What Is Micro Risk?
Micro risk is a type of political risk that refers to actions in a host country that can adversely affect selected foreign operations of a company that does business internationally. Micro risk can come about from events that may or may not be in the reigning government's control. These micro risks may make it challenging for companies to generate revenue in certain countries outside their own borders. Before companies decide to do business in a foreign market, they may conduct a risk analysis to determine what political risks they might encounter once they establish their business in a particular foreign country.
- Micro risks are firm-specific risks that impact companies that conduct business outside their home country.
- These risks can stem from political, economic, governmental, or societal events that have occurred in the host country.
- Micro risks can impact a company's ability to generate revenue and impact an investor's ability to reap a profit on their investment.
- Unlike micro risk which is firm-specific, macro risk refers to the risk across all businesses or industries for entire geographic regions or countries.
- International companies face a variety of risks including political and civil unrest, war and terrorism, exchange rate risk, and shifts in government regulations and taxation.
Understanding Micro Risk
Micro risks are firm-specific political risks that affect businesses that conduct operations outside their home country borders. These risks do not impact all companies or industries doing business in a foreign country but instead impact a specific firm. Micro risks can also occur at the project level, thus impacting a specific project a company is attempting to implement in a foreign country. These risks can stem from political, economic, governmental, or societal changes or events that have occurred in the host country.
For example, suppose Company A establishes a manufacturing facility in another country to take advantage of lower labor costs in that country. After a period of time, the workers in that facility decide to go on strike for better wages and benefits. Company A then suffers reduced revenue as the manufacturing plant is idled during the strike. In this example, only operations from Company A were faced with an adverse situation. Operations from other companies were not affected.
Micro Risk vs. Macro Risk
Macro political risk differs from micro risk because it refers to the risk across all businesses or industries for entire geographic regions or countries. Unlike micro risk, it is not firm-specific. Macro risks can stem from changes in a government's leadership, political and civil unrest, monetary policy shifts, and changes in government regulations and taxation.
For example, a country's government might enact new environmental regulations that impact factories. The legislation could include new fees and taxes imposed on all factories in order to discourage pollution, such as a carbon tax. It could require factories to redesign their facilities to reduce their impact on the environment. These new regulations represent a macro risk that would not target just one company but would affect all companies operating in the industrial sector.
Political risk is the risk an investment's returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policymakers, or military control. Political risk is also known as "geopolitical risk" and becomes more of a factor as the time horizon of investment gets longer.
Companies that operate internationally, known as multinational corporations (MNCs), can purchase political risk insurance to remove or mitigate certain political risks. This allows management and investors to concentrate on the business fundamentals while knowing losses from political risks are avoided or limited. Typical actions covered include war and terrorism.
A related concept is a country risk, which refers to a set of risks associated with investing in a particular country. Country risk varies from one country to the next and can include political risk, exchange-rate risk, economic risk, and transfer risk. In particular, country risk denotes the risk that a foreign government will default on its bonds or other financial commitments. In a broader sense, country risk is the degree to which political and economic unrest affects the securities of issuers doing business in a particular country.
Country risk is critical to consider when investing outside of the United States. Because factors such as political instability can cause great turmoil in financial markets, country risk can reduce the expected return on investment (ROI) of securities. Nearly all multinational companies face these risks, and many of them insure to what extent they can against them.
Investors may protect against some country risks, like exchange-rate risk, by hedging, but other risks, like political instability, do not have an effective hedge.
A company will list the micro and macro risks they face in their filings with the Securities and Exchange Commission (SEC). For example, in their 2019 Form 10-K filing, Apple Inc. lists a variety of risks that impact the company's bottom line. Under risk factors, Apple states that a majority of the company's supply chain, manufacturing, and assembly activities are located outside the United States. This results in a good portion of the company's performance and operations significantly dependent upon global and regional economic and political factors. Apple faces the ongoing risk that an adverse micro or macro event in another country could disrupt its ability to manufacture its products.