One is a “too big to fail” financial institution that was founded in London during the late 1600s, an era when the monarchs William and Mary ruled over England. The other is a contemporary fashion brand that was launched in Italy during the 1960s.
At first glance, Barclays Bank and the Benetton Group appear to have nothing in common. They occupy different industries, compete in different markets, and function within different organizational structures; how can their interests possibly overlap?
Looking back over the past year, though, it is obvious that they have each grappled with the same existential challenge. Namely, they have each struggled with globalization risk.
Barclays and Libor
How difficult has this struggle been for Barclays? Well, former Chief Executive Bob Diamond was actually pressured into resigning his position last year because of the Libor manipulation controversy. Barclays then agreed to pay $450 million in penalties to U.S. regulators for its conduct during the scandal.
So what enabled the American authorities to impose such punitive measures on the bank? Barclays was betrayed, in fact, by its very breadth as a global organization. Although the Libor conspiracy was perpetrated by British employees, regulators in the U.S. maintain oversight authority over transactions in America. One of those American transactions was affected by the illicit British activity, hence exposing the bank to America’s legal system.
The bank’s internal controls should have been designed to address such cross-border risks. Regrettably, though, Barclays’ internal auditors were not up to the challenge of addressing them; as a result, the bank suffered an enormous blow.
Benetton and Bangladesh
The internal auditors at the Benetton Group have also recently failed to manage global risk. Last month, the factory of a Bangladeshi supplier collapsed because of shoddy construction standards. More than 1,000 workers died as a result of the tragedy.
Western firms are expected to require that their suppliers maintain humane working conditions for their employees. In reality, though, Benetton and other customers of the Bangladeshi factory did not do so.
This mismatch between expectations and reality is attributable to shifts of manufacturing operations from Europe and America to the least costly regions on earth. Such strategies have accelerated as a result of globalization; thus, Bangladeshi garment workers now work in unsafe facilities for wages as low as $38 per month.
Shell Games, Fashion Style
But why is it so difficult for internal auditors at organizations like Benetton to identify suppliers with unacceptable working conditions? Why is it such a challenge for these companies to refuse to do business with such suppliers?
Some firms do manage to develop blacklists; Walmart, for instance, has banned 250 suppliers from its supply chain. Industry experts, though, often complain that when a region loses manufacturing contracts, “the brunt of the pain falls on workers left jobless by the disruption in trade.”
Furthermore, the managers of blacklisted entities can often play “shell games” by shutting down banned corporate entities and facilities, shifting staff to different locations, and then resuming operations at any time. Conversely, managers who make good faith efforts to improve operating conditions may never be permitted to resume operations.
Shell Games, Banking Style
Similar shell games, of course, have been plaguing the efforts of government regulators to compel global financial institutions to disclose the interest rates of their borrowings. Although transaction based reporting requirements have been recommended by many regulatory bodies, none have yet been implemented by the financial markets.
Why not? Well, consider a hypothetical scenario in which Barclays needs to borrow $100 million from HSBC at an interest rate of 5%, but wishes to disclose to the public that the interest rate is only 3%. How can Barclays do so without breaking a law that mandates the truthful disclosure of direct interbank loan rates?
Barclays can easily achieve this objective by directly borrowing $1 from HSBC at 3%, and then by utilizing a third party intermediary institution to borrow $99,999,999 indirectly from HSBC at 5%. The direct loan rate of 3% would be reported to the authorities, but the overall effective interest rate would be approximately 5%.
So with these “shell games” generating such globalization risk, how can organizations manage the risk of failure throughout their networks of subsidiaries and affiliates? Indeed, how can firms maintain appropriate internal controls throughout all of their business functions?
A vertical integration strategy might help them achieve such goals. Such a strategy, for instance, recently compelled Delta Airlines to purchase and operate its own oil refinery. It is now also compelling Chinese automobile companies to acquire or establish fledgling operations within the United States.
Ironically, a decade ago, Dell became the largest personal computer manufacturer in the world by eschewing vertically integrated systems and by creating an extended enterprise instead. Boeing and others implemented this strategy as well, outsourcing many of their manufacturing and administrative activities to external suppliers.
But by doing so, they inevitably exacerbated the type of global risk that is now bedeviling Barclays and Benetton. Although globalization can bring immense benefits to multinational firms, it can generate tremendous risks as well.