How to Prepare for Recession Risk with ERM
Steven Minsky | Jan. 16, 2019
Today the economy is strong and your business is doing well. But are you prepared for when this strength turns to weakness? Enterprise risk management has been proven to help companies survive a recession.
While there is much debate over whether a recession is looming or not, the fact is, you need to be prepared. Whether in 2019, 2020, or 2021, it’s not a question of “if,” it’s a question of “when” a recession will occur, as history has proven that fluctuations in the economy are both inevitable and normal.
What I would like to help organizations understand is that preparing for a recession has everything to do with enterprise risk management. Any good business prepares for changes within and outside of their environment. A recession is just like any other change, and the consequences of not having a recession strategy in place could be grave.
I will outline some of the ways in which having an effective ERM program in place can help you survive a recession and even gain a competitive edge.
Can ERM Really Help My Business Prepare for a Recession?
To start, I’d like to share a success story with you. When I started LogicManager in 2005, everything was going up economy-wise, and it was an incredibly difficult time to get people to realize they needed risk management when business was booming.
Our first customers were early adopters of ERM and understood that only risk management provided a mechanism to adapt to market changes, implement strategic initiatives, and gain internal operational efficiencies. All of those customers not only survived the great recession but thrived in their business, a feat which they attributed to ERM and the use of LogicManager.
For instance, a small, regional corporate credit union used LogicManager’s ERM platform to assess third-party risk. Prior to adopting LogicManager, they considered their riskiest vendors to be the ones they spent the most money on. With LogicManager, they risk assessed each vendor based on their business impact using multiple criteria.
As a financial institution, their assessment revealed that investment advisory services like Standard & Poors were the highest risk vendors because their advice determined where the credit union invested most of their capital. Realizing the connection between bad advice and bad investments, they set up a framework to risk assess investment recommendations.
With a new system for identifying risk in place, they were able to take a closer look at subprime mortgages and mortgage-backed securities. Ultimately, their risk-based due diligence showed that, contrary to S&P guidance of AAA ratings, these securities did not have a sufficient risk-reward tradeoff. Thus, the credit union stopped investing in them all together.
This was a particularly difficult decision to make since all their peer institutions were investing heavily in these financial instruments. They needed evidence to present to their committees and board why they should not be doing the same. ERM provided them this evidence.
ERM helped this credit union make good decisions in this case, identify new opportunities and guide their execution, and survive the recession. As a result, they rose from a regional company, to one of the largest corporate credit unions in the United States.
What Kind of Risks Do I Need to Prepare For?
There’s a misconception that core business priorities, shifted by the recession, will bounce back after the recession is over. In fact, these priorities typically shift permanently as a result.
Before a recession, when everything is going up, companies tend to go on autopilot and focus less on how they’re providing their core service or product. But then, when the economy is on the downturn, organizational priorities shift to value and efficiency, and suddenly, businesses have to scramble to refocus their attention on creating business processes that deliver their product or service efficiently and cost-effectively while making difficult personnel, product, policy, process, and service decisions.
Another common misconception is a recession only carries financial risk. But if you look at performance management, and this concept of a balanced scorecard, a recession actually poses many threats to your business.
The four legs of performance are customer value and satisfaction, efficient use of capital resources, process efficiency and quality, and the capacity for learning and growth. As you can see, financials are only one-fourth of good business performance. And what’s more, because these four legs are so interconnected, if one falters, stability in all four areas will suffer.
For instance, if your core business is providing software to customers, you may have been on autopilot for a little while and forgotten to think about where your resources are best allocated to provide a fast, reliable, and affordable product. Since the economy has been good, your customers have also been a little more lax on where their money is going. But when a recession hits, customer priorities will quickly shift and they will look for a product that better suits their new needs.
Let’s look at a hospital as a different example. The same number of patients are likely to fall ill, but their insurance status may change with their employment status. As a result, patients may shift from preventative medicine to emergency room visits, and with fewer insured, where will funds come from to treat these patients? Will staffing levels be prepared for the shift? How will an increase in complaints and incidents be handled?
No matter what your core business is – providing software to customers, banking, or healthcare, etc. – identifying ways to create more value and efficiency before a recession will be crucial to surviving it.
How Can ERM Help Me Prepare for a Recession?
Enterprise risk management by nature is proactive and engaging, two essential characteristics that will help you survive a recession.
First, being proactive will give you much needed stability in a fluctuating market. To prevent the scrambling refocus on value and efficiency described above, organizations need a way to risk assess their offerings and identify which aspects of them provide or hinder value and efficiency.
An ERM platform not only helps you risk assess your offerings and processes, it also helps you engage subject matter experts from the front lines up to the right level. It aggregates information from multiple sources and identifies the interdependencies that cannot be seen from a single silo viewpoint and gather information to make smarter decisions. Ultimately, it enables a comprehensive action plan to be presented all the way up to the board as needed.
Personnel at the front lines are subject matter experts and know the risks if asked, but they lack an ability to escalate these insights up levels and across silos to the decision makers who can act in a timely manner. Cross-department managers who have identified and prioritized risk issues can then determine where to focus their time, money, and energy. Maybe it’s a streamlined sales process, or maybe it’s time to switch vendors. The key is to make these changes before the recession hits so that you have time to meet your customers’ expectations before they shift away from what you can provide them.
Here are some of the key questions you should consider:
What preventable mishaps may occur due to a recession? Are our priorities aligned with safeguarding against these mishaps?
Will we need to adjust our hiring plans? Which key personnel would we need to retain? Are there skills missing from our organization or areas of inefficiency that will make us slow to respond? Which processes are poorly defined, making changes difficult?
How do we identify our vulnerable key customers? Will their needs change and are we prepared to meet them? If some of our key customers are going to disappear, who will replace them?
How do we evaluate vulnerabilities in our supply chain? Are there contractual changes we need to make? Will the advisors, vendors, or partners we rely on be affected?
Could our privacy and security policies and mitigations be affected by a recession? Will third-parties holding sensitive company information have the right resources in place to protect it? If layoffs need to occur, will former employees’ access to sensitive information be properly revoked?
Only ERM crosses business silos and levels to answer these questions and determine how the waves of creative destruction due to economic change will impact your organization’s strategy.
Housing all of this information in one centralized platform with reporting capabilities will also be key as the heroic risk manager leaps into action and approaches the board with a plan of action: “Here’s what could happen, here’s what we need, here’s where I need your help.” Getting buy-in will be key, and ERM reporting is the way to do it.
Ultimately, ERM helps identify decision controls in a fast-moving environment, to make sure the right people with the right knowledge are making key risk-reward account decisions. With a proactive and engaging ERM strategy in place, you’ll be able to ward off recession risk before it irreparably damages your business. ERM will provide your business with superior execution and better planning to out-perform your competitors.