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What Are Some Different Operating Models That Will Emerge After COVID-19?

The rapid acceleration of COVID-19 into a global pandemic that has cost many lives and livelihoods won’t last forever. On the other side of the bridge, firms will either still be in business or have closed their doors permanently. The operating model that made sense pre-COVID will require changes to be competitive in the new normal. This post outlines some potential changes that firms might want to consider.

An operating model is a framework for how a business delivers value to its customers. A trend over the past few decades has been focusing on the core competencies of a business, and outsourcing capabilities to third parties where this is possible so that a firm has a lean operating model and can focus on what it does best and the areas where it adds the most value.

What the COVID-19 pandemic has highlighted is that there are risks from outsourcing and offshoring that require flexibility and quick thinking inside often complex contractual arrangements. For firms that have their locations offshore, the movement restrictions will have reduced the capability of these teams unless investment in people, processes and systems was made well before COVID-19 arrived.

A firm will need to design a new target operating model to reflect the higher risk aversion and control over your value chain that boards will demand from senior executives. ESG risk is more important now, and in the new normal, than it was at Davos earlier in the year.

Institutional investors will expect great improvements in responsible corporate behaviour and efficiency. Employees will expect a strong focus on a safe workplace and measured changes to employment as opposed to indiscriminate cost-cutting. Regulators will expect compliance projects to deliver, even if deferred, and more regulation in many areas is likely to emerge in the new normal.

This scenario paints a picture of an ever more complex operational environment in which to design your new target operating model. For firms that were already struggling with people, processes and systems before COVID-19, this crisis could end them. The uplift in capability required for your *entire* workforce to be able to work remotely for extended periods will be beyond the constrained resources of many firms.

This remote work drive ignores the fact that two-thirds of the economy *can’t* work from home because of the type of work they do – for example, construction or in-person service at a retail store. The higher level of social scrutiny will mean standard responses to crises will face serious social media and political backlash if firms implement them. Already, those who are missing out on help because of the “lines in the sand” drawn by politicians are a major social unrest risk factor.

Because the core focus of the target operating model design is about delivering value to customers, the products and services that a firm offers will be adjusted. If firms are more conservative, risk-averse, and less willing to spend on discretionary items, your product and service offering will need to offer value-for-money and easily plug-in to existing operating models to win new business. The appetite for multi-year or even multi-month implementation projects will not return unless there are clear drop-dead regulatory deadlines.

The top value streams that your firm delivers to customers will need to be enhanced to reflect the new normal. Firms need to remove friction or pain in their customer experience, which implies high-skill people quarterbacking implementations and focusing on automation of processes wherever possible to reduce the overall cost of delivery and run-cost in BAU.

Simplifying the operating model of a business unit wherever possible, will assist in sustainable cost outs. The organisation design workstream of a target operating model design will need to carefully build the right structure that enables value delivery with no excess FTE requirements but sufficient flexibility to respond to ebbs and flows in transaction volume. Firms will need to work with collaboratively with customers and employees to arrive at this new organisation design. An indiscriminate restructuring that doesn’t consider the end-to-end value stream delivered to the customer will result in poor outcomes for the firm.

The role of location and place in how the assembly of value streams occurs will need to change. If more people are working at home, less office space will be required. Thankfully, because of outsourcing and offshoring, many handoffs between different organisations are already managed remotely through email, video chat, collaboration tools, and conference calls. There will need to be an uplift in the tools available if your firm doesn’t have these because getting people to use their cellphone and desk at home without full reimbursement will become untenable in due course.

The onshoring of all elements of the value stream, wherever possible, is a scenario some boards may ask senior executives to plan for. This will involve evaluating the entire value stream to ensure that end-to-end domestic replication is feasible. Firms will review customers and suppliers equally – it may become uneconomic to do business with some customers.

Some suppliers may find themselves cut out of entire markets overseas because of COVID-19 with no foreseeable way back in as the era of globalisation ends. Governments should be aware of the risk to the economy if entire value chains collapse under the strain of changes made by firms unilaterally as a result of this crisis. The end of business travel for the foreseeable future means that large enterprise sales are unlikely to be cemented which further increases the pressure on firms to cut costs and automate as much of their value delivery as is realistic under the constraints they are operating within.

The post-COVID-19 target operating model will be very different from the digital transformation or cross-functional capability TOM that found favour over the past few years. If you thought that the increase in risk and compliance projects stemming from the GFC and higher levels of supra-national regulation, then you are in for a surprise. Expect an enormous focus on risk management in supply chains and increasingly invasive due-diligence from customers.

