Change your operating model now!

Companies have been working hard to gradually restart their activities.

Admittedly, Covid-19 has taken us by surprise. The first signs appeared by the end of December, but we gave it little attention because we conveniently assumed that it was a regional problem in the Far East, just like SARS in 2002-2004. The initial cover-up action by the Chinese government rocked us all to sleep.

So you can hardly call the virus a black swan event, because the effects were perfectly predictable. That's why some people talk about a grey rhino. A large animal hard to overlook, but that we didn’t see coming.

Then, why our surprise?

Our attention was fully focused on optimizing our companies. Expensive strategy consultants told us that we could reduce our costs even further. But lean and mean also made us more fragile. Moreover, those same consultants told us that 2020 would be more of 2019. They couldn't have been more wrong.

We reduced the number of suppliers to optimise our supply chain - but this increased our vulnerability. We managed our balance sheets tightly, returned every penny of unspent capital to shareholders, and replaced it with debt. This ended up taking away our financial buffer.

Our eagerness to achieve greater efficiency gains made us extremely ill-prepared for the arrival of the Covid-19 virus. The enemy overwhelmed our camp at night without firing a single shot, because the officer on guard had fallen asleep.

Today, all our attention is focused on resuscitating our companies, reactivating operations and managing the acute effects of the crisis. This should however not distract us from the fundamental question: how do we arm ourselves against the next major shock? We would better question this now. Review the Global Risk Report of the World Economic Forum in this regard.

It may seem like overdoing it to add a longer-term dimension on top of all the fuss about reconstruction work. But there is a risk that the pressure to return to a normalisation scenario as soon as possible will make us forget to draw appropriate lessons from this crisis. No doubt, the same expensive consultants will come and tell you, that you will need help to resolve these complex issues and that you need their advice.

Plus est en vous

Why would it be impossible for a management team to learn from this Covid-19 experience and build a stronger and more resilient company, if armed with the right tools, models and sound systematics.

The banking crisis of 2008 provides us with unexpectedly interesting insights in this respect. Indeed, banks had focussed on achieving abnormally high return on equity targets. In order to achieve these, they had inflated their balance sheets considerably with limited equity and too little liquidity. At that time, their profitability also took precedence over strength and resilience.

After the banking crisis, regulators forced them to strengthen their capital and liquidity buffers and tighten their risk management. Regulators imposed boatloads of new rules and procedures on them, and also subjected banks to regular stress tests. These tests simulate a bank's resilience to varying external circumstances.

The regulations imposed in the aftermath of the 2008 crisis increased the responsibilities on the risk committee within the board of directors. Risk committees were made responsible for ensuring that the bank maintains sufficient capital and liquidity, but also focuses on drawing up business continuity plans. These plans contain roadmaps that help the banks to ensure the continuity of operations in the event of external shocks. The risk committee ensures that these plans are also tested regularly. This is quite similar to the instruction manuals that pilots must follow scrupulously when a serious breakdown occurs during flight. Improvisation is then ruled out, only a strict pre-rehearsed drill can bring comfort.

At most banks a pandemic was included in the scenarios of possible external shocks. The business continuity plans provided a blueprint of measures to be implemented by the bank in order to respond adequately. All banks were able to continue their operations smoothly with staff spread across their branches, contingency centres and telecommuting. Procedures, locations, communication and IT infrastructure were planned. Roadmaps were roled-out smoothly.

The majority of the members of a risk committee are independent directors. This is hardly surprising, as it is extremely difficult for each operational director to easily distance themselves from their tasks and objectives, while examining very diverse risk scenarios from an innovative and broad perspective.

The formula for success lies in the cross-fertilisation between detailed operational know-how and a critical and broad-minded attitude of the respective executive and non-executive bank directors.

Companies are generally not well equipped to list everything that can happen and define appropriate measures long before one or more external shocks actually occur.

So create your own risk committee. It does not necessarily have to consist of directors. A good mix of two members of your management team (COO and CFO for example) and two external experts you hire for the exercise will help you a lot.

How will you benefit?

In the short term: a thorough review of your operational model in order to remove the unacceptable risks. Corrective measures will undeniably have a price: diversification of suppliers, the geographical spread of subcontractors, more intermediate stocks, less just-in-time, on shoring of production. But for that price, you will get a stronger and more resilient company.

In the medium term: a well-designed business continuity plan that, if tested regularly, will protect your company when the next tsunami strikes.

I guarantee you, it's worth the effort.

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