From Reactivity to Robustness

Posted: October 1, 2007 in Readiness & Strategy

I’ve been thinking a lot lately about the requirements for success and preparedness in the global economy, where a shock in one part of the world can have a disproportionate impact on businesses in another part of the world. The best example is the liquidity crisis in the U.S. stemming from excesses in the sub-prime mortgage market. Almost overnight, the National Bank of Canada, which had almost no exposure to sub-prime mortgages, had to suspend redemptions of asset backed commercial paper issued by solid companies because of the knock on effect on their own liquidity. The mechanisms at play are interesting but irrelevant for our purposes; the effect, however, isn’t. Two apparently unrelated phenomena have proven to be, in fact, quite related.

How can global – and local – organizations and businesses deal with this kind of complexity? In this kind of environment, is the ability to react in a crisis sufficient, or should organizations and their executives be doing more to protect themselves and shape their environment? I think the latter. I plan on writing much more about this topic in the near future, but here is a quick summary of what I call the levels of organizational preparedness.

The first level of organizational preparedness is reactivity, which I define as the ability to discern an organizational shock or environmental change that may lead to crisis, and to take a measured approach to resolving the crisis. The National Bank of Canada reacted in a measured and appropriate way to the liquidity crisis it has been facing, although there have been disgruntled customers and depositors. The bank’s management appeared relatively unaware of the potential risks beforehand, but they reacted quickly as the situation developed and are probably now on the road to recovery, although not without costs.

On the other hand, many of the sub-prime lenders in the U.S. have been forced into receivership because of their almost complete exposure to the sub-prime market. Even though they could see what was happening, they were unable to react because they had no financial reserves that could cover the losses. Consequently, they were fragile and had almost no reactivity.

The second level of organizational preparedness is readiness. The ready organization is one which has identified a number of risks and threats beforehand and has taken measures to mitigate or even eliminate some of these through a number of measures. Many organizations have contingency plans to deal with various disasters, emergencies, and crises due to technological or natural hazards. The quintessential ready organization is the fire department, which has a well defined set of threats and risks and is structured, trained, and equipped exactly for that purpose. There are others, however, such as airports, hospitals and other health-care facilities, law enforcement agencies, etc. Firms such as builders, manufacturers and mining companies also must have plans and procedures in place to deal with workplace accidents and technological hazards.

There are other less evident sources of risk and threats and these mostly concern human induced hazards and economic risks. Take the example of the current rise in commodity prices. The world prices for everything from oil to cottonseed are at cyclical, and in some cases, historical highs. This encourages production from higher cost areas and sources. What happens to these producers when the prices of all of these commodities inevitably go down again? Will they be ready for this situation? Will they have sufficient cash reserves to weather the downturn, or will they struggle on the prior assumption that the happy situation will continue forever?

The highest level of organizational preparedness is robustness, which I define as the ability to absorb change and shocks by shaping the environment and leveraging the inevitable risks, threats, and uncertainty. Not many organizations operate at this level of preparedness in their chosen fields. Military forces come to mine as singularly robust and they can be used in a number of areas beyond combat because of their built in resiliency, flexibility, and access to logistical and human resources anywhere, at any time. While they can provide a useful example of what is possible, the reality is that most organizations are currently not very capable in this regard.

There are some companies that have proven to be fairly robust in certain respects. The example which comes to mind is Royal Dutch Shell in the early seventies. The company was much more prepared than the other “Seven Sisters” were to weather the first oil price shock. This was due in large part to its superior forecasting and having taken measures to build oil reserves at much lower pre-shock prices and then sell them at post-shock prices.

What all of these levels have in common is a certain level of resiliency, the ability to bounce back from adversity and shock and to continue functioning adequately. Further to that, however, reactivity, readiness, and robustness are functions of increasing flexibility, risk-taking, resourcefulness, and management initiative. All of these capabilities can be built into an organization and inculcated into its leadership and employees.

This requires the will to make organizational changes in that direction. This requires forethought and the ability to see a return on investment where others only see costs. In all cases, the ROI must be identified in order to make a sound business case. As we saw in the case of Royal Dutch Shell, however, this kind of investment isn’t just good from a theoretical perspective, it is also good business. Robustness may not be needed in all areas of the organization, but it should certainty be the goal in the organizations main field of endeavour.

© 2010 Richard Martin. Reproduction and quotes permitted with proper attribution.

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