COVID-19 and its global impact is an important reminder of a glaring weakness many companies and investors face: we’re not very good at assessing and mitigating systemic risk.
Typically, when we’re engaged in business strategy, we’re in a more reactive mode. We’re looking to make changes so we can react and respond to new opportunities or threats, or optimize existing systems and processes.
But COVID-19 is an example of what’s known as systemic risk. It’s a risk that can create severe instability or even collapse an entire system.
In the context of a global pandemic, this means the risk of instability, disruption and even the possible collapse of economies, healthcare systems, governments or societies. In the context of running a business or managing a portfolio company, it means any event or change that could fundamentally alter your business or even collapse it.
The challenge is that system changes can be difficult to predict. They can emerge slowly over time or develop suddenly, and they can cause an entirely new disruption or a paradigm shift with little or no warning.
As many companies and investors are finding out, we’re operating in a world of highly complex and interconnected systems, and a single disruption or change in one area can cause a cascading effect that takes down entire systems. In other words, one seemingly small event can have an awfully big impact, such as a localized virus outbreak leading to a global pandemic.
This is why it’s imperative that we evaluate systemic risk, develop a better understanding of how systems interrelate and work together, and develop plans that will allow us to move proactively rather than reactively when a systemic risk becomes reality.
In business, systemic thinking starts with understanding system-level risk and how specific threats could potentially jeopardize your business systems or your entire business model or organization.
It also means trying to anticipate the systemic changes that specific events might trigger, including disruptions to your business processes and systems.
What are the interconnected and interrelated systems most at risk of systemic change in your business and industry? What could potentially alter or disrupt those complex systems?
As Forbes contributor Bob Zukis has pointed out, “The essence of this approach is to begin to understand market shifts and opportunities and threats that will arise beyond the obvious. This involves understanding the macro-level issues and impacts, but more importantly the micro-level ones.
“Systemic thinking is about understanding how things work together. How a single point of infection can cascade and take down an entire healthcare system along with every human-made system globally. How consumer behavior can alter a business model, value proposition or competitive advantage and create market opportunity.”
Zukis recommends focusing first on the forces of change that have the highest levels of probability, predictability and certainty. But he also warns against ignoring small, micro-level changes that often have an outsized impact.
It’s also important to keep in mind that systemic thinking should look at major strategic risks and not just operational and financial risks, which are often the focus of corporate risk management.
In fact, according to a study published in James Lam’s book,Enterprise Risk Management: FromIncentives to Controls, 60 percent of major declines in market capitalization among publicly traded companies result from strategic risks. Operational risks account for just 30 percent of those declines, while financial risks represent only 10 percent.
Strategic risks are the risks inherent to a company’s business model and its core strategies and systems. These can be changes in macro-level economics and market trends, shifts in consumer demand and preferences, legal and regulatory changes, competitive pressures, technological changes, merger integration, and changes in senior management.
The specifics will vary in each case, but every business needs to take this kind of systemic and strategic approach to risk management, mitigation and planning.
Ideally, every company should be doing this as part of its enterprise risk management (ERM) program. And it’s often helpful to seek guidance and expertise from risk analysts and management consultants who can help you conduct systemic risk assessments and provide strategic guidance as you develop your plan.
At Graphite, we connect leading enterprises and investment firms with some of the world’s top independent consultants who specialize in corporate strategy, risk management, and systemic thinking. To learn more about our experts and how they can help you anticipate and manage system risk, visit us now at www.graphite.com to search our public consultant profiles, and either post a project or reach out to our team for hands-on assistance.