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Are you prepared for the next disruptive risk?

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Geopolitical Risk

By Frederick Gentile | July 16, 2021

The COVID-19 pandemic is one of many events that should help organisations understand why they must be aware of the global risks to their supply chain.

Our fragile world

The news of the grounding of a large container ship in the Suez Canal in March reminds us how fragile supply chain operations can be. The cost of the disruption to international trade is yet to be finalised but estimated1 losses are around $1 billion and are only likely to rise as time goes on. Was this just a freak event and there’s nothing to worry about?

This idea may work for the eternal optimist but in the real world we just have to look around us:

  • COVID-19 is still taking its toll with new variants and human losses tragically exceeding 4 million worldwide2,
  • Rising tensions in the Middle East
  • Humanitarian crises notably in Yemen, Venezuela and elsewhere
  • A growing list of climate events such as hurricanes, wildfires and earthquakes
4million+
Global death toll from COVID-19

These are just some of the global and geopolitical risks we hear about with alarming frequency.

Who can we look to for a better understanding of risk?

Sadly, many of these events are not new. The World Economic Forum (WEF) studies global, emerging and geopolitical issues and produces a Global Risks Report3 every year. Interestingly, they predicted the risk of a pandemic and other health related risks back in 2006 and since then we have lived through Swine Flu, Ebola, SARS, MERs and now COVID-19. These risks are derived from the expertise of the Forum’s extensive network of business, government, civil society and thought leaders. Their Global Risks Perception Survey (GRPS) extends to multi-stakeholder communities (including the Global Shapers Community), the professional networks of its Advisory Board and members of the Institute of Risk Management. As a point of reference for global risk the WEF makes for a credible starting point when talking about future risk.

In this year’s GRPS the WEF asks respondents to forecast risks they believe could become a critical threat to the world over the next decade split into three timeframes:

  • 0-2 years - Clear and present dangers
  • 3-5 years – Knock on effects
  • 5-10 years – Existential threats

Of the total 35 risks identified, some of the key perceived risks that could affect us over the next 10 years are outlined below.

  • 2021-22: Extreme weather, infectious diseases, livelihood crises
  • 2023-27: Asset bubble bursting, price Instability, IT infrastructure breakdown
  • 2027-2032:
    • Deployment of chemical, biological, nuclear or cyber weapons
    • State collapse
    • Permanent loss of one or more natural species with irreversible consequences

Risks in the short-term outlook were the strongest concerns identified and these are, arguably, to be expected considering the challenging events of 2020.

When we look at the medium term, we see the impacts of the earlier risks creating a situation for potential further risks. Signs of a global recession kick in as we hear worries about the asset bubble bursting (affecting property, investment funds and shares for example) and price instability as economies stumble to recover. However, we also see the risk of IT infrastructure breakdown identified as an area of concern which given the shift to remote working over the last year and the ever-increasing dependency on IT, seems wholly reasonable.

Darker clouds appear when we look at the perceived existential threats over the next decade. Here the deployment of chemical, biological, nuclear but also cyber weapons, is top of the list resulting in loss of life, destruction and possibly international crises. This risk is followed by state collapse (e.g. fragile states like Venezuela, Yemen, and Pakistan) and permanent loss of one or more natural species with irreversible consequences.


Trying to make sense of the supply chain risk landscape when faced with this scale and gravity of risk isn’t easy. Boards should be asking themselves how is our business approaching risk? What are our top concerns?

Willis Towers Watson’s Geopolitical Risk team, for instance, takes a unique approach to this problem by looking at the drivers behind these risks through six distinct “lenses” i.e. People, Investment, Resilience, Cyber, Climate and Reputation.

Diagram showing geopolitical risks across different lenses and how they connect
Geopolitical risks and how they interconnect

Using this approach, we begin to see below how an extreme weather event, for example, interrelates with risks across each lens.

The investment and return lens

Extreme weather events will result in higher levels of financial damage. Last year for instance global losses from natural disasters came to $210 billion4, of which some $82 billion was insured. Hurricane Harvey alone in 2017 was estimated to have caused $125 billion5 of flood damage.

This translates into increased insurance premiums as well as higher societal costs:

  • Health systems stretched
  • Housing shortages
  • Education disrupted
  • poorer geographies as a result of location blight

But there is also the potential impact on industry sectors such as:

  • Aviation: due to changes in air routes
  • Tourism: coastal areas at greater risk
  • Agriculture: as crops are flooded, burnt or hit by drought

Any of these could impact your organisation directly or indirectly through suppliers. Your commercial strategies should be evaluating mitigations such as alternative suppliers or accessing new markets.

