Worst Case Scenarios

The best CEOs in the world – whether they run multinational corporations or small, growing businesses – are those who possess, among other traits, the ability to understand what the ‘worst case scenarios’ could be for their businesses and they keep a keen eye over those risks and exposures.  Like a hawk watching over its prey, they’ll swoop in with lightning speed and remove the threat preemptively. 

Sounds like paranoia?  Sure, but that is what it takes to successfully run a company and prevent the business from being overtaken by the competition and the ever-changing business landscape.  In almost every analysis of failed or failing businesses, the result will inevitably show that the managers and executives had taken their eyes off the risks. 

Everyday, businesses (and investors) take risk and they expect to be rewarded for doing so.  Risks are a normal part of business – whether it is in the form of new investments (assets, manufacturing plants and equipment) or inventory (stocking up ahead of the holiday season) or in granting credit (facilitating customer purchases), there are risks.  However, service and product pricing can only assume that there will be certain reasonable risks – otherwise, few people will be able to afford to buy the service or product.   The impact of a ‘worst case scenario’ (and varying degrees of that) must therefore be evaluated and avoided (where possible) or hedged against where the likelihood of it occurring is more probable than not.

Consider the car-manufacturing business.  For decades, fuel costs were low (some might even remember when a gallon of gas cost less than a bottle of Coke) and manufacturers had no worries about what could happen to their business model if the cost of gas doubled or tripled.  Despite the Clean Air Act of 1963 and the public’s support of the electric car, manufacturers that had leased fully working production models to the public removed them from the market.  They could not and would not imagine that the ‘worst case scenario’ would happen – that gas prices could go so high so quickly. 

When gas prices in the US started its fast track upwards and broke the $4 per gallon mark in the summer of 2008, gas guzzling SUVs and fancy big cars weren’t selling anymore and a paradigm shift occurred.  Hybrids cars went from being a fashion item to being a necessity and the return of the electric car became inevitable, sending those same auto-manufacturers scrambling back to their drawing board to come up with a product. 

Just as suddenly, automakers were faced with a credit crunch (thanks to the near collapse of the financial markets due to property speculation, sub-prime mortgages and collateralized debt obligations) at a time where declining sales resulted in a burgeoning inventory of unsold units on the dealers lots all around the country.  To make the whole thing worse, an increasing burden of pension obligations began to appear on their books (thanks to new financial reporting regulations) and forced those that were ill prepared or undercapitalized to file for bankruptcy protection.  The ‘worst case scenarios’ that they did not or would not permit themselves to worry about became a reality.  Lesson learned: one can only put off dealing with problems for so long - they will not go away and the consequences can and will likely become increasingly severe the longer we hold out.

The age-old adage “don’t put all your eggs in one basked” pretty much sums up what business need to be doing to stay ahead of the ‘worst case scenario’.   If and when the ‘worst case scenario’ happens, the business must not be found wanting.

Even in our personal lives, we need to always have an ‘exit strategy’ – just so that if ever the ‘worst case scenario’ happens, we know where we’ll end up and we have a ‘Plan-B’ that we can put into action. 

In learning how to ski, what stuck with me the most was the instruction I received on how to fall without incurring avoidable injuries and how to slow the fall or the slide down a slope and to get up and get going again. 

Parents have a tendency to be overly protective of their children.  Instead of teaching them how to anticipate problems and to cope in the event that bad and undesirable events took place, many parents do everything they can to put their child into ‘safe’ spaces so that their young would never have to deal with the disappointments in life.  In reality, they are only trying to spare themselves of the heartache and pain of ever seeing their own flesh and blood in a bad spot. 

My parents did not have the means or luxury of weaving protective cocoons around their children so they taught us the best way to cope, to fill our bellies when the rice jar was running low, to spice up the curry when there’s little to go with the rice on the table.  Although illiterate themselves, they taught us to study hard so we could have a better life than they did.  We learned what the ‘worst case scenarios’ could be and we learned enough to steer clear from them. 

When you have only one egg in the basket, you’ll quickly learn never to let the basket fall.  And if it should fall, you have done everything you could to keep the floor clean so you can still make a meal out of the broken egg.

Ignore At Your Own Peril

Lest it be misunderstood, the crux of my previous posting titled ‘Pointing Fingers’ was not to absolve those people in positions of power. By their callous and careless actions, they have created the gigantic sink hole we are witnessing – a crater filled with lost jobs, foreclosed homes and wiped out retirement savings. History will judge them for what they have done. Their reputation will turn out to be less-than-flattering when the book is closed on this chapter of our history.

The point is that we need to take responsibility for our individual actions because collectively ‘We the People’ have the power to determine the course of how things turn out. By our daily decisions on what we do and what we consume, we have the power to determine which services or products and, by extension, which companies succeed and which fail. Because what we can expect in the future is determined by what we do today, we have a duty to ourselves and to future generations to be more thoughtful and less ignorant of the longer term impact and benefits of our decisions.

If we had not ignored the possibility that a finite supply of fossil fuels would result in ever increasing energy costs, we would have more aggressively pursued the development of technology to tap into alternative and renewable energy sources. We would not have abandoned the idea of the electric car and we certainly would not have bought into the deceiving appeal of gas guzzling SUVs. We would have severely restricted or discouraged suburban sprawl requiring longer commutes.

If commodity traders and hedge fund managers had not ignored the fact that oil prices above a certain threshold would have the impact of a sudden and massive reduction in consumption, companies would not have had to cut back production and factories would not have had to close or to lay off workers.

If executives in corporations had not ignored the impact (to the very consumers they rely on) of their relocating all types of jobs overseas, there would have been a less of a drain on the US consumers’ power to spend and there could have been fewer home foreclosures.

If bankers and housing developers had been less speculative and had not ignored the possibility of the housing bubble bursting, fewer new homes would be on the market and fewer sub-prime mortgages would have existed and fewer foreclosures would have resulted.

If home buyers had carefully weighed their income against their mortgage obligations and considered the effect of a change in circumstance such as illness, loss of job, decline in property values, they would not have taken risks they can ill afford or fallen prey to predatory lending practices.

A progressive society is one that has a conscience and does not chose to ignore the future consequence of its actions today. Ignoring tomorrow does not make it go away. We need leaders that are forward thinking and who understand that we can’t mortgage our children’s future for our own short term enjoyment.

We can learn to say “NO” and we can learn not ignore the danger signs. Some did and are surviving the present crunch. It was encouraging to hear on the news today that a small bank in Kansas stuck to its policies by not making risky loans in exchange for higher profits. In addition to remaining financially sound, it helped its customers by discouraging speculative borrowing.

Survival is a long-term game and ‘We the People’ are all in it together.