Executives are suddenly preoccupied with risk management. The number of distressed companies is rising, credit rating downgrades are ubiquitous, and equity markets are volatile. Add recent and highly visible accounting scandals to the mix, and it is no surprise that many CEOs rank risk management as one of their top priorities.¹

Industrial companies grappling with risk face a particular problem. Though many have long been aware of the need to better manage risk, scant few have advanced very far along the learning curve. Few tools tailored to industrial companies' specific needs exist. Naturally, many industrial executives turn to approaches borrowed from other sectors, such as financial companies, to calculate sensitivities to individual risks. This can be a costly mistake.

For example, the conventional wisdom that derivatives are dangerous and must be checked carefully would suggest that an industrial company should take inventory of its derivatives exposure. Yet this would be of limited use. While the derivatives portfolio of some financial firms often constitute an important element in overall risk exposure, for most industrial companies they represent only about 10 percent of total risk.

Likewise, a comprehensive audit of a company's exposure to risks from fluctuating commodity prices, exchange rates,...