Dealing with Disruption

This post first appeared on Risk Management Magazine. Read the original article.

Feature Disruption

Not so long ago, business disruption referred to sudden shocks to a company’s operations that caused immediate but relatively limited damage. Such events could range from equipment malfunctions and power failures to the ­fallout from natural catastrophes or political unrest. However, the concept of “disruption” is evolving to include threats to a company’s long-term viability posed by more agile competitors, increased regulation, changes in consumer tastes and new technologies.

Executives are waking up to the scale of disruption threats, and the potential impacts on their organizations continue to push the issue further up the board’s risk agenda. According to research by Accenture, C-suite mentions of “disruption” during earnings calls, investor conferences and company announcements have increased significantly over the past decade—as have the anxiety levels of executives across industries.

They are right to be worried. In the report Breaking Through Disruption: Embrace the Power of the Wise Pivot, Accenture found that 13 of the 18 industry sectors surveyed experienced increased disruption over the past eight years, leaving exposed $41 trillion in enterprise value (market capitalization plus net debt). The energy, retail, life sciences and consumer goods industries were the most susceptible, while the industrial equipment manufacturing, natural resources and chemical industries were among the least.

Contrary to popular belief, Accenture’s report revealed that disruption is not sudden and short-lived—in fact, it is persistent. Four out of five industries spent at least five years experiencing some form of disruption between 2011 and 2018. Similar research conducted by the firm in 2018 revealed that 63% of the 3,600 companies reviewed faced high levels of disruption, while 44% showed severe signs of susceptibility to future disruption.

Such findings fit with what other experts have seen—most industries experience disruption not from the sudden impact of a single force, but rather from a collision of interacting forces, and often with multiple, related consequences. “Organizations are facing accelerated complexity coupled with complex change,” said Sean Murphy, managing director of professional services firm BDO’s crisis management and business continuity practice. “So much so, in fact, that the natural environment for business has now become one of instability and persistent threats.”

Most industries experience disruption not from the sudden impact of a single force, but rather from a collision of interacting forces, and often with multiple, related consequences.

There are several lamentable examples of major companies that went out of business because they failed to react to industry or market changes. Photography pioneer Kodak went bankrupt after jumping on the digital bandwagon too late, while U.S. bookseller Borders fell by the wayside when it undervalued the threat from Amazon and other online book retailers. Video rental company Blockbuster could not find a way to affordably compete with digital downloads, ultimately filing for bankruptcy in 2010. Meanwhile, competitor Netflix gained an advantage by cutting out physical stores and mailing DVDs to customers directly. In terms of other, more recent examples of disruptive companies, consider the impacts that Airbnb and Uber have had on the hotel industry and taxi firms, respectively.

Indeed, the prospect of not keeping up with a rapidly changing business environment is giving executives nightmares and now ranks as the top C-suite concern, according to a recent Emerging Risks Monitor Report by IT consultancy Gartner. Corporate anxieties about a changing future include fears of being overtaken by competitors, the lack of clear avenues for growth, a failure to meet client needs or demands, and executives not responding to macro trends and changing consumer preferences. Executives also reported concerns that their organizations’ strategies for leveraging digital technologies could be inadequate.

In the second quarter of 2019, Gartner surveyed 133 senior executives across industries and locations, finding that “pace of change” and related threats from business model disruption had become the top emerging risk for 71% of respondents, with health care, insurance and industrials fearing its consequences the most. “Part of the reason they may feel this risk so acutely is related to concerns around their own operations, including digitalization strategies and an inadequate talent pipeline,” said Matt Shinkman, managing vice president and risk practice leader in Gartner’s audit and risk practice.

Many organizations have cited the lack of available talent as a significant fear in executing major IT and change projects—and not without justification. Last year, Gartner predicted that 75% of organizations will experience visible business disruptions due to infrastructure and operations skills gaps in their in-house IT functions by 2020. The firm warned that the lack of skills is so dire that, through 2020, 99% of artificial intelligence initiatives in IT service management will fail due to the lack of in-house skills.

