Risk Management

Who’ll Stop the Rain?

Mother Nature is business's biggest saboteur.
John GoffApril 1, 2005

Terrorists and hackers may spook corporate managers, but the forces of nature remain the biggest threat to the daily operations of most companies. It didn’t take much besides fallen trees, after all, to knock out electrical power throughout the Northeast two summers ago.

To ensure that such an outage doesn’t hurt its business, International Rectifier, a maker of power-conversion chips and circuits, is now in its third year of contingency planning (in conjunction with Marsh & McLennan). The $1 billion (in revenues) company started the first year by conducting a high-level review of liabilities, then devised plans to deal with those risks. Each successive year, says executive vice president and CFO Michael McGee, management has attempted to drive its business-continuity plan down one level. The ultimate goal: to be able to fulfill orders even if one of the El Segundo, California, company’s 12 far-flung manufacturing plants goes off line for a full year.

To be sure, risk management has long occupied the attention of finance managers. But of late, operational resilience (that is, business continuity or disaster recovery) has taken on a new importance. In fact, International Rectifier is hardly alone in its contingency-planning efforts. A recent survey conducted by Deloitte & Touche LLP and CPM Global Assurance found that, over the past five years, the number of companies that have devised business-continuity plans has jumped by 20 percent. Many observers believe this heightened interest stems from newfound worries about terrorist attacks and network outages.

Certainly, bomb-toting extremists or “black-hat” hackers evoke fearsome, powerful images in the minds of corporate risk managers. But according to government data, fully a third of the U.S. gross domestic product is directly affected by weather. Indirect effects are harder to measure, but weather-triggered events like downed phone lines or downed corporate jets can throw a spanner into a company’s operations for hours, days, even months.

In this era of on-demand manufacturing and razor-thin inventories, interruptions can have dire consequences. That’s especially true for companies that supply larger businesses with parts and raw materials. For those companies, a tornado in Topeka or a landslide in a California canyon can crimp production and, in turn, obliterate hard-earned reputations. In such cases, indemnification may not be enough. “You can insure your assets,” says Michael Morganti, a client-training manager at insurer FM Global in Johnston, Rhode Island. “You can replace your building, but you can’t replace the customers who don’t come back.”

Weathering Extremes

Larger companies are not immune to the weather, either. While multinational corporations are rarely shut down by the rain, harsh weather can stall plant operations and impair services. Worse, unseasonable temperatures often gut sales, particularly for retailers. In fact, scores of companies mentioned bad weather in their 10-Ks and 10-Qs when discussing poorer-than-expected results in 2004. Of course, one can’t help but wonder how many of these references were simply an excuse for poor performance. But some surely were not. In October, for example, management at airline operator ATA Holding Corp. blamed, in part, the four hurricanes that tore through Florida last fall for the company’s descent into Chapter 11 bankruptcy.

It’s hard to fault ATA executives for failing to prepare adequately for four Category-4 hurricanes making land in one season, an extremely rare occurrence (in fact, a 50-year event). Still, the Florida hurricanes were typical of the unnatural natural disasters that ravaged the planet last year. The massive tsunami that struck southern Asia in late December, for instance, was the third worst natural disaster of the past 100 years (see “But Could It Happen Here?”).

Domestically, blizzards, frigid temperatures, floods, landslides, and wildfires struck with unusual ferocity. In fact, according to insurance-industry data collector ISO, property/casualty insurers paid out more in catastrophic claims in 2004 ($27.3 billion) than in any year since that group began keeping statistics (see “Riders on the Storm”). Around 80 percent of the total insurance bill came from hurricane-related claims. Even communications specialist Sprint, a company known for its detailed contingency planning, was buffeted by the succession of hurricanes. “Those hurricanes played heavily on our resources,” says Greig Fennell, director of business continuation at the Overland Park, Kansas-based company. “For six weeks, everybody was working weekends.”