 For example, if I were advising a firm on due diligence of a potential supplier, a report of how they managed their response to COVID-19 in extreme detail would be a bare minimum expectation. This reporting will increase the timeframe for major supplier changes because firms will have to produce even more collateral and potential customers review it in detail to manage risk appropriately for any changes to components of an operating model.

The different target operating model designs that emerge after this crisis will have simplicity at their core. Wherever a value chain currently hits a border or complex manual handoff, the removal of these frictions will be a core focus of how capabilities combine to deliver value to customers. A higher level of governance, accountability, and assurance around controls and risk mitigants is by higher risk aversion at board-level.  

There is also a higher level of ESG risk sensitivity from stakeholders, particularly asset managers concerns about enormous asset price fluctuations. This sensitivity means that any firm embarking on a target operating model design for the new normal must ensure that a responsible operating model is an outcome. A responsible operating model gives boards assurance that ESG risk reduction is part of the target operating model from the start of the program. It will enable the delivery of the revised strategy for the post-COVID-19 world that is a lot more conservative and cautious than it was even a month ago.

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How Can Firms Restructure Responsibly During COVID-19?

How can firms restructure responsibly? In the COVID-19 era, many boards and senior executives have made enormous decisions about the short-term changes they need to make to their business to stay alive. Many have acted with integrity and considered their entire group of stakeholders, not just shareholders, and done the right thing for their customers and employees. Others have reverted to the crisis playbooks of yesteryear.

Just a few months ago, in January 2020, the rise of ESG investing reached a crescendo at the World Economic Forum in Davos, Switzerland. The global elite spoke lovingly about their sustainability initiatives and measures they were taking to reduce ESG risk inside their firms. Institutional investors, riding high on a decade long asset price rise, were very comfortable with the new direction.

Where are many of these voices now? The environmental, social and governance risks for firms emerging from the response to the COVID-19 health crisis are enormous. Because of the advice around social distancing, use of personal protective equipment, and working from home wherever possible, there are obvious worker health and safety risks. Some firms have responded well, others have acted as if the last 50 years didn’t happen.

The social risks from continuing to insist on retail tenants trading when there is already low foot traffic in shopping malls, for example, will be held to account once this is over. The inability of a firm to hibernate in a competitive and contract-driven world should have been clearer to policymakers. However, the speed of the response has led to grave policy errors that will extend the hurt throughout the economy and risk social problems because of the prioritisation of larger firms over small business and workers.

Restructuring your operations responsibly in a crisis can be done. It means working closely with all stakeholders wherever possible, and not making unilateral decisions without open communication and at least an attempt at consultation or engagement. The “panic stations” approach taken by some during this crisis has highlighted how everything they wrote in the front matter of their most recent annual report was complete nonsense.

What has been good to see is some firms choosing to draw down credit lines and leverage the support the banks are getting from central banks to tap their banking syndicate before doing highly dilutive equity raising in a time of high uncertainty. For firms that have a decent chance of doing well on the other side of the bridge, the extra medium-term debt in their capital structure is probably a better bet than an equity raise.

For small businesses, restructuring responsibly in a situation like COVID-19 can be almost impossible. To have the flexibility to do a responsible restructure, you already needed a strong balance sheet and decent cash flow history. Your banker will be aware of government guarantees, but you still need to be a good credit.

Many of the businesses most impacted by the collapse in sales simply were never and will never be good credits. Low margin, high volume businesses will only be good credits if they have some sort of collateral like owning the restaurant building or a distribution warehouse with a low loan-to-value ratio.

Completely independent of what policymakers may think, the banks still have their internal business rules around risk. Even though there has been some easing of regulation, that doesn’t mean the banks will suddenly make enormous amounts of credit available. The bank CEOs have been clear about this – they will eventually be picking winners and losers. Banks have the best transaction and risk data to consider whether the business they’re considering extending credit to will be able to make a good go of it on the other side of this pandemic.

An example of the difficult position small businesses find themselves in is that three main areas of risk – payroll, lease obligations and trade creditors – can’t all just be put on pause without consequences. A move towards cash on delivery and repayment of any deferred lease liability could mean that more businesses are untenable because of the higher working capital requirement alone.

