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 / Autumn 2011 / Issue 64(originally published by Booz & Company)


How to Prepare for a Black Swan

Thus, most ERM teams can assure their board and executive team that they have covered the more common risk areas of compliance, ethics, finance, and accounting, as well as safety, quality, and customer experience. But ERM simply does not have the capacity to also monitor high-magnitude, low-frequency disrupters on a continuous or regular basis.

This does not mean that black swans can or should be ignored. These events can threaten a com­pany’s survival, and boards and senior leaders are responsible for protecting shareholders and other stakeholders. They must ask, What else can go wrong?

A Disrupter Analysis Stress Test

The solution to this conundrum is disrupter analysis. Disrupter analysis does not seek to predict black swans; that cannot be done. And it is not meant to replace ERM, but rather to complement it. Disrupter analysis — which is typically conducted by a separate team working in collaboration with the ERM staff, functional and business unit leaders, and senior management — is designed to periodically administer a stress test to a large company in order to assess its ability to withstand black swans.

The analysis consists of 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 implements the contingency plans.

1. Mapping the enterprise. The shape of a company is determined by a number of factors, starting with its 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 its suppliers purchased a critical polymer used to make the batteries from the 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 lithium-ion batteries, is 70 percent. This is why analysts must also map second-order relationships (the suppliers of the company’s suppliers). In some 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 team sessions to map sources and concentrations of revenue, profit, and capital. Then the often-hidden concentrations that exist in go-to-market activities — including the business’s products, services, channels, and customers — are considered.

A determination of the com­pany’s shape must also include a mapping of industry structure and competitive dynamics, as well as the firm’s position in both. To determine how a black swan event could stress a company, the team needs to understand the foundation on which the status quo rests.

2. Creating the disrupter list. The key to creating a list of potential black swan events is to cast a wide net by cataloging possible catastrophic environmental, economic, political, societal, and technological events. The team should add much more to the list than ERM typically does, and continue until the net is wide enough to include representatives of as many different black swan categories as possible.

After the long list is compiled, the events are categorized by the type of impact they might have on the business. The result is a shorter, more workable synthesis that encapsulates the black swan events that could threaten the company.

3. Asking “what if.” Armed with the enterprise map and a concise list of disruptive events, the analysis team can begin to ask what would happen to the company if the events, or even combinations of events, occurred. The likelihood of occurrence is not a major concern here; these are, after all, black swans. Rather, the team needs to determine the relative impact and consequences of a given catastrophe.

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