Sprint began preparing for the 2004 hurricane season the same way it always does: by conducting exercises before the season commenced to assess the company’s preparedness. Once Hurricane Charley made the radar screens in early August, the telco began dispatching power generators, batteries, extra food, and cell phones into the region. Fennell says Sprint, which reported sales of $27 billion last year, also dispatched extra technicians into Florida ahead of the storm. That move, like most of Sprint’s actions during the devastating event, followed an internal script created by Fennell’s team while Charley was still forming. “You have to have an appropriate process already in place to handle the situation,” he explains. “Without the process, you’re just reacting. And in a Category-4 hurricane, you don’t want to be shooting from the hip.”

Like Sprint, some companies conduct dress rehearsals of their business-continuity scripts. Each year, FedEx Corp., for example, prepares for hazardous winter weather by testing the time it takes to get its aircraft ready for cold-weather takeoffs. “We need to know how long it will take to de-ice, then wheels up,” explains John Dunavant, managing director of the cargo carrier’s global operations control center in Memphis.

Similarly, a growing number of businesses have begun to war-game emergency situations, usually in conjunction with a consulting firm or insurance carrier. FM Global, for one, conducts a workshop for clients in which the heads of a simulated corporation with five business units are charged with protecting the mock company’s profits, market share, and stock price during a simulated disaster. And how are those disasters determined? “We roll dice,” says Morganti. “A six or seven means your company has been hit by a fire. Snake eyes, it’s a volcano.”

Admittedly, few companies in the continental United States are in danger of being buried beneath a magma flow. And as any insurance vendor or risk manager will concede, it’s impossible to prepare for every natural disaster. “Ultimately, business continuity is a business decision,” notes Sprint’s Fennell. “It’s based on cost—how much are you willing to spend to protect the enterprise?”

According to the Deloitte & Touche/CPM Global research, however, half of the surveyed companies have no enterprise business-continuity plan whatsoever. Experts say lots of corporate officers don’t have the resources to invest in disaster prevention and recovery. Others are simply short on time. That’s understandable. As International Rectifier’s McGee acknowledges, business continuity is an awfully big topic. “It could consume you forever,” he insists.

Planning for the Worst

If crisis planning is an onerous, unpleasant task, consider the alternative. About four months before last year’s Daytona 500, Nascar’s biggest race, Hendrick Motorsports’s controller and CFO, Scott Lampe, got a phone call at his Charlotte, North Carolina, home. The voice on the other end, that of Hendrick marketing director Pat Perkins, delivered devastating news. A company airplane, en route to a race and engulfed by thick fog, had hit the side of a hill in south-central Virginia. All 10 passengers had died, Perkins said, including eight Hendrick employees.

Usually, general manager Jeff Turner handled problems with the company’s 10-plane air fleet; company president John Hendrick oversaw the day-to-day operations of the company. But both Turner and Hendrick were passengers on the ill-fated plane. With a gaping hole now in senior management (and with CEO Rick Hendrick coping with the loss of a son and a brother), Lampe—barely versed in the tenets of crisis management—went to work managing the crisis. After reassuring employees, consoling loved ones, and attending funerals, he contacted team sponsors, aviation insurers, and later, the company’s bankers to make sure they understood that Hendrick was still in business. But Lampe was going on instinct. “We didn’t have any plan for this,” he says. “There was no script to follow.”

In time, the crisis at Hendrick eased. One of the company’s racing teams, led by Jeff Gordon, won the Daytona, getting employees thinking more about future victories than past losses. Now Lampe himself believes “we’ve sort of turned the corner.” But in light of the crisis, Lampe says he has no choice but to examine all liabilities, all possible disasters. He says he will eventually draft a road map for dealing with the unexpected. “We were caught unawares by the accident,” he grants. “Now, we’re trying to get our arms around all the risk at the company.”

Of course, most businesses are unlikely to face the type of disaster that struck Hendrick. But few can afford to lose manufacturing capacity, let alone top managers, for even a short period. And that goes double for small businesses. Business-continuity experts point out that supply-chain vendors in the heartland are especially vulnerable to bad weather—violent, unexpected storms that can flood plant floors and take sheet-metal roofs right off of prefab buildings.

What’s more, such companies often supply businesses located hundreds of miles away, with deliveries typically carried out by truck. “It doesn’t have to be a tornado or hurricane,” insists Mike Croy, director of business continuity and disaster recovery at Forsythe Technology Inc., an IT infrastructure consulting firm in Skokie, Illinois. “Small and midsize vendors can be hurt by a bad winter in the Midwest where I-80 goes through.”

