In the unpredictable landscape of the business world, weathering difficult times is critical to value creation and preservation. While it is nearly impossible to predict the nature, timing, and extent of every potential threat, it is possible to predict reasonably likely scenarios such as a facility closure, the loss of a major source of financing, a recession, an increase in materials or labor costs, or the loss of a key customer, supplier, or employee.
Every business will eventually face at least one, and maybe even several of these events. Stress testing your business and proactively developing contingency plans can help ensure that you are prepared for impending challenges.
Following are six steps you can take to make sure that your business thrives in difficult environments.
- Identify Vulnerabilities. The first step in the process is to holistically evaluate your business, including suppliers, facilities, systems, processes, distribution channels, customers, employees, and financial condition to identify key dependencies and variables. For example, if you rely on one supplier for a key component of a major product, changes in the availability or pricing of that component could adversely impact sales and/or margins.
When identifying vulnerabilities, it is important to involve leaders from each of your significant segments because they may identify risks that would otherwise be overlooked.
- Define Alternative Scenarios. Next, consider alternative scenarios for each of the vulnerabilities identified. For example, if interest rates pose a risk to your business, define the alternative rates that you will use for financial stress testing. Or, if supply chain disruptions are a risk, determine the scenarios that you need to evaluate (e.g., a 60 or 90-day delay in the receipt of critical raw materials).
- Evaluate Impact Severity. This step usually comprises both quantitative and qualitative analyses of the alternative scenarios identified in step two, both individually and in concert with one another. For example, you might be unlucky enough to have both a supply chain disruption as well as higher interest costs.
- Prioritize. Once you have evaluated impact severity, you will need to prioritize vulnerabilities for contingency planning purposes. One easy way of doing this is to map them out in a simple two-by-two matrix with the likelihood of occurrence on one axis and the magnitude of impact on the other. If your business faces a risk that is highly likely and could have a significant impact, then addressing that risk better be high on the priority list. Conversely, risks that are highly unlikely and would have a minimal impact on the business probably do not warrant much attention.
- Develop Contingency Plans. Now that you have a list of high priority vulnerabilities, it is time to determine how to mitigate those risks as well as develop action plans to respond if and when an event occurs. Some plans may need to be more formal than others, but regardless, the people responsible for the execution of those plans need to be well-informed so they understand their roles and responsibilities.
- Revisit Vulnerabilities and Contingency Plans Periodically. Your business, personnel, and the ecosystem in which you operate are constantly changing, so it is important to periodically reevaluate risks and contingency plans in light of those changes.
Stress testing and contingency planning takes time and energy, but the rewards can be significant. When done properly, they reduce risk, ensure that your business has the resilience to thrive in highly volatile situations, and preserve value for all stakeholders.