Complacency Before a Storm

The Risk Management and Decision Processes Center at the Wharton School of Business, University of Pennsylvania, is focused on the research and management of low-probability, high-consequence events that may be difficult to cover with insurance. After all, insurance is largely a function of probability that an event will occur vs. the cost of recovery from damages resulting from the event.

According to Erwann Michel-Kerjan, Ph.D., managing director of the Wharton Risk Management Center, the probability that, in the span of two hurricane seasons—little more than a year, seven hurricanes would make landfall in the Florida and Gulf Coast regions, is practically zero.

However, in 2004 and 2005, that is precisely what happened. Although the devastation from these hurricanes remains—particularly from hurricanes Katrina and Rita—the mild storm seasons in the last two years have lulled many back into complacency.

“Short-term memory is a challenge to planning for disasters and it’s hard to put a number to the probability that a [high-consequence] event will occur,” acknowledged Michel-Kerjan.

He suggested two aspects of a high-consequence event that need to be evaluated. First, retailers should contemplate courses of action should they become the victim of an event.

“The day after a disaster strikes is not the time to make first contacts with government agencies or local authorities,” Michel-Kerjan advised. Instead, the local decision-makers in a retail corporation should establish and maintain relationships with local agencies and law enforcement.

Secondly, retailers should evaluate how they might support disaster recovery, even if their operations may not be a direct victim.

“In the United States, 80% to 85% of the so-called critical services are provided by the private sector—and so, 80% to 85% of the expertise to manage critical services likely is in the private sector as well,” noted Michel-Kerjan. “The government may not have the distribution network or the expertise that you would find in large, corporate retail supply chains—such as Wal-Mart, Target or Home Depot.”

The questions Michel-Kerjan would pose to retail executives are these: “Following a disaster, what do you expect from others? And, what do you expect from yourself?”

Retailers that answer those questions with strategic planning, relationship building and concrete executive commitments will be better equipped to deal with potentially catastrophic events.

World-view risk management: In a global economy where retail enterprises envelope trading partners worldwide, adopting a world view is another critical component to managing high-consequence events.

“Interdependency is the key word to focus on,” advised Michel-Kerjan. “A major flood in China is going to impact American companies—it may not directly impact the company you are dealing with, but it could impact one of your partner’s suppliers and in turn impact your business.

“You can buy insurance if you think your company might be the victim of a disaster, but it’s hard to buy insurance against the possibility that one of your supplier’s suppliers might get into trouble.”

What Michel-Kerjan is seeing more frequently is scenario-planning among corporate executives. His advice is to identify and discuss “what if” scenarios, then start by building a strategic plan around a small and concrete aspect of one potential scenario.