This vulnerability, in turn, creates all sorts of problems downstream. To steer clear of weather-related supply-chain problems, Croy says some larger companies (especially demand-driven manufacturers) insist on reviewing the business-continuity plans of their key vendors, with a few drawing up contingency-service-level agreements. Case in point: Corning Inc., a diversified technology company that makes glass for LCD screens and fiber-optic cables. James Flaws, CFO at the $3.9 billion (in revenues) company, says risk managers at Corning try to review the disaster-recovery plans of key vendors, including utilities that provide electricity to their manufacturing plants.

You can’t blame Corning for wanting to see those plans. The company operates one plant in Wilmington, North Carolina, an area that gets its fair share of hurricanes. Last spring, a tornado tore through the western Virginia town of Danville, downing power lines and damaging a nearby Corning warehouse. And in 2002, a large ice storm, accompanied by gale-force winds, knocked out electricity in parts of northern New York, including the company’s home town of Corning, New York, where it operates a big plant. “That storm really harmed us,” recalls Flaws.

Determined not to repeat the experience, Flaws says Corning contacted the local utility soon after the weather cleared. “We worked with the utility on a separate way to get power,” he notes. “We now have power available from two grids.”

Key-man Policies

Corning applies that same caution to executive travel. Although the corporation operates its own fleet of six planes, company rules limit the number of senior managers who can fly on any one flight. “We would never put six members of our finance team on one plane, for example,” offers Flaws. “It wouldn’t be prudent.”

Not all companies are as risk-conscious, however, a fact that leaves them wide open to disaster. In recent months, a number of corporate jets have gone down in bad weather, including the fatal accident at Hendrick Motorsports, the November crash of a private jet carrying NBC Sports chairman Dick Ebersol, and that of a Circuit City jet in February in which eight employees were killed.

While the National Transportation Safety Board has not issued a final determination on the cause of those crashes, the recent rash of accidents raises doubts about the ability of some corporate planes to navigate through bad weather.

Phil Livingston, who sits on the board of several companies, including Vienna, Virginia-based software maker Approva Corp., says he is amazed by the number of companies that don’t implement key-man policies for air travel. Livingston serves as a director for one business that has fractional ownership in a jet. “We haven’t discussed policies yet, but I guarantee we’ll talk about it,” he says. “This is a hot topic.”

Of course, when Livingston served as CFO of World Wrestling Entertainment, he says management at the privately held sports entertainment company talked about the same topic. Nothing ever came of the discussions. Instead, the WWE, which produces several TV wrestling shows each week, would load some of its biggest stars, along with senior executives, into the company jet on a regular basis. So much for hedging. “A company invests a great deal in top management,” says Livingston. “It’s a huge asset. And it’s the hardest one to replace.”

John Goff is technology editor of CFO.

Tonight’s Forecast: Dark

In an episode of the “Mary Tyler Moore Show,” Lou Grant chews out Gordie the Weatherman because an unexpected snowstorm has scuttled his vacation plans. When Gordie asks the WJM executive producer why he’s blaming him, Grant looks the weatherman square in the eyes and says: “You’re right. It’s not as if anyone could predict the weather.”

Actually, that’s precisely what some companies are trying to do. In a trend that started with the weird weather touched off by El Nino in 1997, a growing number of businesses are purchasing private seasonal weather forecasts. The companies, which run the gamut from manufacturers to tourist operators, use the forecasts to adjust inventory, tweak capacity, or purchase weather-related insurance. Why not just turn on the Weather Channel? Says one meteorologist: “Only a few meteorologists have a background in climate prediction. Most are geared toward short-term forecasts.”

Meanwhile, the weather derivatives market, slowed down by the demise of big player Enron, is regaining steam. According to the Weather Risk Management Association, the notional value of the contracts jumped 10 percent last year, to a record $4.6 billion. Stephen Jewson, director of weather risk at consultancy RMS, believes that in time, weather derivatives will be fairly commonplace on the corporate scene. “Weather risk is a new thing,” he notes, “and it takes time to quantify.”

