The instances of adverse events are increasing, as are the speed and reach of their cascade effects. The growing number of natural disasters, financial crises, terrorist threats and health emergencies that have taken place in recent years have put countries and businesses in jeopardy. As the world gradually moves towards a general recovery from the COVID-19 pandemic, four key elements must be taken into consideration—the ‘dark side’ of globalisation, a new approach to predict future events, risk mitigation through redundancy and flexibility, and the need to pick the right trade-offs.
Globalisation
The growing uncertainty connected to globalisation has been endorsed by top economic policy experts. For instance,
OECD Secretary-General José Ángel Gurría recognised that the world was facing unprecedented unpredictability, identifying three causes for it—tectonic shifts in geopolitics, the speed of technological progress, and the complexity of cross-border challenges.
Production and distribution chains, combined with quick global connections, increase efficiency and profitability make us more vulnerable to shocks that may occur anywhere in the world. This fragility is exacerbated by the structure of economic systems and current production models, and the interconnections between them amplify the effects of each threat. The impacts of a crisis, a disaster, an epidemic or any other negative event are no longer limited to just an economic system, a country or a company. The ‘breakdown’ of one link of the chain triggers a ‘breakdown’ in the whole system. What should corporations do to navigate uncertainty?
Predicting future events
Nowadays, companies and governments are highly committed to understanding complex, non-linear, variable phenomena, but reducing uncertainty is not just a current need. As far back as 1965,
Shell asked some economists to develop frameworks that could predict future events. It soon became clear that it was more useful and efficient to think of more alternative "futures" than trying to make a single accurate forecast. This is how scenario planning was born.
The upside to scenario planning is the possibility of integrating hypothetical future scenarios with corporate strategies and public policies, thus moving from the quantitative analysis of probabilities to the qualitative analysis of possibilities. By identifying and combining variables that influence the future in the short and long term, it is possible to speculate on which possible scenarios companies, countries and people will find themselves in. However, a limitation of this model is that the quality of the forecast made loses accuracy over time, and looking too far in the future could lead to ignoring important signs of crisis in the present.
But we cannot wait for the model to be perfect. We must learn as we go and refine strategies along the way.
Risk mitigation
There is a need to combine ‘redundancy’ and ‘flexibility’ to ensure business continuity, and to reduce and manage the effects of an external shock. Adding redundancy means keeping excess resources, such as additional production capacity and financial liquidity, to deal with unexpected events. Flexibility can be achieved, for instance, by increasing the variety of skills available within the organisation. When supply chains are fragile, the key priority should be business continuity, not cost efficiency, and the right combination of redundancy and flexibility may help achieve it. To reduce operational risk, managerial practices based on both flexibility and redundancy can be adopted, including postponement, strategic stock, multiple sourcing, and make and buy.
Postponement consists of delaying supply chain steps as time goes on, and forecasts accuracy increases. Companies willing to minimise operational risks by using this technique should adapt their product design and stages of production to ensure that the point of differentiation can be postponed.
Strategic stock implies inventory dislocation in different warehouses and distribution centers. Should an unforeseeable event isolate some geographical areas, companies will still be able to restock their facilities and guarantee continuity of supply. This strategy is the one used by the US
Centers for Disease Control and Prevention to store medicines and medical equipment across the country to protect the population during a potential health emergency.
Firms adopting multiple sourcing make use of several suppliers to minimise the risks connected to supply chain interruptions. In doing so, organisations will avoid the costs of researching and selecting new suppliers in case the current one is unable to fulfill the order as well as potential losses due to a reduction in production volume. For instance,
Nokia took advantage of this practice to minimise losses when its main supplier could not complete, while Ericsson, which did not adopt this technique, suffered US$400 million in losses.
The make and buy strategy is implemented by outsourcing part of the production process while performing other stages in-house. Companies will be able to quickly shift production in the event of a supply chain failure, thus reaping the benefits of a flexible corporate structure.
The right trade-offs
It is necessary to identify the right trade-off between the upsides and costs that these models entail. While adding redundancy protects against exogenous shocks, surplus assets and human resources can be expensive and it must be seen that they generate value. Similarly, making a corporate structure or an economic system more flexible is costly and time-consuming. The measures designed to overcome negative events must be prepared so that they can be sustained over the necessary periods of time. To do so in the most efficient way, more appropriate and reliable decision-making processes should be considered. As redundancy makes the whole system more resistant, flexibility helps it to adjust to new situations, and so it is crucial to understand when and how flexibility can be enabled only through the use of redundant resources and when it can hedge risks without them. Recent experiences have taught us that it is essential to rethink politics and administration in terms of flexibility and redundancy since accurate information may not always be available. Sometimes, a slow reaction to unpredicted events can have serious consequences on the economy and on our lives, and acting quickly is better than waiting for the foreseen event.
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