Electrifying Business Impact Analysis

How is the cycle a good thing? For the believer of the free market’s supremacy, the natural reply is that cycles exist as by-products of the free market and therefore must be good. The opinion is based on the premise that companies that have taken control of operational concerns may be in danger of going out of business. Consider Sweden-based Ericsson’s run in with lightning – a seemingly innocuous natural occurrence that ultimately brought this once megalith mobile phone manufacturer to its knees.

A SHOCKING CHAIN OF EVENTS

St. Patrick’s Day, 2000 – a stormy night in Albuquerque, New Mexico that began with reserved raindrops and ended in a lightning laser show. The stopper featured a destructive dart of lightning, which stuck a power line causing devastative effects that were felt thousands of miles away.

An electrical surge ensued igniting a fire at an Albuquerque-based Philips microchip plant. While the flames caused little immediate burn damage, millions of chips–almost the plant’s entire stock–were contaminated by the smoke.

The fire caused major problems for Ericsson, one of Philips’ largest customers, as it had recently chosen to purchase all of its integral mobile phone microchips from Philips. Ericsson immediately became vulnerable to business meltdown as its lone supply of microchips had gone up in smoke. Placing all its voltage in one socket, Ericsson had nowhere to turn.

Ericsson lost approximately $400 million in sales – a figure that far exceeded the Company’s insurable amount. Ericsson was forced out of mobile business. However, the Company managed to stay operational thorough its other business lines. The corporate lesson learned is that while events are often uncontrollable, a near-crippling catastrophe can still be avoided if proper planning and attention to detail is implemented.

BALANCES, RISK AND REWARD

If risk generates reward it pays to understand the risks fully rather than seek rewards blindly. Well-managed companies know this, and the investment community appears to be coming around to this way of thinking.

Nine out of 10 investment professionals at the largest North American and European buy- and sell-side firms say risk management planning should be a board-level issue at Global 1000 companies. In addition, more than three-quarters say they “frequently” analyze potential risks to companies’ revenues, according to the 2004 “Protecting Value Study” conducted by Harris Interactive.

Business practices and processes are constantly changing, so today’s plans and assumptions could be obsolete tomorrow. If a single interruption can have a substantial impact on revenues and market share, it pays to be proactive and forward-looking with regard to risk management.

The good news is potential areas of vulnerability can be identified today. Disasters, like Ericsson’s, are preventable.

With this in mind, corporate executives should encourage the undertaking of a business impact analysis (BIA). These top-to-bottom studies examine all the relevant risks to an organization and the potential impact of each–financial and otherwise–no matter how complex the business model or far-flung the operations.

The most effective companies take a three-step approach to conducting their BIA.

STEP 1: THE BIG PICTURE

A thorough analysis of a company’s business model and overall operation will likely take several months to complete. At most large, multi-national companies, those performing the study need the time to meet with key personnel across all areas of the organization.

These sessions should be conducted with mid-to-upper-level management from the finance, operations, information technology, procurement, marketing/ sales, human resources and legal departments and any other applicable areas. (See sidebar one for areas requiring special attention) .

This research will provide a company with a more accurate and comprehensive picture of its overall risk – how the company generates revenues and profits; what its dependencies and interdependencies are; and, what its biggest vulnerabilities are.

In addition, corporate leaders will be more aware of the bottlenecks and potential interruption-related effects on customers, employees, partners and, of course, shareholders.

STEP 2: A CLOSER LOOK

A more focused look at the unique, inherent risks –both physical and non-physical–to specific facility locations is the next crucial step.

Think back to the Ericsson case. Natural catastrophe hazards, fires and equipment breakdowns are non-financial risks that can have a devastating material impact on revenues.

The goals of this step in the process should be to:

* Understand the underlying risks in operations

* Analyze vulnerabilities at key locations within the business model

* Develop benchmarks and risk profiles for each location

* Identify natural hazard exposures (e.g. earthquakes, floods, windstorms, etc.)

* Refine or set the stage for thorough business continuity plans

This exercise determines what production alternatives need to be in place for key locations and how to incorporate production make-up capabilities for each location.

Many forward-thinking companies routinely dispatch teams to their facilities to obtain and/or update vital location information and to create risk reports on each particular facility. This helps build knowledge of the major risks to each location and their worst-case loss scenarios.

You are now prepared to gauge a disaster’s potential financial impact on your company.

STEP 3: NUMBER CRUNCHING

Examine your financial information to assign actual dollar amounts to each risk by first calculating total revenues at each facility, subsidiary or business unit. Next, subtract variable cost elements (costs that can be varied flexibly as conditions change).

Finally, consider risk-mitigating factors (such as production make-up capabilities) and your dependencies or interdependencies with other locations. These should be taken into account to arrive at a value – or dollar amount – for each risk at each location.

Other significant items noted in the review of the business model and operations are also quantified in this fashion. These could include possible long-term market share impacts and costs beyond normal operating expenses. An example of the latter would be costs that may be needed to expedite resumption of normal operations following an unplanned interruption.

Once these three phases are complete, a detailed picture of the potential consequences of a significant disruption to a single business unit or multiple points in operations is at hand. Now, a basic understanding of how such an event can affect a company’s profits is established and this allows the business to meet continuing expenses and recognize how the disruption can affect market share and share price.

CONTROL THE WEATHER

Taking a fresh look at risks and quantifying them to earnings and value will provide a company with:

* Thorough, current knowledge of all business risks

* Summaries of financial vulnerabilities at each location

* Analyses of direct labor vulnerabilities

* Increased awareness of financial risks due to internal interdependencies

* Increased awareness of financial risks presented by external suppliers and other contingent relationships

* Impact estimates (margins, earnings per share, etc.)

* Accurate understanding of the company’s level of preparedness to deal with catastrophes

* Frameworks for prioritizing where capital improvements and response efforts (including business continuity management efforts) should be made

* Better understanding of your organization’s current Business Continuity Planning efforts

It is understandable that a company will be hesitant to divert its resources in order to conduct a BIA. However, strong evidence suggests that sound risk management practices directly contribute to financial performance by reducing losses and allowing more stable, predictable cash flow quarter-to-quarter.

Conducting a thorough business impact analysis will enable a company to improve its communication channels and strategic thinking. And, the next time lightning is in the forecast, weather will not be quite so daunting.