Resilience Management — Managers’ Supreme Discipline

Why Resilience matters

Before the COVID-19 pandemic many organizations focused on maximizing returns and increasing shareholder value through various channels, e.g. implementing complex supply chains. While these organizational measures were successful in the short-run, they were putting the company at risk in the long-term. Nobody expected a crisis on a global scale which would disrupt life at almost every corner around the globe. In order to survive this crisis as a functioning enterprise, the implementation of new systems and restructuring of organizational measures were necessary. To achieve this companies have to be resilient. But what is resilience and why is it important?

In business context resilience is a sustainable management process that is established over time by adapting the organization to potential risks, creating more robust structures and developing capabilities that buffer the impact of crises. Resilience is not just about surviving a crisis but rather leveraging the unforeseen business impact to improve performances. Therefore, resilience is a crucial capability which enables companies to identify threats early on, adapt to structural changes and recover faster. Ultimately, it can give companies an edge over competitors. The COVID-19 pandemic is a prime example to observe operational performance differences between resilient and non-resilient companies.

Economies of Resilience are essential for Business Success

Today, technology challenges the outdated conviction that resilience can only be bought at the expense of efficiency. That’s partly due to the fact that in recent decades, value chains have grown both in length and complexity, as enterprises have expanded in their constant pursuit of margin improvements. Such intricate production networks were designed for efficiency and cost rather than for transparency or resilience. However, these operating models can pose serious trouble if they’re not calibrated to risk exposure.

Source: McKinsey Global Institute
Source: McKinsey Global Institute

Apple, just like other firms that are considered one of the most successful (≈ efficient), had implemented a lean model of manufacturing, allowing for improvements in inventory levels, OTIF deliveries, and short lead times. In February, 2020, Apple faced severe supply issues as its main supplier, located near Hubei (CHN), wasn‘t even close to reaching forecasted production targets, following drastic restrictions to contain the SARS-CoV-2 pandemic. At the time, Apple‘s global terminal equipment business exclusively depended on a small Chinese province‘s pandemic response policy. Its production-intensity proved to be highly susceptible to external shocks. Following this harsh blow, Apple evacuated large parts of its iPad and MacBook manufacturing capacities to another country by November 2020. Nestlé, on the other hand, has been considered a crisis insurance, and it has proven to live up to this reputation, publishing an organic growth rate for 2020 amounting to 3.5%. Demand has plummeted for nonessential goods while basic needs still needed to be catered. Despite Nestlé‘s business model has been much more resilient than Apple‘s, because food is much more essential to societies than the latest smartphone. Supply chains of high value and concentration have been observed to be much more exposed to external shocks.

A network of many regional, diversified value chains — like Nestlé‘s — is notably more shock-resistant than a bundle of few, global but geographically concentrated value chains — like Apple‘s. An organisation‘s supply chain operations can be a source of either vulnerability or resilience, depending on the respective effectiveness in monitoring risk, implementing mitigation strategies, and establishing business continuity plans. This is of tremendous significance, as shocks inevitably tend to exploit the weak spots within broader value chains, as happened with Apple‘s Chinese supplier. Nevertheless, complexity per se is not necessarily a weakness, at least to the extent that it provides firms with redundancies and flexibility to resort to during crises. Companies like Nestlé, that held larger inventories and had lower fixed costs, incurred smaller financial losses from shocks. Such intentional decisions — how much inventory to carry, the complexity of the product portfolio — can make all the difference between a resilient company and one that perishes. Susceptibility to shocks and crises often stems from the structure of supplier networks in a given value chain. Concentration among just a few suppliers may make it easier and cost-efficient to manage them, but it also heightens vulnerability should anything major happen. In some cases, suppliers may even be concentrated in a single geography due to the particular country‘s specialisation in economies of scale. A natural disaster or localised conflict in that part of the world can cause critical shortages that snarl the entire network.

What we can learn from China and South Korea

When faced with global pandemics, there are countries which have managed the situation considerably better than other regions when it comes to ensuring that impacts on local business are minimized. The efficiency of handling such high impact events is affected by different factors including cultural, economic, political, legal and environmental differences.

From a general perspective, more developed economies have higher levels of business resilience compared to developing countries. This is partly due to the fact that wealthier regions are financially able to provide industries with sufficient funds to somewhat protect them from financial constraints. At the same time economic performance showed significant correlation to a country’s overall ability to contain their respective number of infection cases. A simple example is given by the US and China, two resilient economies pre-corona. While China quickly to isolated COVID-19 hotspots and implemented a number of mandatory hygiene measures, the US followed a more hesitant approach, leading to an exponential rise in infections — these results speak for themselves. While the American GDP shrunk by 3.5% in 2020, China was able to recover faster, finishing the fiscal year with 2.3% growth. Other countries such as South Korea, that also successfully avoided mass infections by acting swiftly, experienced similar economic trends.

