“A wife does not so much object to her husband gambling, she mostly objects him losing”, Mark Twain
Hedging is a process used to mitigate the risk of potential losses due to the fluctuation of commodity or raw material prices in order to preserve the added value generated by the core business.
Depending on its risk appetite, the Board of Directors establishes a hedging strategy and the appropriate governance. Management then determines the operating model to execute the strategy.
As reported in The Risk Revolution (McKinsey, 2008), Southwest Airlines maintained three decades of profitable performance through the industry-wide downturn in the airline business following September 11, 2001. A contributing factor was a sophisticated fuel hedging strategy started in the 1990s, which allowed Southwest to reduce its fuel costs by as much as 50 percent compared with competitors.
While our environment becomes more and more VUCA (Volatile, Uncertain, Complex and Ambiguous) it is crucial to establish the right set of skills, processes and tools in order not to jeopardise your core business.
Depending on your business, the related commodities and your risk appetite, a variety of mitigation strategies (with a varying degree of complexity) can be implemented.
More reading materials:
- Bernstein Peter L., Against the Gods, The remarkable Story of Risk, 1996.
- The Risk Revolution, McKinsey, 2008
