good offense. Henisz says companies need to consider these issues at the outset and build the trust that might be needed later on. "Once there is a crisis, it is often too late; you can't fix it. From day one, you need to be out there meeting with people. There is no way you can foresee everything that will make people angry and willing to raise their voices against you. There is no way you can contractually specify those things. There are going to be unforeseen contingencies, and you need to be well poised to deal with them. This is why companies do more active stakeholder engagement."
Henisz says managers need to identify the many stakeholders who can influence the success of their projects. "The OK Tedi case shows the myriad influences that stakeholders can have," he says. "It is not just consumers who can go after you, with a boycott, for example. It can be the government, suppliers, capital, labor — anyone who feels aggrieved can come after you in so many different ways. The OK Tedi mine is an example of how these influences can be more subtle than we think. You have to design an entry strategy with a long-range vision about the social and political reaction to your investment."
Finally, managers need to think about how all these forces might play out, using war games or scenarios to examine interactions. "You have to think not just battle by battle but about winning the war. If you pick the right strategy for any given moment, it could have unforeseen spillovers down the road. You have to think about different futures and different outcomes."
Of course, while most companies may focus on the downside of policy risks, this complexity also presents opportunities for companies that can manage it. "We often think about these events as creating costs, but that is only half the story," he says. "When firms know how to do this from day one and are sophisticated in stakeholder management, it opens the door to a host of profitable deals that were previously unprofitable. Half the story is minimizing the downside, but the other half is creating the upside."
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