By Suhayl Abidi and Manoj Joshi
If there's one thing that is certain in business, it is uncertainty and COVID-19 is only the latest example. The acronym VUCA expands to Volatility, Uncertainty, Complexity and Ambiguity. The fundamental challenge facing leadership is how to make strategic decisions given the uncertainty of the future. However, we continue to take decisions as if we are still living in a stable age where the future is a continuation of the past, such as taking on inordinate debt for fast growth.
Many of our big failures in the past such as Kingfisher Airlines, Jet Airways and Hotel Leelaventure have occurred due to downplaying the uncertainty factor in future planning. Uncertainty always involves risk and managing risk as managerial tool has gained importance in the recent past. How much hedged are you against these risks?
Risk Management is an underrated function in corporate India. We have seen in fast-growth companies such as Lehman Brothers and our own IL&FS how this function was downgraded and its subsequent results.
Proactive risk management system
In the past, we have managed risks by extrapolating the incidents which happened in the past and plugging holes for the future. When novel situations arise, which have not been experienced before, our Risk Management Systems (RMS) fail. We need a proactive RMS which can peek into the future and present various scenarios and mitigating strategies can be developed for each of the scenarios. As more knowledge accumulates and insights are gleaned out, certain options become more feasible than others. worldwide industry bodies and government, regulators and international institutions have spoken of for better RMS and processes that can mitigate the increasing shocks of global uncertainty.
Coronavirus has added to the already existing substantial political, economic and social risks. Thus, overhauling of RMS is the need of the hour.
Nate Silver notes in his book The Signal and the Noise on Lehman bankruptcy, which led to the 2008 economic meltdown that "the problem of rating agencies was that they were unable to or uninterested in appreciating the distinction between risk and uncertainty. The alchemy that the ratings agencies performed was to spin uncertainty into what looked and felt like risk. They took highly novel securities, subject to an enormous amount of systemic uncertainty, and claimed the ability to quantify just how risky they were. Not only that, but of all possible conclusions, they came to the astounding one that these investments were almost risk-free".
A large number of investors misinterpreted these embellished & elaborate conclusions for authentic ones and Franklin India apparently did the same to its bond portfolios which have recently been frozen.
Risk is usually assumed to be the same as uncertainty although there is a significant difference between risk and uncertainty.
Let us take an example from the field of cricket. Two world-class teams -Australia and India - decide to play a match. One cannot say which team will win. However, by reviewing and analysing the historical data of each player, the teams and captains, the results of matches they played against each other and the venue, you can make an educated guess of a 60 percent chance of a particular team coming up trumps. This is called risk analysis and this is what the bookies do.
Now, take a different plot. We do not know the composition of the team, the two captains and where the match will be played. Here, you don't have any information on past events and cannot predict which side will win, even though the rules of the game are the same. This is called uncertainty. Therefore, risks can be measured and quantified while uncertainty cannot. Risks can be managed while uncertainty is to be accepted and faced with positive traits such as determination and optimism. Therefore, RMS fails when dealing with uncertainty as these are novel situations.
Should we be paralysed in our decision-making when the future is uncertain? We can take certain action to plan for uncertainty, even unforeseen, devastating black-swan events like COVID-19 pandemic. Just like the 2008 economic meltdown, the world economy is largely entering uncharted territory.
There is no substitute for a healthy balance sheet, low debt and high cash flow and building up a reserve which can be used in novel situations.
A report in Mint noted that "Survival of firms with weak balance sheets is at risk". Companies with high debt, especially in a country like India where the cost of debt is high, will be the most to suffer once COVID-19 is history as we have seen in previous cases such as Jet and Leelaventure.
According to an article in Business Standard dated 30 October 2014, in FY14, Leela Hotels had a total debt of Rs 4905 crore on net sales of Rs.718.44 crores while its rival East India Hotels had a debt of Rs. 451.75 crores on net sales of Rs. 1539.61 crore. In today’s lockdown scenario, which of the two will survive?