A host of suppliers have sprung up to fill the demand for private forecasts, including EarthSat, AER, CustomWeather, and Planalytics. Michael Schlacter, chief meteorologist at New York­based Weather 2000, says his firm’s seasonal forecasts are about 80 percent accurate. “Forecasts generally fall apart past a year,” he says.

Some corporations purchase private predictions to augment in-house projections. At FedEx Corp., the company examines longer-term forecasts, looking for weather trends that might affect its fleet of 643 planes. For daily operations, however, the cargo carrier relies on its own team of 16 meteorologists, says John Dunavant, who oversees the company’s 19,000 monthly flights. “Cold weather doesn’t matter much to us,” he says. “The biggest concern is fog.”

Hurricanes and typhoons do create problems, says Dunavant, because of their size and unpredictability. Schlacter concurs. “[Long-term] predictions about hurricanes, especially regarding location, go beyond the realm of science,” he says. “That’s more the realm of magic.”—J.G.

But Could It Happen Here?

If there’s a hell on earth for CFOs, this is surely it. On vacation in the United States this past Christmas, Keat Lee was watching television when he saw a news flash about a killer tsunami that had ripped through parts of southern Asia on December 26. Lee was devastated. As the finance chief at Bank Mandiri, Indonesia’s largest financial institution, he knew that the bank employed 70 people in Aceh, the province in Indonesia that took the brunt of the giant wave. In time, Lee’s worst fears were confirmed: four of Bank Mandiri’s workers in Aceh were dead, another six lost. “We’re providing assistance to their families and other staff there,” says Lee.

Comparatively few CFOs in Asia have been as directly affected by the incomprehensible tragedy of late December, which killed nearly 200,000 people. Hardly any large manufacturers have a commercial presence in the devastated coastal areas, which were mostly home to fishing communities. Neither do outsourcers in Malaysia or India. “The factories, high-tech research centers, and ports that drive Asia’s growth escaped largely unscathed…,” the Asian Development Bank noted in a report.

But the devastation inevitably raises the question: Could such a thing happen here? After all, the coastal regions in the United States are home to low-lying financial and technology hubs that fuel the national economy, including New York, Boston, and San Francisco.

The answer to the could-it-happen-here question seems to be maybe. Companies on the West Coast are clearly at greater risk, geologists say, since the Pacific Ocean—particularly the area off of the northwest coast—is more tectonically unstable than the Atlantic. Admittedly, the risk is small (probably a 500- to-1 shot) in and around the Cascade region, and wave activity in the Pacific is monitored by the Hawaii-based Pacific Tsunami Warning Center. But early warnings won’t help companies move factories or facilities. One study found that waves reaching half a mile inland would cause $7.6 billion of damage in the San Diego area alone. In fact, a warning might give employers just a few minutes to evacuate workers to higher ground.

Tsunamis triggered by landslides pose a more likely threat to New York and Boston. Last year, researchers uncovered such a rift-in-the-making off the coast of North Carolina. So-called landslips can also occur during volcanic eruptions. Some geologists believe a future eruption of Cumbre Viejo (a fissured volcano on the Canary Island of La Palma) could send a granite slab the size of Manhattan plunging into the sea. That, they say, might generate a tsunami so huge it would submerge a seven-mile strip of coastline running from Boston to Miami.

More good news: Astronomers point out that a celestial object crashing into an ocean would trigger an even more catastrophic wave. Ominously, an asteroid dubbed 1950 DA is currently on a collision course with the earth. According to one recent simulation, if it landed in the Atlantic, 1950 DA would create a 12-mile cavity in the sea. Within several hours, 328-foot waves would break on the East Coast.

But unless your board is committed to serious long-term planning, don’t relocate headquarters quite yet. Cumbre Viejo has been silent for 56 years, and landslips on La Palma happen about once every 100,000 years. As for 1950 DA: the asteroid, which has a 0.3 percent chance of crashing into earth, isn’t scheduled to show up until 2880. By that point, the average human lifespan will be 342 years, Alpha Centauri will be a vacation getaway, and researchers will finally be close to solving the riddle of male pattern baldness.—Cesar Bacani & J.G.