Article: Corporate Board Member — Rethinking Risk After The Pandemic

One thing we’ve learned from Covid is that big companies are still run by flesh-and-blood human beings, not artificially intelligent data-crunchers. Despite frequent warnings about potential pandemics, most companies and CEOs did little to actually prepare for the calamity. Eight of the 10 largest publicly held U.S. companies didn’t even identify pandemics as a risk in their 2019 SEC filings. If we hadn’t developed successful vaccines so quickly, we’d be looking at a lot more bankruptcies.

What happened?  Nearly all big companies have board-level committees charged with assessing and protecting against major risks. But it turns out that in practice, these committees rely on management to surface and estimate the risks. And those leaders, like the rest of us, tend to overestimate the familiar problems (supply chain disruption, regulatory blowback) and play down the strange ones (global pandemic).

Many risk management consultants, along with the U.S. Director of National Intelligence, identified pandemics as a rising threat. But hardly any company or CEO took seriously the initial reports out of Wuhan. And the few industries that were prepared for the shutdowns, such as cruise ships, who had built up cash reserves only because leaders were nervous about volatility after a period of rapid growth—not because they foresaw a devastating pandemic.

There’s also a larger problem with how we handle risk. Most CEOs and executives tend to compartmentalize risk. Last year it was all about pandemics, and now that Covid (we hope) is under control at least in the United States, we’re back to worrying about climate change. But reality doesn’t compartmentalize. We need to worry about both individual risks and the dangers that feed on each other—the equivalent of “rogue waves” that suddenly emerge from the chance combination of separate ocean swells, and sink unsuspecting ships.

Still, it’s actually a good thing that we have real people running companies. That’s because risk, as any investor will tell you, is also another word for opportunity. After all, more billionaires emerge from downturns than from periods of prosperity. Not only can they profit from greater leverage on the rebound, but they have fewer rivals to compete on price. Investing in the downturn, and in volatile times generally, takes plain old gumption, animal spirits, which we won’t get from cautious computers.

By recasting risk as opportunity, companies and CEOs will also have an added reason to take risk seriously. It’s not just the unpleasant work of protecting against catastrophe; it can also be the springboard to a new level of prosperity. CEOs prepared for resilient growth can take bigger bets and succeed more often.

Developing a Risk Radar

Of course, companies shouldn’t jump from compartmentalizing risk to suddenly entertaining all possibilities. The board’s risk committee needs to narrow down the possibilities to the major threats, customized for its industry and market position. The challenge is to establish a discipline that reflects the real world, not the narrow experience of a few executives.

Companies need to move beyond their comfort zone on risk, which means going beyond what they know already. They must drop their binoculars, focused on places they know to look, and develop radar, scanning everywhere. That means a larger dataset than they probably think is necessary, as well as timeframe extending into the future. The world of 2050 is irrelevant, but the pandemic just compressed seven years of digital transformation into one.

In particular they must watch out for the simultaneous and combining trends that amplify a threat into disaster. That means combining probability with impact. After all, I can ignore a 20% chance of thunderstorms over my house, but a 20% chance of a hurricane will send me packing.

For example, in 1997 the movie rental company Blockbuster dominated its industry. Then a startup named Netflix began physically shipping CD versions of movies to customers, a segment of no interest to Blockbuster whose brick-and-mortar stores handled the far more popular VHS tapes. As the startup gained traction, it improved its online presence and customer service. Blockbuster now had a rival with better offerings on the web, an area with growing popularity.

After three years, Netflix still wasn’t profitable, so its owners offered to sell out to Blockbuster for $50 million to become the company’s new online division. But the incumbent, still dominant, brushed them off. Then another trend arose, the switch from VHS to DVD, which made Netflix’s mail-based business more acceptable to the mass market. Still, Blockbuster held off—this was just an incremental innovation, requiring only minor adjustments in its stores.

Meanwhile video streaming technology and bandwidth capacity were increasing steadily. Eventually it became good enough for streaming entire movies. Netflix was ready—and Blockbuster could never catch up in time, even with all its resources. The one-time king of movie rentals went bankrupt, sunk by a convergence of trends.

In the other direction, in the mid2010s, Upsite Technologies was a small manufacturer of supplies for telecommunications. But its leaders spotted three complementary trends. The first was the familiar expansion in data centers with commerce moving to the web and the cloud. Less well known was that, as chip makers maintained Moore’s Law with faster processing speeds, the chips were getting ever hotter. Forty percent of the electricity drawn by data centers was going into cooling, not the actual calculations. And third, the American electric power industry was failing to keep up with demand because of the shift to renewable energy. Some utilities were starting to ration the energy going to data centers.

For most industries, these complementary trends, if noticed at all, could have been a worrisome risk. Upsite saw the opportunity—and invested in a series of infrastructure supplies that helped to minimize cooling costs. These were fairly ordinary building products such as grommets and vents, under the brand name Koldlok, but engineered specifically for improving the efficiency of data center cooling. Then came the pandemic, when data center usage exploded, and Upsite rode a rocket to growth.

The pandemic is making many companies and CEOs rethink their approach to risk management. That’s appropriate, but the solution is not to go to the opposite extreme and get cautious. You can broaden your awareness of risk, but channel that worry into a disciplined process that can generate upside too.