Hysteria; common sense and enterprise risk managment
The September Canterbury earthquake prompted an article in our December 2010 edition from Tom Wilson. The second earthquake, with both fatalities and far-reaching economic impacts well beyond the first, has motivated this second article by Dr James Lockhart, Associate Pro Vice-Chancellor, Massey University to offer a broader perspective on risk and risk management.
When Tom Wilson wrote his article four months ago he suggested, quite rightly, that the September earthquake was likely to become the most damaging natural disaster experienced in New Zealand. Within months, New Zealand’s, and all first world understanding of natural disasters and unintended consequences, have had to be recalibrated. The two earthquakes in Canterbury pale into insignificance when compared to Japan, which happened to be the fourth largest earthquake ever recorded
- Japan 2011 magnitude 9.0
- Chile 1960, magnitude 9.5
- Alaska 1964, magnitude 9.2
- Indian Ocean 2004 magnitude 9.1.
Some observations about the response to these disasters and effective risk management strategies follow. An attempt to separate growing hysteria from common sense is also offered.
What will be remembered
Well before the confirmed death toll from the Sendai earthquakes exceeded 27,000, global media focus shifted to the radiation leak at the Fukushima Dai-ichi nuclear power plant, located 65 kilometres from the epicentre. Uncertainty, the unknown and even disbelief concerning the release of information from Japan contributed to the growing media frenzy. But in five years’ time what will be remembered? The mass of people who were killed from the earthquake and following tsunami, or the comparatively few who suffered from radiation sickness, related illnesses and death from radiation?
The equivalent of the population of Timaru was killed in the immediate aftermath of the earthquake, but media focus quickly changed to the burned feet of several workers at the plant. The plant was constructed by General Electric in 1967 and is owned by TEPCO (Tokyo Electric Power Company), all of which supposedly adds further mystery to the nuclear catastrophe.
TEPCO is described as secretive by the western media, but given that it is responsible for the generation of about a third of Japan’s electricity needs this appears somewhat unlikely. General Electric is also being blamed. The Mark I reactor provides no venting for hydrogen gas from the containment buildings. In the event of a cooling failure there is a massive production of hydrogen gas from the exposed fuel rods in the reactor core.
Two dimensions of risk
Can an appropriate risk management strategy be developed and deployed to meet such circumstances? Or is acknowledgement and acceptance of genuinely extreme events, with very low probabilities, a better course of action? This is providing, of course, that conventional prudence is exercised.
A second observation which is no criticism, is the gulf in self-sufficiency between rural and urban households. Immediately after the second earthquake Christchurch received seven millimetres of rain, or 120 litres of water on a conventional household roof if it was, or could be, collected.
The recommendations to close the gap in sufficiency between rural and urban communities in New Zealand are fascinating. For example, a proposal has just been put to Wellington City Council for a portable emergency toilet and a large water container in every house in Wellington. By contrast, the immediate needs of farmers in Rangiwahia following the 2004 Manawatu floods were cigarettes.
Two dimensions of risk to consider are the probability of failure and the probability of regret. The probability of failure is the likelihood that a specific course of action results in failure, namely business failure. The probability of regret refers to a course of action that is or is not followed which subsequently results in regret, rather than failure.
Minimising risk is normal
Horticulturalists, more so than most other business owners, actually face the probability of failure, especially crop failure. As a result much has been done in the industry to minimise these effects. These interventions range from technology to moderating weather in the form of frost protection and irrigation, crop insurance, post-harvest insurance, and post-harvest technologies to extend the shelf-life of fruit and vegetables.
However, they are unlikely to include forms of cover for extreme natural or man-made disasters such as those encountered in Sendai or Canterbury. The responsibility for business protection against these forms of disasters falls first with business owners, and then with the state. The latter, over an extended period of time, has developed reasonable provisions such as that available in New Zealand through the Earthquake Commission.
Immediate relief from the effects of floods, fires, cyclones and storms is, by comparison, considerably more variable. For example, the 2010 winter snowfalls in Southland attracted considerable media attention and support for those affected farmers. However, the devastation to the lamb crop of North Island hill country which occurred at the same time, while less spectacular, had considerably greater economic effect – up to twice as much.
Those affected properties simply got on with it, and have had to manage through significantly depressed farm income over the last six months. Ironically, depressed production from the wettest and coldest September on record, occurred at a time when nominal product prices across the sector. They are significantly higher than that achieved over the previous decade.
Research quantifying risks
The probability of regret refers to following a course of action that, with the benefit of hindsight, proves sub-optimal. The uncertainty encountered during decision making is resolved over time. Much research has been conducted on quantifying such risk functions, probabilities and coming to terms with decision makers’ appetite for risk.
Growers are confronted with the need to manage the probability of regret on a daily basis. Considerable science has also been applied to enhancing decision choices, especially those related to crop selection, disease control, harvest management and post-harvest regimes. None of these, however, would benefit a grower on the Sendai plain or a Canterbury orchardist whose home and buildings had just been destroyed.
Research conducted at Massey University on risk management in New Zealand, supervised by Dr Bernie Frey, provides disturbing news. While companies acknowledge that they would benefit from more formal risk management processes, most companies surveyed were found to have a fragmented, highly manual or incomplete approach to managing risk. Reasons for not having a formal risk management strategy included −
- Being too busy with other business issues
- Lack of knowledge on how to go about it
- Not knowing how to identify an expert to assist
- The belief that risk management is not important for small business.
By way of contrast, Bernie Frey states that risk management should be forward looking as opposed to backward looking. Rather than being compliance-focused it should be performance-focused. Also, instead of being directed solely at financial performance, it needs to include value creation in the long term. Appropriate enterprise risk management should therefore be viewed as a wealth creation activity rather than a cost to the business.
Responsibility with business owners
The responsibility for risk management lies with the business’s board. The Securities Commission states in Principle 6 that ‘the board should regularly verify that the entity has appropriate processes that identify and manage potential and relevant risks’. While most small to medium sized enterprises lack formal governance structures, the importance of enterprise risk management cannot be ignored. In the absence of a formal board, that responsibility inevitably falls on business owners.
The Canterbury earthquake has motivated reflection on New Zealanders’ preparedness for similar or even more destructive events in the future. These will inevitably happen, but in what form and when they will occur is currently beyond the ability of anyone to predict. The preparedness conversation is also being manipulated by self-interest.
As time passes, and providing New Zealand does not suffer further catastrophes on the scale of the Canterbury earthquakes, preparedness will inevitably wane, resilience will falter and latent dependency on the state will again increase. New Zealanders live on the edge of a tectonic plate. Our largest urban area is sited on a volcanic field, and much of our agriculture and horticultural production is located in the roaring forties.
As a nation, New Zealand cannot afford to become complacent. Growers and farmers must balance preparedness for natural catastrophes by diligent planning with the desire to continue to grow their businesses.