Risk: Seeing around the corners

Risk-assessment processes typically expose only the most direct threats facing a company and neglect indirect ones that can have an equal or greater impact.

Source: McKinsey Risk Practice

Risk, Corporate Risk article, Risk Seeing around the corners

In This Article
  • Exhibit 1: Companies are susceptible to interconnected cascades of risk.
  • Exhibit 2: Carbon regulation would reshuffle the aluminium industry’s cost curve.

The financial crisis has reminded us of the valuable lesson that risks gone bad in one part of the economy can set off chain reactions in areas that may seem completely unrelated. In fact, risk managers and other executives fail to anticipate the effects, both negative and positive, of events that occur routinely throughout the business cycle. Their impact can be substantial—often, much more substantial than it seems initially.

At first glance, for instance, a thunderstorm in a distant place wouldn’t seem like cause for alarm. Yet in 2000, when a lightning strike from such a storm set off a fire at a microchip plant in New Mexico, it damaged millions of chips slated for use in mobile phones from a number of manufacturers. Some of them quickly shifted their sourcing to different US and Japanese suppliers, but others couldn’t and lost hundreds of millions of dollars in sales. More recently, though few companies felt threatened by severe acute respiratory syndrome (SARS), its combined effects are reported to have decreased the GDPs of East Asian nations by 2 percent in the second quarter of 2003. And in early 2009, the expansion of a European public-transport system temporarily ground to a halt when crucial component providers faced unexpected difficulties as a result of credit exposure to ailing North American automotive OEMs….Unfortunately you will only be able to read the full article if you are a McKinsey premium member.

I wanted to reference this (brief) introduction to emphasise that, whilst risk management and insurance can provide a high level of protection, RISK manifests itself in all kinds of forms. Some that you can insure against assuming, that you can afford the premiums…but still rely upon an element of luck!

“You can’t manage what you “can’t” measure”

This statement is as true as it ever was but, with an understanding of the nature and impact of “complexity” upon a business…WHICH IS SOMETHING THAT THE INSURANCE INDUSTRY NEEDS TO WAKEN UP TO…in the near future the statement should read “You cant’ manage what you DON’T measure”. Confused!? Perhaps some clarity from Donald Rumsfeld might help:

Fortunately the answer(s) are more straightforward and they lie with the business owner. YOU are (or should be) THE world-renowned expert on the subject of your business! You need to invest time and resource to ensure that your business is fit enough to withstand the unexpected. You need a means to perform a detailed analysis of the interdependent functions of your business: finances; activities; processes; operational efficiency; etc. Having done this assess and manage the key functions as part of a risk prevention strategy. But modern business is already complex and is becoming moreso.

Managing the total cost of risk: Reducing fragility

Reducing the reliance of a business upon external factors…particularly (in these trying times) financial and political institutions…and, in the future, the changing climate, are the most practical and affordable steps that can be taken.

The alternative is to accept that your business MAY become increasingly vulnerable. Of course you may have an in-house or external resource of professionals ready to react at the first signs of trouble but, as the article highlights, risk comes in many forms.

I would welcome an opportunity to discuss HOW you create an early warning system for your business. Feel free to get in touch.

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