Resilience for the Long Term

Resilient Sprout in Drought

In 1973, CS Holling, a biologist, argued that the “Equilibrium” idea of natural systems that was then popular with ecologists was wrong.He said that natural systems went through drastic, unpredictable changes – such systems were “profoundly affected by random events”.  He defined resilience as:

A measure of the ability of these systems to absorb changes . . . and still persist.

He also talked about how natural systems go through a four-phase cycle—a cycle that is amazingly like what we experience in business.

Four-phase Cycle

To illustrate those four phases, let’s look at a graph of how housing prices have performed over the past 40 years.

Four-Phase Cycle

For the first 20+ years of this graph, housing prices were moderately volatile.  There were some large swings as well as short-term bounces in housing prices.  We will call that a Moderate period.  Then for a few years, prices went almost straight up.  We will call that phase a Boom.  Which as we all well know was followed by a Bust.

But the unusual thing about this chart is that it very clearly shows the environment that we all have been struggling with for the past 3 – 4 years—an Uncertain phase.  These four phases are remarkably like the four phases that Hollings described in nature.

Resilience in the Cycle

Resilience means something different in each of these four phases.  And the firms that are the most resilient will take advantage of the best strategy during each phase.

  • Boom – During the boom, the best resilience strategy is to grow!
  • Bust – Triage is the strategy best-suited resilience strategy for the bust.
  • Moderate – During the moderate phase steadily improving is the best strategy.
  • Uncertain – And the best strategy during uncertain times, as you have all figured out the hard way, is to diversify your business.

The good thing is that these four phases will be repeated and some version of these four strategies will always be the best resilience strategy for your firm.

Boom Strategy: Grow

The strategy of the boom is growth.  That is not obviously a resilience strategy.  But here is where we can borrow the most from the biologist Holling.  In Holling’s view of living systems, the species that had the best long-term resilience were those that took advantage of the best times to grow to be the most numerous and the strongest.  So grow your business and grow your balance sheet during the boom.

It is not hard to notice the start of the boom.  Either your sales start to jump, or you notice that your competitor’s sales jump.

During the boom, your job will be to help to fund that expansion of capacity that is needed to grow.

The thing to watch out for is that, at the end of the boom, many firms have borrowed very heavily to fund their growth, and some of them are stuck with one plant too many, possibly even an unfinished plant built entirely with borrowed funds.  So for the boom, you want to make sure that your firm can grow and take advantage of the great environment but you need to be on the look-out for the end of the boom and help to steer your firm away from making one too many expansionary steps.  A tricky call to make and not likely to be a popular position at the time.

Bust Strategy: Triage

The strategy of the bust is triage:  trimming away those pieces of the operation that are not self supporting and not reliably profitable.  This is a drill that many of you have gone through several times now.

The bust phase is not hard to recognize, as you know.  The bottom falls out, sometimes very quickly, and other times gradually over a few quarters.  This triage operation needs to be started as soon as the bust is clearly upon you.

There may not as much resistance to the triage during the bust.  The problem is to make sure that your firm will still have the resources for growth that will come with the end of the bust.

The biologist view of this phase is that the most resilient species are the ones that can both survive their worst environment but also be healthy enough to successfully go around the cycle one more time.  So minimal survival is not sufficient.

Moderate Strategy: Improving

The moderate environment is when the somewhat boring strategy of improving is best.  In this environment the little things add up.  Your engineers and quants and other expert employees are the best asset of the company.

Improve is a resilience strategy because these improvements are small and carefully implemented.  The moderate environment still is dangerous and changes must be made carefully.

It is a little tricky to see the start of a moderate environment, the indications of its start are mostly negative – extreme events, both good and bad become less and less common.  Those of us with a financial background will mostly feel at home in the moderate background.  The Greenspan-led “Great Moderation” from 1984 to 2001, was an extended period with only moderate ups and downs in the economy.  Our abilities to help to carefully fine tune a company to maximize its efficiency were very valuable and in demand.

But it is important to realize that that very push for efficiency gradually starts to reduce resilience and in some ways that Great Moderation with the almost 20-year period of improve strategy created the fragility that helped to make the Great Recession so toxic.

Uncertain Strategy: Diversity

Finally, in uncertain times diversity is the best resilience strategy.  That means that you need to move away from the strategies that concentrated all of your investment into those things that you did best and instead limit the degree to which your firm is dependent on any one product, or territory or distributor or supplier or manufacturing process.  You have also been building up your firm’s cash position.  And, as the uncertain times persist, you start to see opportunities to acquire smaller firms who can help to broaden your base even further.

With the diversify strategy, you are admitting that you are not really sure what will come next:  that any of your business units may be the next growth opportunity or any might well tank completely.

However, you need to be aware that the diversify mindset is toxic when the uncertain period ends.  Then you will need to shrug off the slow and careful decision-making and the under-commitment.

So What is Next?

What is next will certainly vary by sector.  Some sectors, like energy extraction, have already entered a new boom.  But, for most of us, the likely course is for the uncertainly to gradually reduce and for our environment to slide into a moderate phase.  That may have already happened in your sector.  Have you noticed it?

And when it does, you will be back in the game of promoting efficiency and improvement as the resilience strategy of the firm.  Slow and gradual growth of business and of margins.

Conclusion

Holling said that the species that were the most resilient grew enough when the environment was right so that there were still enough members left at the end of the bust.  And they also were able to avoid making any fatal errors in any of the other environments.

Like in biology, to achieve resilience in the long run a company must:

  • Choose the right resilience strategy in each environment so that the company has the capacity to both survive the next bust, but also come out of it strong enough to thrive and grow in the following cycle of moderate and boom environments
  • Take care not to unconsciously destroy resilience when increasing efficiency
  • Shine a light on those risks in the dark
  • Stress-test your most dangerous risks to find weaknesses
  • Pay attention NOW to what you will need for the next phase of the environment

 

About Dave Ingram

Dave is an Executive Vice President of Willis Re, specialising in theory and practice of ERM for insurers. Based in…
Categories: Reinsurance

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