Risk and resilience: When does efficiency compete with effectiveness and which wins?
Swiss Re 2010 Sigma Study
“In the past the decisive factor in success was productivity, the efficiency with which you used resources. Today the most important success factor is to recognize risks and mitigate those risks.”
Klaus Schwab, Founder, World Economic Forum
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“On Tuesday shares in the utility known as TEPCO fell by their daily allowable limit of 80 yen, or roughly 18 percent, dropping below the previous record-low close of 393 yen on Dec. 11, 1951.” (Kyodo News Service) TEPCO is the owner-operator of the Fukushima Nuclear Power station. The CEO has been hospitalized. The stock has lost more value since Tuesday.
On April 5 last year a blast at the Big Branch Mine in West Virginia resulted in the death of 29 miners. The mine’s owner, Massey Energy, stock price fell from an April 1, 2010 high of $53.05 to a July 6 low of $26.31. Don Blankenship, the long-time CEO, resigned at the end of 2010. The Massey stock price has since recovered to over $60.00 per share. ”Shareholders are suing Virginia-based Massey, its officers and directors… The class-action fraud lawsuit accuses Massey of misleading investors and seeks damages for artificially pumping up its stock price.” (Associated Press)
On April 20, 2010, the day the Deepwater Horizon exploded, BP stock was trading at $60.48 per share with a market value of about $180 billion. By the end of June the price-per-share plunged to $26.75. Tony Hayward was replaced as CEO in late July. More recently BP has been trading in the mid-$40s per share price. A Wednesday headline in the Wall Street Journal reads, “BP to face investors wrath“.
In each of these — and many more — examples, a strong case can be made that concern for efficiency tended to discourage serious attention to the risk of low-frequency, high consequence events. The BP CEO admitted, “We were not prepared… The contingency plans were inadequate. We were making it up day to day.”
In a scathing article on TEPCO’s risk readiness, the Wall Street Journal reported, “The disaster plan didn’t function,” said a former Tepco executive. “It didn’t envision something this big.”
Private companies — like most of us — tend to discount low-frequency risks. We especially tend to avoid near-term costs that may mitigate, but cannot be guaranteed to avoid future losses. The National Commission on the Deepwater Horizon Oil Spill and Offshore Drilling found, “Whether purposeful or not, many of the decisions that BP, Halliburton, and Transocean made that increased the risk of the Macondo blowout clearly saved those companies significant time (and money).”
Klaus Schwab, source of the quote at the top, is a thought-leader. His thought regarding the growing primacy of risk and mitigation is still waaay out front of most enterprises, public or private, large or small. But the gap is beginning to close. A few recent quotes from the business media:
From Harold Sirken writing in the Harvard Business Review:
Companies are always shocked when low-probability events such as an earthquake or a tsunami disrupt their supply chains — as has happened after the tragic events in Japan two weeks ago — because of two fallacies. One is the mistaken belief that no corporation can prepare for such events; they can’t even be predicted. For instance, the scenario that an earthquake, a tsunami, and a nuclear crisis would simultaneously hit Japan Inc. seems far-fetched, so most companies hadn’t drawn up a suitable Plan B. The other is the persistent feeling that supply chains represent a cost. Most companies focus on minimizing costs rather than maximizing flexibility, which would entail making large investments in supply chains.
Michael Schuman writing as the Curious Capitalist at Time Magazine:
The earthquake, tsunami and nuclear crisis that hit Japan have woken up the world’s business community to the precariousness of the global supply chain… Japan has taught us all a lesson: Those “borderless” supply chains are actually quite vulnerable to something bad happening within one of the borders. Perhaps your factory uses only a part of a part of a part made in Japan, but a disruption in the supply of that part could halt your entire assembly line. “Borderless” manufacturing, in other words, isn’t that safe after all.
Barry Ritholtz writing for Bloomberg:
Anticipating (versus reacting to) Black Swan events… Emergency planning is what we do before an emergency — not during one. Being proactive, rather than reactive, allows you to avoid the emotional mistakes many people make during unexpected events. That is why you look for the emergency exits before takeoff, not when the wings fall off the plane. The best way to do this is to have a plan in place. Ideally, you design this when you are objective, unemotional and calmly contemplative.
According to Swiss Re’s latest sigma study, “worldwide economic losses from natural catastrophes and man-made disasters were USD 218 billion in 2010, more than triple the 2009 figure of USD 68 billion. The cost to the global insurance industry was more than USD 43 billion, an increase of more than 60% over the previous year. Approximately 304,000 people died in these events, the highest number since 1976.”
The most recent estimate of economic losses from the Japan earthquake-tsunami-nuclear emergency is, at least, $300 billion… and we are barely into the second quarter of the new year.
A couple of conclusions: The “infrequent” is becoming more common. Catastrophic risk is increasing. This is a function, in part, of increasing dependence on attenuated global supply chains. Those who effectively anticipate — which is very different from trying to predict — catastrophic risk will win. Those who deny the risk will lose their jobs, cause their companies to lose billions, and multiply death, injury, and destruction.
