Spend Matters welcomes another guest post from David C. Wyld of Southeastern Louisiana University.
If your cable lineup is like the one at our house, CNBC is sandwiched between the Weather Channel and CNN. Perhaps that is very fitting, as today we have unprecedented coverage of natural disasters. We live in a remarkable age where we truly live in an interconnected world, where we can witness a tsunami hit Japan or a hurricane hit Miami live in HD. Yet, severe weather events have very real financial consequences, and as soon as a tornado hits a major metropolitan area or a tropical depression forms in the Gulf of Mexico, markets move.
There is an entire segment of the financial industry that analyzes how weather impacts the energy, food and other markets, and even a weather futures market where companies can hedge the impact of mother nature on their financial performance. Thus, in an age where all forms of natural disasters can have a major impact on entire industries, it is entirely appropriate that many of us can click between breaking news coverage of severe weather and severe natural events and coverage of how investors are reacting to and companies are coping with these phenomena.
With complex, global supply chains for companies having become the norm for industries ranging from automobiles and aircraft to technology products and retailing, natural disasters have to be on the radar of all CPOs and other procurement executives. Paul R. Kleindorfer and Germaine H. Saad wrote a classic article for Production and Operations Management on the subject, titled “Managing Disruption Risks in Supply Chains.” The two esteemed professors from the Wharton School of Business at the University of Pennsylvania stated that there are really two broad categories of supply chain risk:
- risks arising from the problems of coordinating supply and demand
- risks arising from disruptions to normal activities
Up to a decade ago, while companies paid much attention to the former, the latter area of “disruptions” had been largely regarded as random occurrences that could not be planned for. In this category, while in the modern world there will always be risk arising out of political and economic instability (from strikes, political protests, terrorism, civil insurrections, and actual armed conflicts), by far the greatest source of “disruptions” is not man-made.
The extent of the impact natural disasters can have on supply chains was brought home with the release of a major report on the global impact of natural disasters, both in human and economic terms. This month, Aon Benfield, a leading intermediary in the global reinsurance market and capital advisory service, released its Annual Global Climate and Catastrophe Report. According to the firm’s methodology, for a natural “event” to be classified as a natural disaster, the occurrence must at least result in an economic loss of $50 million U.S. dollars; an insured loss of $25 million; at least 10 fatalities; 50 or more injuries; and/or damage to at least 2,000 homes or structures.
While 2013 was a below average year in terms of economic losses from natural disasters—the global estimated economic losses of “only” $192 billion being 4% below the yearly average of $200 billion over the past decade (see Table 1)—there was a significant uptick in the number of non man-made events that reached the severity to be termed natural disasters. In fact, last year there were 296 natural disasters, which was significantly higher than a “normal” year in which there would be 259 such occurrences. And unlike in past years, the vast majority of economic losses (84%) occurred outside the United States (see Table 2). However, please do note the vast gulf between the total economic losses and the insured losses, which speaks to how natural disasters, particularly those like Typhoon Haiyan in the Philippines, have a devastating and long-standing impact - sometimes decades and even generations - on places in the world both near and remote.
Table 1: Top 10 Global Natural Disasters in Terms of Economic Loss - 2013
Source: Aon Benfield (2014), Annual Global Climate and Catastrophe Report, p. 4.
Table 2: Top 5 Most Economically Significant U.S. Natural Disasters in 2013
Source: Aon Benfield (2014), Annual Global Climate and Catastrophe Report, p. 25.
The majority of these events were weather driven, led by the two opposites of floods and drought conditions. While it may seem odd to talk about global warming at a time when much of the United States is in a deep freeze, the Aon Benfield researchers noted that severe weather events caused by higher water and atmospheric temperatures (tornadoes, hurricanes and cyclones, flooding, etc.) were only likely to increase in the future. They went into extensive detail analyzing the correlation of each category of weather-related natural disasters to rising temperatures and warned that 2013 was the fourth warmest year since land and ocean temperature records began to be recorded in 1880.
And so what are CPOs to do with this knowledge that natural disasters borne from both above and below terra firma will undoubtedly impact the value chain for their company and more specifically, the supply chain that they are overseeing? Should they cower under their desks every time a severe weather alert is issued? Should they conclude that every time they see a cold reporter on the Weather Channel standing beside an Interstate Highway somewhere in the lower 48 states reporting on a serious accident that the trucks involved were heading for their distribution center? Should they surmise that every time they see a cable news story about a sink hole swallowing part of a warehouse in an industrial park or an earthquake collapsing part of a processing plant in California that the company was one of their suppliers?
As one might take as a lesson from Freakonomics, even big, area-affecting events do not affect everyone. So, this analyst does think it wise for procurement executives - both themselves and those under them in the procurement hierarchy - to monitor the Weather Channel, CNN, and other sources for breaking news available on TV and on the Web and to keep in communication with their supplier and transport partners to see how weather and other natural phenomena may impact their operations and their ability to deliver critical goods and services to the organization. However, there is a caveat to be realistic in the amount of effort devoted to both monitoring activities and contingency planning. As the old adage goes, try as one might, you simply can’t plan for everything. And so, CPOs should try to strike a balance between being prepared and being obsessed.
I would conclude with a rule borrowed from a radio show from Washington, DC that I listen to almost religiously. Tony Kornheiser, of PTI fame on ESPN, has what he calls the Jim Cantore rule. He is himself obsessed with weather and how it might impact his daily life and work, and thus, weather takes up a major portion of his local “sports” radio show on WTEM ESPN980 every weekday morning in Washington. Plainly stated, Kornheiser jokes that while severe weather is well worth paying attention to, you really should pay attention when the Weather Channel sends meteorologist Jim Cantore to report on a weather calamity on your block or in your city, because that means that they believe that the killer hurricane or blizzard has a bull’s eye on you!
By then, yes, it’s really too late to plan, as it’s time to cope with immediate conditions and get ready for the aftermath of whatever is to come. However, if a CPO has monitored conditions and effectively planned for such an occurrence both internally and externally with partner firms in the supply network, he or she can have a critical 24, 48, or even 72 hour jump on what weather-related event is about to happen and lead his or her procurement operation in a coordinated, thoughtful manner. And sure, there are natural disasters of sky (tornadoes) and earth (earthquakes, sinkholes) that, while regional, are random in exactly who they will ultimately impact. For these, this management consultant would say be prudent and prepared.