Bain: Getting Business Resilience Right
The Covid-19 pandemic is the latest in a long series of disruptions and disturbances that expose vulnerabilities in unprepared companies. In recent years companies have had to cope with trade wars, a financial crisis, geopolitical posturing and now the pandemic. On top of those, a recent flurry of government interventions have hit global technology giants including Ant Financial, Google and Huawei.
The pandemic exposed dependencies on far-flung supply chains, which are showing increasing strain.
Resilience has become more important but the retreat of globalisation, new technology risks and the ever-present dark clouds of climate change mean it faces its biggest challenge.
In recent conversations with business leaders, global management consulting firm Bain recognised five stubborn myths that distort the resilience discussion.
Myth 1. Resilience eliminates volatility
In current times, the likelihood and consequence of events cannot be forced into a tidy probability distribution. As a case in point, consider how ineffective most polling proved in forecasting recent US elections or the British vote to leave the European Union.
In such an environment, it’s both unrealistic and unhelpful to treat resilience as a trait that will eliminate earnings and share price volatility. Instead, we distinguish volatility ― strpredictable fluctuations in every business over time ― from true risk ― exposure to a lasting adverse change in trajectory.
Failure to properly define risk appetite is the original sin in many discussions on resilience.
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. In fact, resilience spans five dimensions:
- Strategic, including absolute and relative scale, demand elasticity, revenue and profit diversification and cross-correlations;
- Financial, including leverage and liquidity, but also insurance coverage and hedges;
- Operational, including operating leverage, supplier concentration and redundancy;
- Technological, including availability, workload mobility and cybersecurity; and
- Organizational, including crisis preparedness, organizational agility and personal resilience.
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 in resilience.
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. Many companies that have shown resilience in responding to strategic and financial shocks have suffered from major technology outages ― sometimes due to the failure of just one router or server ― and cyber-attacks. As the trends to digitalize and automate operations accelerate, technology will pose greater risks that some firms haven’t yet prepared for.
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 more 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, as noted above, a holistic, firmwide 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 larger firms with at least US$1 billion of annual revenue, other factors play a greater role, such as debt levels, revenue diversification or choices around asset ownership. Bain tracked the shareholder returns of larger firms that remained publicly listed from 2000 through 2019. Those that took on greater risk tended to underperform in years when the broader economy contracted but outperform in expansionary years.
But low-resilience firms pay dearly in another respect, with significantly higher rates of bankruptcy or acquisition. Indeed, over this period high-resilience firms had nearly double the survival rate of their low-resilience counterparts. In other words, a strategy of higher risk works for those that manage to stay afloat despite the volatility. The question is whether these gains are worth the risk of failure.