Stress Testing Your Business

The start of the new years is invariable time for reflection on lessons learned.  The past few years have offered some doozies for companies seeking to understand the challenging and shifting landscape.  Along with that reflection, managers are resolving to find ways to improve in the new year, and ensure their companies are equipped to cope with whatever might come their way.  The following article appeared in Open Forum - Why You Should Stress Test... and I thought the wisdom it provided bears repeating.  Ask the last few years bore witness, events beyond a company's control (and beyond its borders for that matter) can have direct and lasting impact to the company.  To help mitigate disastrous consequences, companies should understand what impact potential events might have on them.  An easy and direct way to see the impact is to perform a stress test.

The goal of a financial stress test is to determine how your business will react under simulated strains while under the protection of a controlled environment. The effort offers rich data as to the true health of the business and reveals underlying problems before they become acute crises. A stress test also helps leadership determine where resources should be allocated to prevent future problems from occurring.

As Peter Drucker stated, “The most serious mistakes are not being made as a result of wrong answers. The truly dangerous thing is asking the wrong questions." An effective stress test measures your company’s ability to respond to plausibly acute situations. The “acute” part is important because the scenarios being stress tested could significantly impact your company, and as usually is the case, they do not offer ample warning.  The article also emphasizes the fact that the plausible part of the requirement is equally important, as these sorts of efforts cost time and money, and you want both resources focused on potentially critical challenges.   Remember these are ideas to get you thinking; ask your team what keeps them up at night.

The article offered a few good examples based on recent events:

Global stressors

• The Euro as a currency collapses, leading to a global disruption of financial markets, a significant increase in interest rates and a severe credit crunch as U.S. banks rigorously try to compensate for their exposure to European sovereign debt.
• China decides to suspend its purchase of U.S. Treasury securities, favoring instead domestic investment to prevent a severe recession.
• A flare-up in political tensions in the Middle East sends oil prices skyrocketing

National stressors

• An inability to reach a consensus on appropriations due to political tensions leads to a major (but not complete) shut down in government services.
• As the budget deficit reaches unprecedented ... levels, corporate income tax marginal rates increase significantly.
• After another financial shock wreaks havoc among large banks, business credit completely freezes while a deadlocked Washington, D.C. fails to agree on a solution.

Industry stressors

• In an effort to placate organizations and movements deemed anti-business, the Executive branch of government significantly expands regulations and slows down the permitting process for your industry.
• After failing to reach a consensus on a new collective bargaining agreement, your factory workers go on strike.
• A raw material used in the development of your product is found to contain hazardous materials and its use is banned by Federal regulators as a result.

Company-level stressors

• An unexpected earthquake in California destroys your main source of raw materials with no expectation of the company returning to operations in the near future.
• A routine audit discovers that several managers and employees colluded to defraud your company of $3 million while also falsifying financial statements that were subsequently used by investors to evaluate an investment in your company.
• After a new technology launches, your company is forced to compete with a solution which offers customers the same results for one fifth the cost of your solution.

Some good pointers identified in the article include:

Record everything for internal training purposes. Similar to a case study, stress tests provide great learning opportunities for future managers at your company. Make the copies available as part of a formal management training process and as a resource on your company’s intranet.

Use a cross-functional team.  You want to have a broad of a perspective as possible, and to make the results realistic, and inclusive.

Remove the org chart from the team so everyone feels free to participate, and not hold back, or only speak if it puts them in a good light.  If its not a complete effort, the results are not much better than if it had not been done in the first place.

Consider making this at least an annual exercise and add new people to the mix.  New people = new ideas,  so that the process does not get into a rut and more people continue to think of the business in terms of these risk mitigation tactics.

May the results of these exercises and the subsequent responses your company has allow you to sleep better in the new year!