Towards A World of Interdependency

Globalisation, outsourcing and ever-leaner supply chains will mean a highly efficient economy by 2025, but the world will also be very interdependent and therefore increasingly vulnerable to systemic problems.

This is the view expressed by Alex Hindson, associate director of Aon Global Risk Consulting in an interview with European Business Forum magazine.

There is a growing trend for companies worldwide to create alliances to remain competitive. In some cases this involves outsourcing back office operations such as human resources, IT, business process operations and financial processes. In others, core competencies are outsourced to where economies of scale can be achieved or access to more economic high skill labour pools are possible. There are many types of partnerships including joint ventures, licences and cooperative marketing and research agreements.

As organisations become more specialised, each is likely to focus on its core activities, hence creating an integrated supply chain of partnerships and interdependencies. This has replaced vertically integrated companies as a much more agile and adaptable response to the challenges of the market place. Organisations with complex interactions and networks of business partners now need to cooperate. This leads to sharing substantial intellectual property and know-how in what is becoming an increasingly knowledge-based economy.

Much of this information is dependent on enterprise-wide IT systems. Organisations are seeking to drive efficiency through systems integration and the trend is for fewer but more complex systems to run individual businesses. These systems will become more critical and over time organisations will come to rely on them more to provide management information, operational planning and control of their businesses.

Pharmaceutical companies, for example, are unravelled into their constituent parts. Manufacturing may be outsourced to China, fundamental research may be delivered by a biotechnology partnership, IT and HR provided by outsourcing partners in India, and sales forces could be provided by contract resource companies. The fundamental engine of the business will remain its ability to drive new products, through product development and testing programmes where barriers to entry are high, and by providing the marketing strength to launch global brands.

These business models not only make the organisation dependent on third-party partners but also place the business’ brand and reputation in their hands. Discontinued operations and regulatory compliance failures put an organisation’s earnings and ultimately shareholder value at risk. These vulnerabilities are based on the unanticipated exposures associated with extending the enterprise’s boundaries beyond the organisation’s span of control.

The change is in many ways insidious and gradual in its growth. Few organisations fully understand the nature of their dependencies. An organisation may select a partner to outsource its IT infrastructure and services. However, does it understand that the organisation will itself have potentially outsourced the facility management and security at its data centre and use significant numbers of contract IT staff?

The world in 2025 may become vulnerable to more systemic exposures, where a single event may trigger a domino effect across seemingly unconnected supply systems. Pandemic exposure is one topical risk that organisations are realising creates this type of issue. It is a good model to identify the challenges associated with a significant failure that global information networks might encounter in 2025.

This type of risk has twin threats. Firstly, how do you re-engineer supply chains to overcome restrictions in the movement of goods or people at short notice? And secondly, how do you manage the flow of information to key stakeholders, such as suppliers, staff and customers, to maintain their goodwill and support and hence the organisation’s reputation? The challenge with lean supply and just-in-time operations is to understand the implications of such an event and ensure supply chains are resilient.

What can organisations do to respond? Traditional site-based business continuity plans are not sufficient to cater for these risks and approaches to business continuity will need to adapt. Insurance companies need to rethink the basis on which they offer business interruption insurance programmes to their clients to respond to these changes. Traditional insurance relies on a physical damage incident such as a fire to trigger a claim for gross margin loss. This will not be representative of the types of risks an organisation in a networked economy will face in 2025. In terms of risk management, organisations will need to develop greater resilience.

‘Enterprise resilience’ is the ability of an organisation to overcome systemic disruptions and adapt to its new environment. A resilient organisation ensures that its decision-making structures, governance and strategy adjust to meet its corporate objectives. This type of organisation would retain the nimbleness to sway in the wind of change and ensure adaptation to its external environment.

The last five years have seen a step change in the level of regulation, be it Sarbanes Oxley, Basel II, Solvency II or European directives. This represents a fundamental change in the way society chooses to manage risk, based on a loss of trust in institutions. This trend makes it a significant challenge for flexible organisations to develop a response based on resilience, rather than more controls and compliance. Regulations by their nature require strengthened controls and processes. Corporate governance is focused on ensuring internal controls are sufficiently robust to prevent failures. By contrast, an adaptive organisation seeks to develop a culture where employees are empowered to make decisions, information is exchanged freely and natural change is accepted.

A risk management culture is key to organisations recovering from major crises. This culture operates at the level of the overall mission of the organisation and how business is transacted, rather than through systems and procedures. Chief executives and boards will need the capability to make sense of increasingly complex risks and respond appropriately without recourse to the insurance markets. It is too early to tell which approach will be the most successful in overcoming the challenges of the next 20 years but we will be able to check by seeing which of today’s organisations are still around in 2025.