The Covid-19 pandemic, while horrific on a social and economic level, is just the latest in a long series of convulsions that expose the vulnerabilities or brittle characteristics of unprepared companies.
Recent years have brought major shocks, including international trade wars, a plunge in oil prices and a financial crisis – each of which pulled the rug out from exposed companies. An increased march of government interventions has started to limit the options of technology giants.
Covid-19 has clearly made resilience a necessity for companies in all sectors. And the turbulence looks set to continue as globalisation unwinds, inequality rises, new technological risks emerge, and the effects of climate change manifest themselves more regularly and severely. Yet the dynamics of resilience aren’t always well understood by senior executives and boards of directors. In our recent conversations with business leaders, we’ve come to recognise five stubborn myths that distort the discussion. Dispelling these myths is the first step on the road to resilience.
MYTH 1 – RESILIENCE ELIMINATES VOLATILITY
In current times, the likelihood and consequence of events cannot be forced into a tidy probability distribution. It’s both unrealistic and unhelpful to treat resilience as a trait that will eliminate earnings and share price volatility. Instead, we distinguish volatility predictable fluctuations in every business over time – from true risk exposure to a lasting adverse change in trajectory.
MYTH 2 – IT’S ALL ABOUT THE BALANCE SHEET
Business leaders often tend to view resilience solely through a balance sheet lens, examining leverage and liquidity, but ignoring other potential sources of fragility. Adopting a holistic view of resilience acknowledges the reality that external events typically affect companies through several of these dimensions simultaneously, compounding the extent of the shock. Accounting for all these dimensions allows executives to make smarter choices about where to invest scarce resources to boost resilience.
In many cases, resilience also stems from the overall simplicity and transparency of the business model. During the 2008 financial crisis, many banks were undone by the sheer complexity and opacity of the mortgage-backed securities they were so heavily exposed to, which made the proper assessment of risk nearly impossible.
MYTH 3 – PAST RESILIENCE GUARANTEES FUTURE RESILIENCE
Once the dust settles from the Covid-19 crisis, most firms will likely be better prepared to deal with the next pandemic, just as banks are better prepared for the next mortgage crisis. “Black swan” events, however, look different than the crises in recent memory. Building true resilience demands asking what could happen that would truly test the business, rather than anchoring on recent experience. Although many potential shocks exist, the number of transmission channels through which these could really damage a particular business is much lower.
Each firm should understand its unique risk profile, based on its specific cost structure, customer segments, supply chain, route to market, and more.
MYTH 4 – RESILIENCE SHOULD BE HANDLED BY THE RISK FUNCTION
Too often, risk gets treated as an obligatory but unfortunate box-checking exercise, then relegated to a corner of the business. Accepting this limited scope, risk functions may fall into the trap of becoming overly tactical and blinkered in their identification of risks.
This approach falls short in a world of greater turbulence. The combinatorial nature of many risks demands that companies identify and mitigate risks for the entire business. A piecemeal buying down of specific risks in specific functions and business units will probably not achieve the resilience needed for the business as a whole (or at least not at an acceptable cost). Moreover, many future risks will emerge from the ecosystem of partners outside the firm, and traditional risk-management functions are ill-suited for this challenge.
Instead, firms will need to elevate and integrate risk into the rhythms and rituals of their most important decision-making processes at the C-suite and board levels. Rather than making decisions
based mostly on the upside, and protecting against a few siloed areas of risk, business leaders at all levels should adopt an ownership mindset that fully accounts for how decisions will affect value creation across the business over the long term.
MYTH 5 – RESILIENCE DOESN’T REQUIRE DIFFICULT TRADE-OFFS
Can a firm shield itself against future shocks without compromising earnings today? True, firms will be able to identify no-regret moves that add to resilience without denting current profitability, such as improving supply chain visibility or introducing crisis readiness. And a holistic, firm-wide approach to resilience can often improve cost-effectiveness. However, gaining a meaningful edge on resilience will often entail investment and opportunity cost. Here, business leaders will have to expand the dialogue with investors on balancing short-term and long-term value creation. For their part, many investors are trying to balance the desire for responsible stewardship of capital over the long term with the need to avoid allocating funds to systematic underperformers.
Tom De Waele is the managing partner – Middle East for Bain & Company