JAA Inc.—A Case Study in Creating Value from Uncertainty Best Practices in Managing Risk
JULIAN DU PLESSIS Head of Internal Audit, AVBOB Mutual Assurance Society
ARNOLD SCHANFIELD Principal, Schanfield Risk Management Advisors LLC
ALPASLAN MENEVSE Risk Officer, Sekerbank T.A.S., Turkey
This case study describes how enterprise risk management (ERM) was imple-mented at a fictitious company, JAA Inc. It provides extensive detail as to thegovernance structure, the processes, and the various tools used. The case is built on the principles/guidance of ISO 310001 and the implementation guidance created by HB 436.2 The key players in this case are the heads of Internal Audit and Risk Management. It is interesting to see what they have done in the five years expended to implement ERM. We offer special thanks and appreciation to Grant Purdy from Broadleaf International in Australia for his continued support, dedi- cation, and help provided to our efforts.
SETTING THE CONTEXT It was a beautiful Wednesday afternoon in Chicago. Matt Damison, the chief inter- nal auditor (CIA), and Frank Gillespie, the chief risk officer (CRO), were hav- ing lunch in JAA’s cafeteria and reminiscing about the times at JAA when the company’s performance was much lower than the current state. Only five years earlier, in 2008, the company had embarked on a comprehensive enterprise risk management (ERM) program. Both Matt and Frank, together with executive man- agement and the board, had been actively involved in this initiative. At that time, JAA was also undergoing various regulatory audits, and employee morale was
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quite poor. The company has now been able to satisfactorily address these issues, and in fact has won numerous awards and been written about in various journals for its risk management program. JAA has progressed from being considered risk management novices to one of being leaders in the field of effective risk manage- ment, having accomplished this in less than four years but still recognizing that improvements need to be made. Matt and Frank have just received a phone call from the Wall Street Journal press. They agreed to be interviewed to explain the gen- esis of JAA’s ERM implementation undertaken five years previously and how as a company it has since flourished. Senior and executive management have encour- aged Matt and Frank to conduct such an interview to highlight the company’s achievements.
In 1972, JAA commenced operations as a private company founded by three broth- ers (Emile, Robert, and Frank Bergand) in Chicago, Illinois. In 1988 the brothers decided to take the company public and launched an initial public offering (IPO), as market conditions at that time were quite favorable and the brothers wished to reap financial benefits (i.e., cash out) after years of hard work. The brothers remained with the company and served in executive roles until they retired in 2003. JAA is listed on major stock exchanges, is headquartered in Chicago, and has a December 31 year-end. The financial statements appear in Appendix A.
The company has three operating segments:
1. A U.S. wholesale business 2. A U.S. retail business 3. An international business (wholesale and retail)
The aforementioned segments reflect the way the business is managed and performance is evaluated. The wholesale business focuses on the sale of undeco- rated apparel products to distributors in the United States and internationally. The international wholesale operating segments also produce apparel products that satisfy the preferences of those customers that favor a more local traditional style, to stay sufficiently competitive in those markets. This was determined from a risk workshop that identified the loyalty factor of international customers as a major business opportunity.
The company operates 57 retail stores in 10 different countries:
� North America—United States (28) � South America—Argentina and Brazil (7) � Asia—China, South Korea, and Japan (11) � Australia (4) � Europe—Switzerland and Turkey (4) � Africa—South Africa (3)
The retail stores cater directly to the consumer, and most such stores are sit- uated in major shopping malls using leased space. The stores target middle-aged men and women. Retail store customers represent quite a sophisticated group of
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shoppers. The stores compete on the basis of location, merchandise availability, price, and customer service. Retail sales are promoted via major newspapers and online media. JAA’s major competitors are McCory, Bertang, and Keramtor.
The wholesale customer base comprises 100 key distributors. The split between retail and wholesale is 40 percent/60 percent, respectively. Competition at both the retail and wholesale levels is fierce and has necessitated that the company out- source part of its manufacturing to lower-cost countries. Key product cost compe- tition is from China, Bangladesh, and Vietnam.
The apparel business/industry is characterized by rapid movements in fash- ion, changing consumer demand, and significant competitive pressures. JAA has emphasized quality merchandise at an affordable price. Wholesale customers are secured through a lean, but stellar, sales force established in the major cities around the globe (45 major cities). No one single distributor exceeds 5 percent of the com- pany’s sales. JAA also has an online catalog operation, whose critical success fac- tors are website availability and design, advertising response times, and social media recognition.
The Bergand brothers are now the largest company shareholders, owning some 22 percent of the stock. There are a couple of large institutional investors that collectively own an additional 12 percent of the outstanding shares.
