Here is an excerpt from another article written by Matthew Le Merle and featured online by Booz & Company. As he explains in the article, Black Swans—unanticipated, catastrophic events—are impossible to predict on an individual basis, but they regularly occur. Too often, the boards and leaders of large companies are unaware of the risks involved in these events, unnecessarily exposing their organizations, their shareholders, and themselves to grave consequences.
The solution to this problem is disrupter analysis.
Disrupter analyses supplement the everyday work of the enterprise risk management (ERM) function and are often conducted by external parties. They are achieved using a four-step process that maps the shape of the company; collects and synthesizes a broad list of potential high-magnitude, low- frequency events; determines their consequences; and implements preventive measures to ensure that the company is adequately protected.
Companies can never gain complete immunity from Black Swan events. But their boards, executive teams, and ERM departments can and should look more broadly at the risks and consequences of such events, and preemptively prepare for the unexpected.
To download a PDF so that you can read the complete article as well as check out other resources, please click here.
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The Unexpected Always Happens
Unexpected catastrophes dominated the headlines in the first quarter of 2011. Japan was hit by a magnitude 9.0 earthquake and tsunami that caused a nuclear disaster, persistent power shortages, and a host of other major societal and economic challenges. China once again limited exports of rare earths, on which information technology, automotive, and energy industries rely. The nations of the Middle East and northern Africa experienced severe political eruptions, including civil war in Libya and regime-shaking protests in Algeria, Egypt, Iraq, Jordan, Syria, and Tunisia, which pushed oil prices above US$100 per barrel. Portugal and Greece tottered on the edge of insolvency, destabilizing their political leaders. Christchurch, New Zealand, was hit twice in quick succession by major earthquakes, and the state of Queensland in Australia suffered the worst floods in recorded history in at least six river systems, resulting in great social and economic disruption.
All of these catastrophes are examples of the kinds of high- magnitude, low-frequency events that Nassim Nicholas Taleb labeled “Black Swans,” after a historical reference to their improbability. The Black Swan, Taleb wrote in his 2007 book of the same name, “is an event with the following three attributes. First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact…. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”
Whether environmental, economic, political, societal, or technological in nature, individual Black Swan events are impossible to predict, but they regularly occur somewhere to someone. Some observers argue that the frequency of these events is increasing, others that global communication networks have simply made us more aware of them than in the past.
In any case, with the globalization of business, it is increasingly likely that Black Swans carry substantial risks for your company, including negative impacts on your customers, suppliers, partners, assets, operations, employees, and shareholders.
Today, not only can a catastrophe in one part of the world affect the sourcing, manufacture, shipping, and sale of products locally, but the interconnections of global financial, economic, and political networks ensure that the knock-on effects of such events ripple around the world.
Stress-Testing with Disruptor Analysis
The solution to this conundrum is disrupter analysis. Disrupter analysis does not seek to predict Black Swans; that cannot be done. Nor is it meant to replace ERM; it complements ERM. Instead, this analysis—which is typically conducted by an external team working in conjunction with the ERM staff, functional and business unit leaders, and senior management—is designed to periodically stress-test a large company and assess its ability to withstand Black Swans.
Disrupter analysis entails a four-step process that will be familiar to professional ERM managers. It quickly and efficiently maps the shape of the enterprise, determines the breadth of potential disrupters, asks the “what ifs” to determine how severely certain events could stress the enterprise,
and then risk-proofs the company as necessary.
[Here is the first of four. To read the complete article, please click here.]
1. Mapping the Enterprise
The first step in a disrupter analysis is to map the shape of the enterprise. Shape is determined by a number of factors.
First are the company’s geographic footprint, its operations, the composition and construction of its supply chain, and its channel partners and customers. In mapping these elements, it is important to look beyond first-order relationships. Recently, for example, Apple’s supply of lithium- ion batteries, used in iPods, suddenly dried up. Unfortunately, as Apple quickly discovered, almost all of its suppliers purchased a critical polymer used to make the batteries from Kureha Corporation, a Japanese company whose operations were disrupted by the March 11 earthquake. In fact, Kureha’s share of the global market for polyvinylidene fluoride, which is used as a binder in lithiumion batteries, is 70 percent. This is why analysis teams must also map second-order relationships (the suppliers of the company’s suppliers). In some very critical cases, even third-order relationships should be mapped.
After the shape of the enterprise has been mapped with the help of the ERM staff, finance and other group functions participate in using disrupter analysis to map sources and concentrations of revenue, profit, and capital. Then the often-hidden concentrations that exist in the go-to-market activities — including the business’s products, services, channels, and customers—are considered. Determining the shape of the enterprise must also include a mapping of industry structure, competitive dynamics, and the company’s position therein. To determine how a Black Swan event could stress a company, the team needs to understand the foundation on which the status quo rests.
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To read the complete article, please click here.
Matthew Le Merle is a partner with Booz & Company based in San Francisco. He works with leading technology, media, and consumer companies, focusing on strategy, corporate development, marketing and sales, organization, operations, and innovation.