The global economy is affected by more and more vehement crises. Risk- and Business Continuity Management are developing into central challenges. What role can the Legal Department play and what contributions can it make in this context?
Vulnerable global processes
Global networking has never been greater than it is today. Global Sourcing and Just in Time concepts for production and supply chains are shaping economic life. In the past two years, we experienced the fragility of these structures in many ways: A container ship in the Suez Canal causes a supply bottleneck for microchips. Protective measures in the context of the Covid-19 pandemic in combination with BREXIT leads English gas stations to dry up. The temporary shutdown of coal-fired power stations in China, aimed at reducing CO² emissions, is making magnesium a scarce commodity, causing aluminum prices to skyrocket and the global economy to sputter. The list can be arbitrarily continued with disruptions caused by political crises – due to populists like Trump and Johnson or autocrats like Putin and Erdogan – and those, resulting from climate change.
VUCA supersedes globalization
What all these actual and/or potential disruptions have in common is that they can and will lead to significantly higher volatility – I.e., a greater range of fluctuation in prices, interest rates, exchange rates and volumes per unit of time – and cause considerably more uncertainty. At the same time, almost all experts agree that the complexity of economic processes will once again increase substantially because of the advancing digitalization (Internet of Things IoT, Digital Factories and Infrastructures IIoT, Blockchain/Smart Contract). In this world, it will hardly be possible to clearly assess which measures trigger which effects. The acronym VUCA intends to illustrate that the future will be characterized by volatility, uncertainty, complexity, and ambiguity. VUCA thus replaces the paradigm of growth and globalization.
Risk management was important and will become even more relevant
Climate change, BREXIT and the Covid-19 pandemic demonstrate that the VUCA future has already become the present. What all three crises have in common is that they caused massive disruptions or even interruptions in business operations as well as significantly harmed value and production chains. Business operations could not be continued or no longer be maintained to their full extent. If one analyzes the consequences of the disruptions, it is hardly surprising that companies with good risk management, including appropriate Business Continuity Management (BCM), were able to react more quickly and in a more targeted manner in the event of crises. These well- prepared companies were often clearly better protected than those who misunderstood Risk Management as tediously ticking off checklists and filling out of forms. Interestingly, 9 out of 10 companies (own sample with 36 participants) still see major room for improvement in terms of their Risk and Business Continuity Management. A complete (systematic) recording of the consequences of a business disruption and better coverage or insurance in the event of damage were named first in the list of possible improvements.
Contracts as the foundation for a systematic illustration of risk consequences
The Legal Department can make a key contribution to the complete recording and systematic presentation of risks. The occurrence of a business disruption is equivalent to not being able to conclude new “contracts” with customers or not being able to fulfill existing obligations to the extent promised. If we look at the above cases, customers were usually affected first, followed by suppliers and partners, then employees and finally shareholders and stakeholders. A complete acquisition of all contracts and a systematic presentation of the economic consequences of non-compliance with the contractually guaranteed services could be a first important contribution of the Legal Department to BCM and Risk Management. This representation can be well contrasted by looking at the actions that have been taken or will be taken within the framework of Risk Management and with how the protection for the occurrence of the incident looks. This makes any errors of action and gaps in hedging transparent. This systematic presentation of risk measures and the comparison with the necessary coverage is increasingly demanded by insurance companies to obtain coverage for certain damages. Systematic processing strengthens the negotiating position and significantly reduces insurance premiums.
Contract analysis makes interactions and cluster risks transparent
The systematic acquisition of contracts can be used to make cluster risks far more transparent. A cluster risk always occurs when you have different risk carriers, but the individual risks are highly correlated and/or have common causes. For example, different logistics partners who all use the same transport route or even the same container freighter. To make these risks transparent, it is necessary to correlate the production and value chains with the existing contracts. In our experience, this procedure has (too) rarely taken place in many companies.
Supply networks and resilience
When analyzing supply chains, or better supply networks, the level of detail of the analysis must be carefully balanced. The more dependencies between partners are considered, the more information is required to drive conclusions and statements. If individual risks are analyzed too much in detail, the view for the big picture and major causal chains can get lost.
The problem can be addressed by looking at the resilience of a network or system as a whole and trying to assess it. In simple terms, resilience means that a system can respond to a disturbance, compensate for it and in the best case adapt to the new framework conditions. Therefore, it is exceptionally important to assess and estimate the adaptation times, which makes it possible to compare precautionary or more general risk management measures over time.
Changed contracts and partnership cooperation
Awareness of the susceptibility of supply networks and production systems to disruptions and the resilience of these systems should be reflected in contracts in the future, especially regarding the regulation of the consequences of non-performance. It will be of little use to use one’s own negotiating power to impose risks on the contractual partner that the latter cannot absorb or compensate for in the event of a disruption to the overall system. In the future, collaboration and platform solutions will be central to meeting the challenges of the VUCA world.