“You only find out who is swimming naked when the tide goes out.”
- Warren Buffet
Much has happened in the past few years to shake the historical assumptions underpinning business and business models. The global economic meltdown is first and foremost of these changes, which has combined with issues surrounding global climate change, the price of oil and supply chains, even talent. The consequence has been a sea-change in the way businesses are run. In effect, they are transforming the very nature of many companies’ business models. Companies need to prepare for a new reality in which emerging risks increasingly impact their earnings and long-term strategy. Those that develop the ability to manage emerging risks will gain a significant competitive advantage over rivals who lack this level of sophistication. The unfamiliarity of emerging risks is the fundamental reason companies still struggle to identify and assess them. Companies need to develop the ability to integrate emerging risks into their decision making.
Given the crossroads that emerging risks are creating for companies, they cannot be ignored in the path of growth. In addition to spending time identifying what highly improbable event could impair them, companies should pay increased attention to assessing the quantum of a financial shock that could destabilize their business. Designing a framework to achieve this is not easy. Companies that operate in the same industry and even geography can have very different exposures to emerging risks, depending on their financial structure, etc. After determining the companies’ capacity to withstand such shocks, , they should examine the potential impact of emerging risks from another angle: risk-adjusted scenario planning. By doing so, they not only gain insight into specific situations or a series of events that can result in a loss, but also understand how the range of potential outcomes will impact their company’s portfolio of businesses. Such planning exercises can reveal not only how potential risks can impair a business, but also how risks can enable a company to gain a competitive advantage. By designing such frameworks, companies can anticipate outcomes and quickly respond when an event strikes. They will be able to pinpoint areas of vulnerability under different market conditions, and the net impact on the overall organization. These insights allow companies to focus on initiatives to mitigate emerging risks and to capitalize on the resultant market conditions.
“Crack-brained meddling by the authorities (can) aggravate an existing crisis.”
- Karl Marx
Regulation is becoming increasingly stringent and multi-layered. As governments recognise that they cannot afford to provide for the populations in these important areas from health to retirement, there will be increasing need for the people to take more responsibility for their own welfare. The result will be more government imposed regulation on the industry. IFRS 4(phase II), Solvency 2 and other regulatory initiatives have implementation dates in 2012. Most in the industry believe that the burden of the regulatory compliance will only increase in this coming decade. Many industries—banking, telecom, transport, and energy, to name a few—face an increasing level of regulation. While there is a legitimate case for more consistent regulation and oversight, such as to reduce regulatory arbitrage, it is less obvious that we really need more or tighter regulation. Financial regulation imposes significant costs on the economy. For instance, excessive regulation can stifle financial innovation, reduce the flow of credit to worthy firms and consumers, and impede economic growth. Thus, what we need to prevent future crises is a more dynamic approach to regulation and oversight -one that is strong precisely when market forces become weak.
“Innovation is the central issue of economic prosperity.”
- Michael Porter
The severe decline in trade, FDIs and access to international financing pose a risk to the global business that underpins innovation. In the current scenario managing risks means correction. Most of the companies that are successful today are so because they took great innovative steps during recessions when others went into red. As Jack Trout said differentiate or die! It’s not an mp3 it’s the IPod. It’s not a TV it’s a Sony. It’s not style it’s Zara. Just look at Apple Inc. - the name itself has become synonymous to innovation. It may be among the very few companies unaffected by the economic downturn. All thanks to its innovation-driven culture. It has, within a decade, revolutionised five industries – music, retail, computers, animation and movie. Similarly, the story of Nokia, a company which has reinvented itself four times, first as a manufacturer of boots, then televisions, then computers, and finally mobile phones. As a result of this, the Company is very serious about innovation, simply because it knows that its survival depends upon that next killer product line. As a result of this, innovation has been written into the DNA of the organization.
Growing aversion to risk combined with other factors (such as difficulties for investors to exit) is already drying up many sources of seed and venture capital. Everyone talks about corporate antibodies that resist innovation, but what about corporate white blood cells. Finnish experience in the deep recession in the 1990s is an example of how knowledge can become the driving force in economic transformation and growth. Korea turned its major 1997 financial crisis into an opportunity to undertake a major reform of its economic incentive and institutional regimes. However, the primary ingredient in innovation isn't brains, but guts. Clearly, innovation will be one of the keys to manage the emerging risks from the downturn.
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