What does resilience mean in capital and balance-sheet management?

Two partners from McKinsey’s Risk and Resilience Practice share their perspectives on dealing with heightened uncertainty and emerging threats during and after the COVID-19 pandemic.

Resilience begins with trying to understand the future—scanning the horizon, generating scenarios, anticipating likely effects, and assessing the resources through dynamic management and a flexible operating model. Efficiency has been the priority for the past decade, but now businesses are moving to a dual way of thinking. They are planning for uncertainty by, for example, building in buffers for inventory, especially for “bottleneck” components and capital, so they can withstand periods of significant cashflow reduction.

Even before the pandemic, uncertainty was rising. Brexit and trade disputes are affecting global supply chains. Decarbonization is having a profound impact on many industries and regions. But COVID-19 has brought resilience to the top of the agenda for every organization and sector the world over.

No two organizations are responding in the same way. Some global banks, for instance, are moving to independent operations in every country where they operate, partly because of increasing volatility and partly because regulators prefer it that way. But having a global view across your portfolio is still essential because it allows you to cross-fertilize solutions and tools.

Short- and long-term challenges

Vaccines provide a path for getting through the public-health crisis, but the economic impact of the pandemic has yet to materialize in full. The challenge is to get sharp about what’s going to happen and work out how to react to it. With the impact differing so much by industry, getting intelligence on the outlook for your business is the first priority. The second is understanding how to get back to normality, what it will look like, and what risks or opportunities it will pose.

In the longer term, businesses will learn that resilience is a capability they need to master, not an alarm button they hit after the fire has started. It’s been neglected because it was traditionally seen as an expensive muscle to have. Now organizations are realizing it’s an expensive muscle not to have. And modern technology makes it possible to build resilience efficiently—the only way to do it in today’s world.

Preparing for uncertainty

To build resilience, the first step is to understand your risks—not just the ones you’ve already experienced, but also those that haven’t happened to you yet. That’s not easy; if it were, everyone would do it. The trick is to assume something will happen that you haven’t thought about so that you’re prepared to handle it when it does.

The second step is scenario planning. Once you know your set of risks, work out which ones you need to worry about and which ones you don’t. Tackling everything is too costly. Resilient organizations decide which emerging risks they need to focus on, whether it’s global pandemics, climate, or other physical and sociopolitical risks.

Third, have playbooks ready to pull out when needed. You can’t have customized playbooks for every possible instigating event; even if you could predict them all, it would be too expensive. So, you work out the key consequences to think about under broad headings like economic impact, and when something does happen, you take ideas from the playbook. Planning ahead protects your business.

One company had deemed a pandemic an ultra-low-probability event, so it didn’t have a pandemic playbook. But it did have playbooks for major supply-chain disruptions and demand destruction, so it could say, “This is bad, but it’s a bad we’ve thought about, albeit on a smaller scale, so let’s get ready.” Having the playbooks spared the company anguish and larger-scale catastrophe down the line.

One of the most resilient sectors has been insurance—a business that’s all about guarding against the unexpected. Some banks reacted rapidly to COVID-19 as well. They had crisis-management approaches and nerve centers already in place, and they converted quickly to remote working without major disruptions. Irrespective of sector, some businesses are simulating risks, taking resilience seriously, and finding it pays off.

Technology and risk

The other essential ingredient is technology. Being ahead in your tech transformation boosts your resilience. You have a more flexible opening model, automated warning signals to help you see what’s coming, and analytical machines to debias your decision making. Naturally, those machines must be built without bias, too—not just in terms of, say, race and gender, but with regard to anything that might influence a decision. For example, an AI algorithm that’s been trained over the past ten years will know only low interest rates; it won’t have a clue what happens when they go high.

Understanding technology risk is important, too. Back in the day, old timers could run a factory with a hammer and a screwdriver. These days, if the computer goes down, young folks have no idea what to do. So how do you adjust your training? How do you engineer crisis management for a generation that has never known nontechnological operating methods? Technology has brought more gains than risks, but it has brought risks.

The upside of resilience

Resilience isn’t pure downside. It’s not just about protection; it’s also a strategic move to improve your risk-return profile and your shareholder value. Boosting resilience not only reduces your risk but also liberates you to take more opportunities. And it’s crucial not to neglect it once the crisis is over. As in racing, you make the big moves on the turns, not the straights. Coming out of COVID-19, we’re in a turn, so now’s the time to make changes in resilience, strategy, and operations. With these elements in our tool kit, we’re much better prepared.

One of the things COVID-19 did was to align interests and priorities very quickly across organizations. You knew you needed to protect your employees and your clients, and you knew you’d get stakeholders’ support. When you have these high levels of alignment, you can achieve a lot in a short time, whether facing a crisis or transforming your organization for the better. That’s one of the glories of resilience.

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