The spread of Covid-19 virus has made perfectly clear that both global value chains and domestic production can be severely disrupted. Disruption and risk is on everyone’s agenda.

The pandemic is a non-financial risk and it lead almost all firms to take action. This blog with finance professor Bert Scholtens focuses on how firms can improve their mastery of adverse events and how they can these events better manage when they occur.

Was the corona crisis a completely unexpected disruption?

“No, it wasn’t. This isn’t a ‘black swan’ event. In the recent past, there were other outbreaks like Ebola, Zika, MERS, SARS, avid flu, swine fever and Q-fever. In addition, scientists have given ample and specific warnings about the risk of pandemics.”  

Are all companies affected in the same way?

“No, not only does the location of the firm and subsidiaries matter, also how its supply chain is organized and the industry in which the firm operates. And some companies are just better prepared than others.”

There is a lot of attention for leadership, how do you appreciate the role of leaders?

“With all due respect, but I feel too much attention goes to leaders in organizations. In crisis situations, there is a tendency to centralize decision making. However, in case of severe disruption, as we are facing right now, this probably is not very effective. It shows that firms that trust their staff and stakeholders are much more flexible and resilient to cope with new and swiftly changing situations. Firms that have a command-and-control attitude prove to be very rigid.”

How a company responds to a disruption depends on different forces. Which are the main ones?

“In this regards, there are six forces. The first one is interdependencies due to migration, travel and the globalization of supply chains. Especially the latter introduced systemic risks with disruption in one region having the potential to severely affect operations elsewhere.

The second is short-term horizon. Reducing cycle times in several areas in business have contributed to a right-this-minute mindset. The Just-In-Time Management movement has led managers to downplay risk-reducing measures, since the benefits would not be realized immediately. Shareholder Value Maximization exacerbated this myopic orientation.

Third force is compliance. Many government regulations are in place to reduce company risks, such as building codes, health and safety, identification. But next to these, many organizations put in place regulation that applies to their entity only. Management can be highly risk averse and put a lot of effort in assuring compliance with these regulations. This can have a dramatic impact on resilience and flexibility. Even more so when they come up with new regulations whilst the crisis is unfolding.

Next is concentration. We find that business operations become more intertwined with more populous regions. Urbanization gives business ready access to large pools of customers. But it also concentrates risks. This is clear with the current pandemic, but terrorist attacks is another example. The fifth force is the greater probability of shocks. Disasters by definition are low-probability events. But when viewed over a longer period, the likelihoods add up.

And finally the sixth force is the pressure for transparency. Openness has reputational benefits and allows stakeholders to respond. However, overreaction to news is also quite common and social media can be very judgmental and harsh. The interplay between these six forces determines how organizations cope with disruption.”

How can firms better manage disruptions?

“The number one advice is to involve personnel at all levels in design of risk management and in crisis-response. This requires trust and confidence in the professionals. They are in the frontline and directly face disruption. So, they know best about what actually is going on.

It is also important is to recognize behavioral biases and the fact that the new situation might call for a different attitude and business model.

Ongoing identification and appraisal of risks is required as well when the crisis unfolds. Furthermore,  investing in protective measures and learning from adverse events should be a continuous process.

Management should also have a strategy for recovery. Here, they should involve personnel as well. Last is that to realize that the best director or leader is the one who feels she can be missed without the organization running into trouble. That calls for a personality trait that goes underappreciated.”

For more information, please contact professor Bert Scholtens:

E: l.j.r.scholtens@rug.nl.

W: https://www.rug.nl/staff/l.j.r.scholtens/

T: 050 -3637064

Further reading:

• World Economic Forum’s Global Risk Reports and Munich Re on impact, perception and likelihood of disasters
• The works of Kahneman and Tversky on behavorial traits
• The works of scholars like Luis Ballesteros, Geoff Heal, Robert Kaufman, Howard Kunreuther and Michael Useem