Eruption Disruption

Who would think a volcanic eruption in Iceland could disrupt you from savoring a chocolate nugget strategically located on your hotel room pillow in Hong Kong? Or that an automaker would advise anxious clients that delivery of their shiny new chariot would be delayed for an undeterminable amount of time?

We are all relatively aware our global economy is a tangled web, with the common goal for outsourcing being to increase profit margins. This is typically accomplished by reducing operational costs through the combined use of foreign suppliers and readily available global transportation.

The new millennium approach of “just in time,” coupled with consumers’ demand for diverse products, has worn thin risk management strategies that would otherwise ensure a reliable, steady stream of products and services. Corporations’ self-imposed logistical demands are proving to be borderline careless, with little or no room for error.

When companies decided to become dependent on worldwide supply chains, did they anticipate the ramifications of these actions against their operational output? Are we assured that risk management plans in effect can safeguard the profitability of operations beyond the initially estimated recovery period? Unfortunately, history has repeatedly proven otherwise.

A VOLCANO: WHO WOULD HAVE GUESSED?

No question, corporations must apply every effort to assess their supply chain risks and establish an effective mitigation and response strategy. Insurers have invested significant time and effort in products and processes over the past three years to aid corporations in addressing the risks previously mentioned. Also, a risk transfer product has been designed that includes — but is not limited to –physical damage occurrences that would otherwise be determined as uninsurable business interruption events.

We can be reasonably assured that no one reliable method implemented by any current organization could have predicted the effects of the volcanic ash upon the air transportation industry and the domino effect thereafter. But it is important to identify and understand predictable vulnerabilities and available formulated methods to address and reduce the probability of loss.

Before I explain further, I would like to draw your attention to some interesting documented facts about the supply chain impact associated with this recent volcanic eruption, and the subsequent down time or disruption of air travel for that five-day period.

The eruption created numerous uninsurable losses as defined by traditional insurance risk transfer; two such instances of business interruption involved automakers’ production plants. There was no physical damage to the product, but the failure or interruption of the deliveries to meet their destination within the predetermined amount of time caused losses.

Contingency plans for disruptive incidents often include the invocation of emergency air freighting from alternative locations. But the plans rarely address the non-availability of air transport either because of the lack of aircraft or the mandatory grounding itself. After the volcano erupted in Iceland, there were numerous attempts to charter aircraft and file alternative flight plans; even then, space availability was insufficient.

Following the five days of the volcanic disruption, the Business Continuity Institute conducted a snap survey: over 80% of mostly European respondents said they experienced some sort of disruption. The volcano caused many side-effects, but most were associated with the availability of staff. One-third of respondents said they were required to initiate their business continuity plans. Seven per cent of respondents estimated their losses at US$12 million or more. It has never been more relevant for corporations to re-evaluate their risk management strategy, since they are bearing 100% of the risk capital for any similar event that causes no direct physical damage.

BUSINESS PLANS

Planning solely for predictable incidents, or passively exposing operations by simply reacting to unforeseen events, can place a company in jeopardy. A proactive approach to safeguarding against future failures should include the application of best business practices. A key decision is to choose a supplier with the resiliency required to survive the previously mentioned risks. This supplier would have safeguard features in place such as regular monitoring, contract management, regulatory control and business continuity management.

As with many other risks, even the most comprehensive risk assessment and mitigation plans won’t guarantee the elimination of interruptions to the supply chain so long as one relies upon others to provide a product flow to maintain one’s own operation afloat. As with all other risks, a company must look to the importance of business operating plans as well as optimal risk financing to protect them from negative financial impacts in the event that mitigation efforts fail.

Needless to say, the ability to assess and transfer risk in a comprehensive way provides the opportunity to use captives, insurance products and other alternative tools effectively to reduce increasing exposure. No no one knows when and where the next disruption event will occur. We do know there will always be another one to test our prevention planning.