In an uncertain environment, companies should go easy on expansion plans. Ultimately, not only Leela had to sell off its prime properties, but in the end, the company itself. A company in an industry such as hospitality or airlines, the first to be affected in any slowdown, high debt is suicidal. Today, many companies will face this situation.
'Cash is King', said management guru Charon Das. In an article in Forbes dated 15 January 2014, he said: "First, if you do not have—or cannot generate—cash in the short term, you are not going to have the long term. Second, figure out how much cash you are generating and then restructure your debt. Third, revamp your business and understand that it needs to be more focussed. This might even mean becoming smaller, but it will keep you safe; then you can generate extra cash to fund for productivity."
The other action which boards can take is to introduce the discipline of Strategic Foresight or Corporate Foresight, which anticipates and influences strategic planning in their RMS. Strategic Foresight is a function companies can adopt to gather and process information about their future business environment. This information includes trends and developments in their economic, political, social, technological, and regulatory environment. The insights can be used to we learn from the future by simulating likely outcomes.
GMR's contract for the modernisation and operation of Maldives' international airport was cancelled by the incoming government in March 2018. On the surface, this looks like an uncertain situation which hit the company without warning but signs of the unrest in the local business community and the population in general over this project were evident much earlier, which was later exploited by the opposition party in the ensuing elections. If GMR had kept the situation under observation through talking to media, business community and the opposition party and taken proactive action for mitigation, it could have turned from an uncertain condition into a risk situation which could have been managed. GMR did acknowledge the fact that "it will have to exercise greater caution in respect of opportunities in other countries in future".
Knowledge is not the monopoly of a few at the top. Foresight study cannot be left to a few specialists but the company must cast a wider net to bring a larger number of employees into Foresight Group which keep tab on the wider social, technological and regulatory business environment and can alert the top management to early shoots of threats. This group must represent various functions so that risk is managed in holistic manner.
Foresight is keeping eyes open for early or weak signals emanating in the environment, understanding these and working out likely scenarios to respond to various options. Today Brexit is a reality but Britain’s future relations with European Community is mired in uncertainty. The Free Trade Agreement, under negotiation, could end up in one of several agreements, such as like one with Canada or one with Norway or no agreement with full tariffs as with India or even a new novel solution. Those companies with businesses in UK must work out their response to each of the likely scenarios. Those who do not act now will land up in an uncertain situation.
Importance of independent directors
In addition, boards should exercise greater control over RMS which cannot be left only to the supervision of ambitious and high growth-oriented CEOs such as Jack Fuld at Lehman Brothers and Ravi Parthasarthy at IL&FS. Left unsupervised, such CEOs can undermine RMS which puts brake on uncontrolled growth in times of uncertainty. The posts of Chairman and MD must be delineated to maintain checks & balances. Here, role of independent Board Directors becomes important. In fact, RMS should be externally audited regularly and reports send to the board directly for review. In VUCA, this function should be seen as important as financial audit.
The government should also recognise the critical function RMS performs as much of the funds under threat come from Indian banking system. It should frame laws & rules for audit as in financial audits.
To take your company successfully through both risks and uncertainty, you must be very cautious, observant, perceptive, proactive, and flexible. Those business leaders gearing up for uncertainties shall progress and those shying away, will perish. Hence, the business leaders should always be well prepared and mitigate VUCA conditions.
(Suhayl Abidi is an MBA from FMS Delhi and Information Management from Leeds Polytechnic, UK. He is a consultant with Centre for VUCA Studies, Amity University & a practitioner in Organisational Learning and Knowledge Management with over 27 years of corporate experience) Prof (Dr) Manoj Joshi is a Fellow Institution of Engineers, Professor of Strategy & Innovation, Director, Centre for VUCA Studies, Amity University. He has authored over 40 articles and co-authored two books - The VUCA Company and The VUCA Learner)