Wednesday, 3 July 2013

What is Resilience? Why is it Important in a Turbulent Economy?


Resilience is the capacity of a system to withstand shocks or sudden and large changes in its environment and to survive catastrophes or extreme events. Rare and catastrophic events are often called Black Swans. In mechanical engineering, for example, the resilience of materials is determined by running an impact test on a specimen, as illustrated in the scheme below. A high-energy impact is an example of an extreme event, just like a global financial crisis or economy meltdown.

The test establishes if a particular material is ductile (i.e. able to absorb much energy without rupture or permanent deformation) or brittle. The test is well-defined, repetable and universally recognized.

Banks undergo the so-called stress-tests in a similar although less objective fashion. Stress-tests are defined as follows (Investopedia): "An analysis conducted under unfavorable economic scenarios which is designed to determine whether a bank has enough capital to withstand the impact of adverse developments. Stress tests can either be carried out internally by banks as part of their own risk management, or by supervisory authorities as part of their regulatory oversight of the banking sector. These tests are meant to detect weak spots in the banking system at an early stage, so that preventive action can be taken by the banks and regulators."

The problem with the above approach to "stress testing" is that one needs to assume what " unfavorable economic scenarios" or "adverse developments" are. And this opens many possibilities, including, for example conflicts of interest or opaque manipulations leading to more or less favorable outcomes. Dexia, the Franco-Belgian bank for example, has passed all stress tests just before its debacle. Just like ratings, stress tests are in urgent need of a major overhaul. First and foremost they need to become objective, repeatable and transparent.

The concept of resilience of a corporation - which today may be measured based on the technology developed by Ontonix - is crucial because our economy is unstable, turbulent, and most importantly, punctuated by shocks. It is difficult to imagine, in the face of galloping globalization, that these fluctuations and shocks would become progressively less intense and severe. On the contrary. All points in the direction of an increasingly rough ride. In order to survive - and the survival of a business will become a measure of its success - resilience will be the prime prerequisite. But more than that,

business resilience is a new and fundamental KPI

Just like in the case of materials,

resilience measures how well the underlying structure of a company can resist crises

In the case of materials it is the molecular and crystalline structure, in the case of a company it is the structure of its business. But how can this structure be determined? Simple. All you need is data which the business "generates" on a daily basis and which companies normally store in an ERP system or database. Ultimately, this data ends up in the respective Accounting Departments which produce Balance Sheets, Cash Flow and Income Statements and all sorts of financial reports.

Financial reports of a corporation may contain hundreds of different indicators  (variables). Clearly, one can expect that these indicators will be correlated with each other. For example, EBIT will depend on revenue. Revenue will be related to, for example, the number of clients or client transactions, etc., etc. In other words, the data will possess structure. An example of such a structure is illustrated below. The Map is based on financial reports of a retail bank.

If a company produces a healthy profit, it is in everyone's interest that it remains stable in a turbulent environment and that it is able to resist shocks, crises or domino effects. However, because the entire business of a company is ultimately reflected in its financial statements, and since these possess structure, it is important therefore that this structure be stable and resilient. In other words,

in the case of a resilient business, its Business Structure Map is also resilient

Business Structure Map resilience is easy to measure - you can even do it online - and assumes values from 0% to 100%. 100% corresponds to an extremely solid structure that is well equipped to face even severe shocks. Values close to 0% point to a business that is not able to resist even minor changes in its ecosystem.

Business Structure Maps should be monitored on a quartely basis

Not only do they provide a simple reflection of a business and its functioning, they also reveal its key parameters, main dependencies and weak points, if any. Business Structure Maps may be obtained for a single company or for systems of interacting companies which form a group or conglomerate. In such cases they provide holistic information of immense strategic value.

An alternative approach to the analysis of the resilience is of a corporation is to analyze the resilience of its organization. Employees form the backbone of any company and are its main asset. Organizations have a formal structure and an informal structure, based on the way employees interact, collaborate and communicate. Such an informal structure is not easy to capture.

Companies often resort to employee surveys in order to identify problems, capture mood and morale, employee satisfaction, etc. However, survey results may be processed to reveal the hidden structure within the organization. An example is illustrated below.

The above map, just like the Business Structure Map based on financial reports, does provide a reflection of a company. It too can be either resilient or feeble. However, unlike in the case of financial reports, employee surveys are very often subjective and may provide a distorted and skewed image of an organzation. Therefore, quarterly financial reports are by far much more relevant when it comes to mesuring the resilience of a business. The importance of resilience is clear:

resilience measures the fitness of a company

and every company should know its own resilience. In a turbulent economy this may mean the difference between surviving or having to exit the market.

You can measure the resilience of your business online using our resilience rating portal. Click on the image below.