Your commercial strategies should be evaluating mitigations such as alternative suppliers or accessing new markets.

The cyber perspective

We already know that storms and floods can affect cyber infrastructure capability by damaging power supplies. But more recently energy suppliers are now considering a proactive approach to extreme weather events by deliberately choosing to shut down power supply to prevent spread of wildfires6, for example as they did in California in 2019.

So, you could be faced with power loss in one location but not the business overall. Data and critical IT systems could be live, but your network monitoring could be affected, leaving your systems vulnerable to attack. Of course, with power restrictions cloud-based systems could also be affected.

What about people?

Estimates suggest that 200 million people could be displaced by 20507 as a result of extreme weather or climate changes. This scale of change could have profound effects on society and labour availability. Whilst this is a macro or global consideration, there are potential implications at a more local level in terms of how extreme weather could affect labour pools, not only for your suppliers but also for your business. Questions to consider:

  • How will your employees access their place of work when affected by snow or floods?
  • Does your organisation have the policies and capabilities in place to cope with this?
  • How would your operating capability be impacted and for how long?
Trust and reputation

Companies are facing increasing scrutiny and pressure to conform to government targets to reach net zero emissions and there is of course the forthcoming introduction of the Taskforce for Climate-related Financial Disclosures (TCFD) for large organisations8. Activist groups are not afraid to name and shame. For example, a popular sports brand was targeted by labour activists, campus organizers and anti-globalization forces for allowing its suppliers in poor countries to abuse and exploit workers. With the rise of environmental, social and governance (ESG) principles, investors are looking more closely at what companies are doing in respect of climate and putting pressure on them to take responsibility.

In the US there are reports of business owners accused of failing to prepare for extreme weather. A chemicals manufacturer was criminally charged in 2020 for releasing pollutants into the air after floods affected their plant protection measures although later acquitted. Closer to home, some years back, the UK’s largest airport and an airline were criticised for slow reaction to snowstorms. More recently, climate activists claimed as a landmark ruling a decision by a court in the Netherlands ordering a well-known oil company to cut its carbon emissions far more aggressively than currently planned. Some argue that this decision could have wider implications in climate change lawsuits.

From a company perspective, consideration should be given to what policies, contingencies and arrangements are in place to deal with the impacts of extreme weather in terms of people, operations and communications often affecting people and leading to revenue loss.

Business resilience

This article opened with reference to the recent Suez Canal incident and its impact on supply chain. The canal is a critical pathway for commerce but not the only one. Take for example the Straits of Malacca – connecting the Pacific and Indian Oceans. Poor weather, high traffic, narrow strait, forest fire that reduce visibility plus the risk of piracy all make for a potentially lethal cocktail of choking one of the world’s busiest shipping routes. If this were to happen countries such as China (reliant on Middle East for oil) and Africa for raw materials could be seriously affected. A blockage due to an extreme weather event leading to an environmental disaster could result in global shipping capacity tie up, higher shipping costs and potential impact on oil prices.

McKinsey’s Global Institute recently published a report on supply chain9 which argues that as climate change makes extreme weather more frequent and/or severe, it also increases the annual probability of events that are more intense than manufacturing assets are constructed to withstand, therefore increasing the likelihood of supply-chain disruptions.

The report features a case study of an automotive original engineering manufacturer (OEM), that uses leading-edge semiconductor chips sourced from countries in the western Pacific like Korea, Taiwan etc. McKinsey’s modelling suggests that by 2040 the company can expect that hurricanes sufficient to disrupt its suppliers will become two to four times more likely. Some of these disruptions may last for several months.

At the other end of the scale is the example in the McKinsey report of a commodity supplier of heavy rare earth elements for example chromium or nickel. This supplier faces the prospect that the probability of severely disrupted production from extreme rainfall may increase two or even threefold by 2030.

Typically, the more specialised the supply chain, the more severe the impact could be for a downstream player especially if supply of a critical material may only be available from the source that has been disrupted. However, the more commoditized the supply chain is, the larger the number of downstream players that may be affected by spiking prices from a sudden reduction in supply.

Interestingly, the report also models how a well-prepared company fares against a poorly or non-prepared competitor. In a scenario of a 1 in 100 hurricane year the poorly prepared company can suffer a 35% reduction in revenue whilst the well-prepared company is modelled to lose only 5% of revenue.

It is worth noting that while we focus on the risk there is the other side of the coin, i.e. the opportunity. Climate change can also create opportunity such as the opening of northern polar shipping routes cutting transit times (albeit with new geopolitical tensions) or deployment of ‘greener’ modes of transport increasing company credentials and appeal.