The executive and senior management teams comprise:
� President and CEO Michael Menorix � Chief Financial Officer Jillian Verdiger � VP of Marketing and Sales Mary Mordensti � VP of Production Boris Dentiger � VP of Human Resources Francine Tanserki � Chief Internal Auditor Matt Damison � Chief Risk Officer Frank Gillespie � VP of Legal and Compliance Michael Perstay
JAA has its core U.S. manufacturing in a 360,000-square-foot facility, which also contains the corporate/executive offices and warehousing/distribution. The company also has two small satellite manufacturing facilities in Tampa, Florida, and Los Angeles, California, on company-owned properties. JAA has outsourced 25 percent of production in various agreements with third parties in Turkey, China, and South Africa. The company’s apparel product line initially focused on men’s coats, but over a period of time expanded to include a full line of men’s clothing inclusive of pants, shirts, and coats. In 1999, an upscale line of women’s clothing was added to the product portfolio.
The company purchases all fabric from 50 key suppliers, having trimmed its supplier base from 400 over the past five years. All suppliers are ISO 9000 certified and, as such, are subject to rigorous reviews prior to becoming JAA’s suppliers. JAA uses state-of-the-art technology to enhance marketplace competitiveness.
The company has been fortunate in attracting high-caliber employees. It has had minimal turnover over the past three years, and it provides a generous com- pensation and incentive package to its employees. It is not subject to any collec- tive bargaining agreements but to various environmental regulations in the United States and overseas. One other key area JAA is heavily focused on, and in strong
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compliance with, is monitoring compliance at third-party manufacturing facilities overseas.
Effective management of risk was recognized by the current management team as being critical to JAA’s success. Thus the company sought individuals who were experienced in this field for key leadership positions in Internal Audit and Risk Management, as well as for the key board positions. When the current heads of Internal Audit and Risk Management joined the company in 2008, JAA had sustained six years of losses. JAA’s creditworthiness is currently BBB as rated by the major rating agencies, having improved from junk status to this rating within four years.
Initial Steps: Strategic Planning and Business Objectives
JAA’s management recognized in 2008 that there were concerns with the annual strategic planning process because the board members typically did not attend such meetings. This impeded their ability to address the key strategic questions JAA faced, and did not create an environment that could generate fresh insights. Typically, the focus on short-term performance was failing to identify risks that threatened long-term objectives. Such short-term thinking also neglected to think about untapped business opportunities.
JAA decided to discard the annual process and replace it with a much more intense form of strategic engagement with management and the board. They are now devoting extra time at each board meeting to pressure-test the strategy in view of its progress and changes in critical variables. There is a strong communi- cation process of this new strategy throughout the organization to both the inter- nal and external stakeholders. JAA prides itself in doing this well under President Michael Menorix’s leadership. Management knows who the stakeholders are and their needs and has established different communication channels with them as appropriate, including webinars, phone conference calls, town hall meetings, writ- ten media, and so on.
JAA’s management is aware of the many pitfalls of strategic planning and has recognized the need to view risk and strategy as two sides of the same coin because it knows that the two are linked. The company aims to increase shareholder value and to address the needs of the other stakeholders through successful pursuit of the following strategic objectives:
� Maintaining market leadership � Sustaining technology leadership � Strengthening global presence � Delivering quality service � Being seen as a leader in compliance with all laws and regulations
Establishing the Governance System
JAA has developed an excellent governance system by using many different met- rics as described later. The Governance Framework is depicted in Exhibit 22.1. The board consists of external directors, including Sally Hendrix, who serves as chair of the Audit Committee. The Audit Committee members have served for periods
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Risk and Strategy
Compensation and Nominating
Executive Risk Oversight Committee
Responsible for managing risk and implementing internal controls
Exhibit 22.1 Governance Framework
ranging from two to seven years. All committee members, in addition to their pro- fessional qualifications and experience, are well versed in risk management. They have all attended formal training in this subject matter at leading risk organiza- tions and have received training by both the Internal Audit and Risk Management groups of JAA as well.
The company’s risk governance framework illustrates the governance arrange- ments for the board, management, independent control functions, and ongoing business operations that exercise governance over risk.
JAA’s board is responsible for the governance processes that it requires man- agement to execute. The company understands that effective oversight by its board and senior management is critical to the overall governance effort. It protects its shareholders and other stakeholders by ensuring sustainability of the business through achievement of superior performance. The board provides leadership to JAA by understanding and accepting its responsibilities for the adoption of strate- gic plans, monitoring of operational performance and management, determining the philosophy and effectiveness of the approach for managing risk (including internal controls for managing the day-to-day operations), and compliance with all relevant laws and regulations.