To assess how exposed companies are to changing circumstances, Accenture developed a “disruptability index” by dissecting disruption into four key components: durability, vulnerability, volatility and viability. Companies that fall into the durability and vulnerability categories, such as chemicals, consumer goods, capital markets and health care, can see obvious short-term signs of disruption, such as high labor costs and poor staff retention. For now at least, these indicators are not enough to cause too much damage, but they do have the potential to be problematic in the future if not addressed.

Companies included in the volatility category, however, such as carmakers, energy firms and extractive industries, will experience dramatic disruption, with traditional strengths becoming weaknesses. These industry sectors typically also find it hard to adapt quickly to change and often have to weather lean times. Meanwhile, for companies within the viability segment, including tech firms, software providers and retailers, disruption is a constant. Sources of competitive advantage are often short-lived, as new disruptors—such as new technology and new entrants—consistently emerge. Almost two-thirds (62%) of the organizations surveyed fell into these two categories.

Countering the Threat

According to professional services firm PwC, CEOs and businesses should consider five factors when trying to counter disruption threats: 1) changes in customer behavior; 2) new kinds of competition; 3) shifting regulation; 4) new methods of distribution; and 5) core technologies of production. The fundamental challenge for CEOs, PwC said, is to figure out when disruption is happening to them, understand where it is coming from, and have a strategy in place for more than one future.

Experts believe that organizations can leverage opportunities from disruption. Companies can learn from what went wrong and strengthen their controls and procedures to ensure that such events do not occur again or, if they do, to curtail their severity. Disruptive technologies such as 3D printing and blockchain, along with new entrants coming into the market using cheaper and more efficient and effective platforms, can also prompt companies to consider scenario planning about how such developments, consumer tastes and regulatory trends might impact them, their products and their service delivery if they fail to adapt to changing circumstances.

Companies can learn to flourish if they spot signs of disruption early and act quickly, according to Paul Nunes, global managing director of thought leadership for Accenture Research. He suggested that there are four key actions that companies should take to be more innovative: First, organizations should “create their next cutting-edge” by embracing new technologies to develop potentially disruptive ideas, in and outside of their current industry. Second, they should “fund their future bets” by progressively bolstering and allocating their innovation investments to test and turn new ideas into commercial realities faster. Third, if organizations cannot build or fund the necessary skills and resources internally, they should find partners (including third parties and suppliers) to scale new ideas and provide access to technologies and specialized talent. Fourth, organizations should “disrupt from the inside” by fostering an internal culture that views innovation as a benefit and establishing an “innovation lab” or “digital factory” to test new ideas.

“Companies need to innovate to stay in the game,” Nunes said. “If you look at the automotive industry, carmakers make around the same profit margin they did about 30 or even 40 years ago, despite selling more cars and improving production techniques. The sector has now hit on the idea that providing additional or customized services is the way to go, such as installing GPS and Wi-Fi in cars at an additional fee. And it has worked—the sector now makes around 25% of its profits from add-ons.”

Despite their leading status, Google and Microsoft still spend billions of dollars each year trying to find new ways not only to retain their position, but to grow further, Nunes added. “Each of these companies is acutely aware that they are only as good as their products and services and that, if a new entrant comes along that is better, cheaper and gives users something new, they’re gone,” he said. “Successful companies avoid disruption by leaning into disruptive technologies, testing new ideas and learning how to remain close to the innovation frontier.”

The Upside of Disruption

Executives should look for the upside of disruption and risk managers need to remind them of this point, some experts argue. What was initially perceived as a negative disruption can sometimes produce a positive transformation. For example, for the traditional players in the automotive sector who roll out new offerings, the shift to electric cars is likely to be a boon rather than the death knell they originally envisioned.