So, what should we be doing?

Reviewing risk registers is important but taking a more proactive approach to building resilience will be advantageous.

One of the few upsides of COVID-19 has been renewed interest by governments and authorities to look more closely at how to improve resilience. Examples include the formation of a UK National Preparedness Commission, whose mission is to promote better preparedness for a major crisis or incident, and WEF which has published several articles on resilience that make for good reading.

The new Protect Duty (Martyn’s Law), currently undergoing consultation, will also contribute to improving resilience by requiring public places and venues to improve security10.

If we are to learn anything from the COVID-19 experience it is that organisations need to take a cold, hard look at how resilient they really are to disruptive events and to what extent resilience is built into their business model and practice.

Organisations need to take a cold, hard look at how resilient they really are

Management action models can help and the “four sight approach” to building resilience11 provides a useful leadership model when considering how to steer an organisation towards resilience.

  1. 01

    Foresight

    Stage one of the model relates to foresight i.e. the ability to anticipate, predict and prepare for your future. This could involve activities such as learning to scan, listen and monitor, notice and learn from events or things that can affect the organisation.

  2. 02

    Insight

    Stage two progresses to insight, in other words being able to interpret and respond to your present conditions. Building situational awareness and searching for latent problems and errors are two key skills in this space. But encouraging people to report anomalies, mistakes and concerns, and providing confidence that these will be addressed, is a fundamental part of this stage and may require a step change in the organisation’s culture. This will enable people to explore the problem and encourage novel solutions, which might shift people’s mindsets from seeing only “either/or” choices to seeing “both/and” solutions.

  3. 03

    Oversight

    Oversight is stage three of the model. Here the organisation must learn to monitor and review what has happened and assess the changes and implications. This can be achieved by putting in place a robust process for identifying, prioritizing, sourcing, managing and monitoring the organisation’s critical risks and ensuring that process is continually improved as the business environment changes.

  4. 04

    Hindsight

    Stage four of the cycle is hindsight. This is about being able to correct organisational practices by learning from experience and past events. Future performance can only be enhanced if your organisation is willing and able to change behaviour as a result of experience. In simple terms reflecting on an event is not about where the fault lies but what could have been done differently?

Building resilience can only benefit the organisation across all fronts but it is not a “plug and play” process. Instead, it’s a journey that will require commitment and resource and above all, the recognition that in all likelihood will also call for a major change in the organisation’s culture. At Willis Towers Watson we are able to support you in your journey using techniques like scenario planning emerging risks, challenging assumptions and strategies through stress testing, board level events such as Red Teaming exercises or using our geopolitical risk ‘lens’ approach to comprehensively audit and revaluate every step of the supply chain.

Footnotes

1 Suez Canal blockage, USA today - https://eu.usatoday.com/story/news/world/2021/04/01/suez-canal-blockage-egypt-could-seek-1-billion-ship-ever-given/4833205001/

2 WHO, https://covid19.who.int/ 03 June

3 The global risks report 2021, WEF, http://www3.weforum.org/docs/WEF_The_Global_Risks_Report_2021.pdf

4 2020 natural disasters balance, Munich Re - https://www.munichre.com/en/company/media-relations/media-information-and-corporate-news/media-information/2021/2020-natural-disasters-balance.html

5 Hurricane costs, Cost - https://coast.noaa.gov/states/fast-facts/hurricane-costs.html

6 California governor says broad power shutdown to prevent fires 'unacceptable', Reuters - https://www.reuters.com/article/us-california-wildfire-pg-e-idUSKBN1WP2Z9

7 Climate change already impacting migration patterns around the world, UNU, https://ehs.unu.edu/media/in-the-media/climate-change-already-impacting-migration-patterns-around-the-world-2.html#info

8 A Roadmap towards mandatory climate-related disclosures, Hm Treasury - https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/933783/FINAL_TCFD_ROADMAP.pdf

9 Could climate become the weak link in your supply chain? , McKinsey - https://www.mckinsey.com/business-functions/sustainability/our-insights/could-climate-become-the-weak-link-in-your-supply-chain

10 Counter terrorism contingency planning, Willis Towers Watson, https://www.willistowerswatson.com/en-GB/Insights/2020/11/counter-terrorism-contingency-planning

11 Organizational Resilience
A summary of academic evidence, business insights and new thinking, Denyer D, BSI and Cranfield University 2017, https://www.cranfield.ac.uk/som/case-studies/organizational-resilience-a-summary-of-academic-evidence-business-insights-and-new-thinking

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