In order to be resilient, a company must be able to control internal and external factors of operation. With governmental regulations forcing industries to reduce production in order to avoid infections, international trade was heavily disrupted throughout the first two quarters. Businesses that required foreign units for production were particularly affected. Countries with net import-heavy industries performed worse than economies such as China or South Korea who, apart from experiencing lower corona cases, also produce most input factors themselves. Thus, these companies are less prone to shortages and ultimately more resilient.

The German Mittelstand’s Pragmatism

A recent KfW research paper on the German Mittelstand’s reaction to the covid-19 pandemic found that those companies that used to be strong innovation driver before the pandemic were more likely to show resilience against the disruption. They were more likely to make changes to their product and service offering, their distribution channels and even their business model. A good example in this regard is provided by supermarkets, such as Rewe or Edeka. These chains, and their partly independent franchises, have been reinventing their offering many times over the past years, for example by focusing their offering on convenience food to rival take-away restaurants in city centres. During the pandemic, they were fast to introduce pick-up and delivery services, to the benefit of people at health risk or in quarantine.

Such a consistent pattern of adaptiveness to changing needs suggests that innovative spirit and entrepreneurial flexibility are embedded in a company’s culture. They are furthermore facilitated by the relatively small size and family atmosphere that characterize such a great part of the German industrial landscape. Those supermarkets, for example, are often run under both the chain’s and the owner family’s names as franchises, which are allowed some degree of freedom in their operations. This allows them to be more sensitive towards local customer needs and preferences, and communication channels between customers, staff and management are more direct.

To withstand a crisis like the current pandemic, they need neither a DAX company’s enormous scale or high cash reserves, nor sophisticated risk management frameworks and excessive contingency planning. In the face of adversity, German Mittelstand will, as president of the Institute for Mittelstand Research Bonn Friederike Welter put it, “moan, turn around, go on”.

IKEA — the Grandmaster of Resilience Management?

After having identified the importance of resilience and the difference it can make for companies, we tried to look for companies that have displayed a great resilience management during the Covid-19 pandemic. IKEA serves as an example of improving a future-orientated resilience concept to prevent further catastrophic impact. The question is how IKEA managed to increase their resilience and thrive in adverse conditions.

IKEA as one of the most successful furniture companies in the retail business faced various problems in the beginning of the crisis. Their stores had to shut down in countries like Germany due to governmental restrictions. Their online business was not very established, since customers were usually not interested in buying expensive furniture online.

IKEA was therefore forced to adapt their business model to the current crisis. They implemented their “Click&Collect” concept, which means that the customer is able to order the furniture online and collect it at IKEA’s “drive-through” pick-up station. The reason why this is successful is that customers have no alternative than to buy furniture online. By implementing this system Ikea took advantage of the E-Commerce rise. A big advantage of “Click&Collect” is that customers are able to receive their furniture without any physical contact point as the order is brought directly to the car. Even though they already had an online shop prior to the crisis, they did not focus on their online sales as the physical retail business was their core discipline. Over the course of the pandemic, online sales grew rapidly, mainly due to the implementation of “Click&Collect” systems.

We can learn from IKEA how important it is to adjust and adapt quickly to potential risks. It is remarkable to see how one of the world’s biggest retailers can change their whole business model to an e-commerce approach in such a short time. Their great resilience management has allowed IKEA to focus rather on taking advantage of the pandemic’s opportunities than just trying to minimize the negative impact. They can be confident that they can manage other obstacles in the future. IKEA implemented principles like diversity rather early and displayed great adaptability and redundancy to be more resilient. This allows them to have sustainable success. The crisis has shown that the attitude towards buying furniture online has changed which means IKEA’s online sales will definitely be higher after the pandemic compared to pre-crisis levels. IKEA’s global revenue in 2020 accounted to €39.6bn, down from €41.3bn in 2019. That relatively small sales hit can be linked back to their good resilience management. In Germany, the revenue has even increased from €5.3bn in 2019 to €5.3bn in 2020.

Source: IKEA Company Information

In 2020, ecommerce sales represented 16% of total sales of IKEA. The company’s ecommerce website welcomed c. 4bn visitors in 2020, growing by over 1bn visits since 2019.

Therefore, from an management point of view, IKEA is a prime example of an agile company due to their centralized business model which allowed them to quickly integrate their new strategy.

This article was jointly written by the Advanced Corporate Finance Class (Spring Term 2021) at EBS University in Wiesbaden / Germany.

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