How to guard against a risky recovery

Businesses may face greater risks at the start of a recovery than at any other time in the economic cycle, as Alex Cardno discovers

The UK economy may be staggering towards a long-awaited upturn, but for businesses this presents a plethora of different risks from those faced in a downturn.

This is particularly critical where the supply chain is concerned as the reliance of one business on a host of suppliers means a single break in the chain can have a catastrophic impact.

Nowhere is this better illustrated than the example of the Boeing 787 Dreamliner. Construction of the aircraft began in pre-recession times with parts from suppliers around the globe, but production was delayed by two years after issues with the delivery of certain components in 2007.

This serves as a key reminder that for even the largest businesses, the need to take control of the supply chain is crucial in an upturn.

As Mark Parsons, senior vice president for development and strategy at DHL Supply Chain, explains: “Whether small or large, businesses should build a portfolio of options, risk tolerances and capabilities to support adaptive, cost-effective flexibility.

“The goal is to build a supply chain that can handle conditions of systemic volatility and unpredictability. The supply chain must be resilient enough to withstand shocks, agile enough to respond quickly to sudden and unexpected change, flexible enough to customise products and efficient enough to protect margins.”

Some experts suggest businesses actually face greater risks at the start of an economic upturn than at any other time in the economic cycle.

Stephen Ibbotson, head of the finance and management faculty at the Institute of Chartered Accountants in England and Wales points out: “More companies actually go bust at the start of an upturn than in the preceding recession mainly because they can’t service the cash requirements. Increased business activity also tends to drive up costs, especially if capacity is limited and it becomes a sellers’ market.”

A key risk that is echoed by other experts is “overtrading”, which happens when businesses, buoyed by renewed demand, take on more work than either they or their suppliers can handle. Business growth will inevitably fuel higher demand from suppliers which in turn places higher demand on the supply chain.

But if parts of that supply chain are not geared for greater production, the entire chain is impacted by the shortage, resulting in unforeseen costs or firms seeking alternative suppliers and potential loss of business.

Sudden increases in demand could also put such severe pressure on businesses that they themselves fail, causing a void in the supply chain.

As David Birne, partner at accountancy firm HW Fisher, emphasises: “It is very tempting to take on every order and project, but businesses need to be sure they can cope with the increased workload.”

The goal is to build a supply chain that can handle conditions of systemic volatility and unpredictability

Of course, a change in risk-taking behaviour is another big risk faced by companies in an upturn. Experts suggest a downturn typically leads to a heightened focus on risk and risk management with companies tending to downsize staff numbers and take stronger measures to safeguard cash flow when the economy is weak.

This behaviour tends to reverse in an upturn, but with that change comes higher demand for key talent which, if not available, means a business can become significantly constrained by a key skills shortage, possibly threatening competitiveness and market positioning.

Jay Tikam, managing director of business risk consultancy Vedanvi, says: “When the mood is upbeat, no one wants to talk about risk and failure, often resulting in group-think with the consequence that organisations actually incubate risks rather than mitigate them. Lessons from the past will often be forgotten or deemed irrelevant and therein lies the risk of another crisis building.”

Similarly, an upturn may push management towards higher risk activities in pursuit of higher profits and this is where economic risk comes into play. Business growth and expansion is likely to require greater amounts of cash, working capital and funding, which may be in short supply at the very time when needed the most.

Also to be factored in is any potential rise in the lending base rate, which becomes more likely as economic prospects and employment levels improve.

Mr Birne adds: “Additional turnover will more than likely require additional funding so the risk of being unable to fulfil an order must be considered unless financing is forthcoming.

“An economic upturn can also have an inflationary effect which must be considered when quoting for projects as the cost of supplies and salaries may rise despite the business providing a fixed-price quote. Even if funding is obtained, the risk of an increase in interest rates in the next year or so must be considered.”

In addition, reputational risk has become a key factor for businesses as the 24-hour news cycle and prevailing use of social media increasingly has the ability to turn stories into national scandals in no time. Witness the horsemeat scandal of 2013, for example.

Richard Collins, global director for procurement services advisers Achilles, argues that customers are increasingly making purchasing choices based on the integrity of the product they are buying and its sustainability.

Despite these factors, there is plenty a business can do to mitigate the new risks posed by an economic upturn. Embedding a strong risk culture in a business is a key move.

Mr Tikam points out: “The starting point has to be one where firms acknowledge that risk management matters, even in an upturn. This philosophy starts at the boardroom and the organisation has to be crystal clear about their standards. Any breaches of standards must be dealt with swiftly, regardless of the level at which the personnel operate. Equally, good risk management behaviour must be recognised and appropriately rewarded through an effective performance management framework.”

And Mr Parsons at DHL says there is a need for collective, rather than sequential, risk management. He argues that the most successful companies operate an interconnected web of trading partners which embrace what he calls the four pillars of supply chain resilience: visibility, flexibility, collaboration and control.

“Rapidly changing and often unpredictable consumer buying behaviour has made volatility and complexity the norm rather than the exception in supply chains,” he says. “This state of play is exacerbated in an economic upturn. Whether small or large, businesses should build a supply chain that can be resilient enough to withstand shocks and agile enough to respond quickly to sudden and unexpected change.”