Risk is your Biggest Cost

Business as we know it has been very stable when compared to the history of humankind.  That sounds ludicrous until you really think about it - even with major disruptions: war, famine, environmental disasters, pandemics - the stability has given us security to make consistent decisions.  We are entering a new business environment none of us has experienced before.  Our reality is that when we do financial analyses we are forgetting what might become the largest cost impact … Risk. 

Why our Assumptions are Breaking

Typically when we are planning and managing our businesses a key starting point is the cost basis.  Without an estimate of cost inputs we have no idea if we have a viable business plan for the addressable market.  Financial analyses take into account input costs like labor, material, logistics, capital, services, and governance.  Rarely are there line items for risk, unless we are doing a separate sensitivity analysis.  Let’s work through what is changing to consider intentionally shifting some of our cost focus to include Risk.

Globalization has been largely driven by the security guarantee from the U.S. as well as easy access to capital.  Open access to markets in combination with associated growth in labor availability made expansion possible for many years.  Now that we are entering a phase where the U.S. is turning inward - largely due to energy independence - the security guarantee for global trade is showing cracks.  Additionally, aging demographics are shifting labor footprints while disrupting established supply chains.  The 2030’s will be a decade of readjustment, especially with the added layer that mature economies will be dealing with a debt reckoning.  

Five Risks to Consider Now

A few wide ranging examples of how these rapid changes can inject risks that we need to either mitigate or cost capture are:

1. Availability of components.   The extended supply chain will be ever more strained.  As labor pools age out component supply chains cannot adapt quickly enough to migrate to new locations.  This goes so deep into an extended bill of material that most companies don’t even know their exposure.  Think about lack of a fastener made in a factory somewhere that will evaporate or an adhesive that can’t be made for lack of raw inputs - before your team even realizes there is a problem! 

2. Access to consistent power.  Low cost labor has driven assembly of complex products to countries that will struggle to continue to perform.  The most disruptive example of this is “anything with copper in it”.  Think about transformers, electric motors, switches, refrigeration compressors - all really boring things until you don’t have them.  A sudden shutdown of your electricity will ruin everyone’s day, week, month.  Companies that are highly dependent on electricity should be performing a risk analysis of their internal systems as well as their local grid. 

3. A feedstock crisis.  Access to oil will continue to be disrupted, especially for those economies that are reliant on supply from the middle-East.  Thinking beyond the continual instability of the typical choke points of the Persian Gulf or eastern Mediterranean, look at a map of what it takes to get tankers from oil sources to Asian consumption points.  Then remember that oil and natural gas are the base materials for plastics, fertilizer, adhesives, inks, lubricants which account for 20% of overall oil/gas consumption.  If refineries and processors can’t access the right oil/gas input they can’t make the stuff that goes into your products.

4. Global logistics volatility.  Costs will be more unpredictable with crises happening with increased frequency.  Typical contracts for long distance shipping will be rewritten to pass on more risk to protect the logistics companies.  Risk premiums and insurance can help after the fact, but the bigger pain is not having the things that you need for an extended period.

5. Access to capital.  Interest rates and limited availability of credit will be like nothing we have known in our experience of access to easy credit.  Government borrowing to service debt will continue to raise interest rates and crowd out the money supply available for lending.  When planning capital investments or operating cash there will be uncertainty for your company, but more importantly for the suppliers you rely on that you don’t have visibility into.  The continuity of supply is highly dependent on solid supplier financing.  

From Awareness to Action

Understanding these macro risks is no longer an academic exercise, it is a survival essential. Business leaders need to move beyond contemplation toward action:  

• Risk Identification 

• Evaluation and Prioritization

• Supply Re-sourcing

• Targeted Inventory Build-up

• Dynamic Cost Capture or Insurance Protection.

Let’s have an extended conversation about the macro risks that we are facing in the next few years and what specific risks your team should be targeting for action. An engagement with Economics Designed expands your ability to evaluate your strategic actions.

Strengthen your future by strategically designing the economics of your business!