“While risk functions need to make executives aware of the challenges, they also need to make them aware of the potential opportunities that changes in the market may present,” said Fergus Allan, head of regulation and compliance at management consultancy TORI Global. However, he warned, executives also need to embrace the latest technologies to stay ahead of the curve. “Change is usually regarded as inherently risky, as well as costly, but improved risk analysis using key technologies like data analytics and AI will help risk functions improve the quality of the risk information they have to pass on to executives to help inform better strategic planning,” he said.

According to Chris Ganje, CEO and co-founder of business intelligence firm AMPLYFI, “disruption in its purest form can be an opportunity as well as a threat—it can be a catalyst for change for the better.” And like Allan, he believes that investment in new technology—particularly AI—is vital to work out where the organization is more susceptible to disruption, largely because of the enormous amounts of data such programs can collect and process. Embracing such technologies will free up risk functions to concentrate on more strategic—and ultimately value-adding—work.

Successful companies avoid disruption by ­leaning into ­disruptive technologies, testing new ideas and learning how to remain close to the ­innovation frontier.

“As AI continues to enable greater economies of scale, risk analysts can expect the nature of their jobs to change,” Ganje said. “Softer skills such as problem-solving and creativity will be of paramount importance, while AI picks up the more mundane tasks of number-crunching and report generation. Managed correctly, this will create risk management functions that drive more value for the businesses they work within, offering more in-depth risk assessments and the ability to dive deeper into the viability of investment opportunities.”

Investor and entrepreneur Samuel Leach agreed that organizations need to view changing circumstances in a positive light, adding that risk managers should create a vision that outlines the risks of failing to adapt and the opportunities afforded by changing. They should then communicate that vision using every medium possible and empower others to act on it. “Get rid of obstacles to change and encourage risk-taking and non-traditional ideas,” he said.

According to Leach, a lot rides on the risk function’s ability to get the board’s attention and its backing. He believes that risk managers need to have good communication skills—coupled with the necessary technical acumen—to convince executives and senior management that change is good, what actions should be taken, and how. They also need to have solid analytical skills, be good at problem-solving and decision-making, and display strategic business understanding and commercial awareness.

Additionally, risk functions must establish a sense of urgency, and form a powerful, guiding coalition so that risk management has the appropriate level of backing to make recommendations that will be listened to and adopted. “Examining market and competitive realities and identifying and discussing crises, potential crises and opportunities is a necessity,” Leach said. Risk leaders should insert themselves early into the strategic-planning process so that they can make their mark. Then they should work across the function by collaborating with strategy and finance teams to encourage positive risk-taking, for example, highlighting the benefits of transformative measures to the business.

Leach believes that risk functions should plan for—and create—short-term wins, then use these improvements to produce yet more change by hiring, promoting and developing employees who can implement the vision. “Risk managers need to assemble enough people with enough power to lead the change,” he said.

Part of the solution is that risk managers need to completely flip the way they have traditionally approached the problem. “Previously, risk managers could plan for outcomes through scenarios, but this is no longer working,” Murphy said. “The more complex the problem is, the greater the need for risk frameworks that are flexible and less detailed. Risk managers need to respond to rapid changes, and detailed plans simply don’t work—they are too rigid and often address only part of the problem and/or solution. Plans, planners, planning and procedures all need to be agile.”

As a result, he said, risk management responses to disruption need to be fluid and emphasize developing a customized response, rather than relying on ready-made plans and templates. This is also true of how executives should respond to such threats—risk managers need to teach executives “crisis skills” rather than produce “crisis plans” for them.

“Executives are ultimately in charge of risk management, so they need to have the skills to come up with their own suitable action plans quickly if they are to deal with trends in the market that may disrupt the underlying nature of the business and how it operates,” Murphy said. “It is up to risk managers to equip them with those skills and prepare them.”

While business disruption may be nothing new, more organizations need to wake up to how debilitating the risk can be. Preparing for the immediate impact of events such as floods and blackouts is standard work for any risk function, but scanning the horizon for signs of systemic disruption requires greater strategic thinking and strong powers of persuasion when confronting executives with the evidence.

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