This situation means that responsible restructuring will only be feasible for the strongest SMEs. They will need to innovate by creating new product and service lines that comply with changing consumer preferences. Their payroll will need to reflect the new normal, and if that means layoffs, paying out full entitlements or claiming wage subsidies to help employees through this is the right thing to do.

The rapid decision-making in a crisis can sometimes stop the risk of going out of business, but there are lasting consequences to any mistakes made during the process. Of particular concern are the audit and assurance risks around many of the decisions made. There will be an accounting for errors made by firms. In essence, banks will closely monitor the use of funds obtained by credit, governments will audit subsidies, employment regulators will audit layoffs, and tax offices will review tax returns and reimbursements.

The consequence of an irresponsible attitude towards restructuring during this crisis is that many businesses will not be able to reopen on the other side of the bridge. This scenario is different from the economic reality. In essence, some firms are simply not viable, and their directors have closed doors because that is the right thing to do in their particular situation.

Where I see a lot of risks is that because so many people have been negatively affected by this economic crisis, there will be a lot of judgement and community expectations around what “the right thing to do” really was during COVID-19. ESG risks must still be identified and managed appropriately during this crisis, just like the rule of law isn’t on hold. Boards and senior executives should consider how they’ve approached their response so far. If you can improve outcomes for stakeholders before the crisis is over, make an in-flight adjustment now. It’s better to alleviate pain than be the subject of investigative reporting or regulatory consequences once this is over.

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COVID-19, ESG Risk And Business Resiliency

Impacts of COVID-19

The impacts of COVID-19 on many businesses around the world have been enormous. The firms that have invested in preparedness and have the operating model to make work-from-home realistic for its people have been able to proceed as if everyone was just embracing flexible working. The firms that have under-invested in preparedness and not managed risk appropriately have had to scramble to change their operating model to support remote work.

For firms in industries profoundly affected by government shutdowns, their revenue could have plummeted to zero already. For others, particularly in discretionary spending areas, they have already seen the negative impact on their cash flow and balance sheet. Many companies have had no choice but to shut down operations and layoff employees. Many boards and senior executives have cut pay and bonuses in solidarity and because they can’t appear unaffected by the seriousness of the problem.

One of the fascinating things to watch as this crisis has unfolded is the difference in response from some firms. Some firms are replaying their Global Financial Crisis playbook – shut down, layoff staff, slash costs and scramble to preserve cash. Other firms are taking a more responsible approach and considering how to balance recognising the precariousness of their position and the impact on their customers, employees, suppliers, and community of their decision-making.

A firm’s operating model is the framework for how they deliver value to their customers. The people, processes and systems they combine into capabilities that enable value streams for customers don’t exist inside a vacuum. They are a living entity that needs continuous improvement and efficiency gains to maintain a competitive position.

The impact of COVID-19 on many firms has highlighted the weaknesses of their operating model. The rise of outsourcing and focus on core capabilities only has left many firms in an invidious position. In essence, they have so many contractual commitments outsourcing functions or capabilities left, right, and centre that it truly is impossible to hibernate their firm for even a month because of the contractual consequences.

There are no easy choices during a crisis, but boards and senior executives and responsible for identifying and managing risks which includes tail risks. If their operating model is fragile, the buck stops with them. While the enormity of the revenue losses due to government shutdowns was extreme, the ability of a business to function with everyone working from home is a bare minimum of business continuity planning.

The rapid decisions to layoff workers or raise equity finance massively diluting existing shareholders will present ESG risks for some firms. There will be consequences as this crisis is more severe than the GFC or the Great Depression and the resiliency of business to sudden shocks will become a critical assessment criterion for enterprise value over the next decade.

Possible Changes To Operating Models

Some of the parts of an operating model are people, processes, systems, locations, and suppliers. I will deal with each in turn.

People are an essential part of any business. Even a highly automated technology business requires highly skilled people who can work together collaboratively to deliver value to customers. Critical considerations for this area of an operating model include:

  • Health and wellbeing – how are we supporting our people through this crisis?
  • Cross-functional capability – how cross-skilled are our people?
  • Digital literacy – can our people work from home productively?
  • Succession planning – has it been done and does it extend down through the business?
  • Minimum FTE requirement – how many people do we need to deliver value?
  • Keep the lights on – what is the actual “business continuity plan” critical number of FTE?

Processes are how the organisation transforms things from raw inputs into valuable outputs for either internal or external customers. The need for manual intervention in a process creates friction and increases risk, particularly in this situation. Critical considerations for the operations include:

  • The known manual process breaks – how do we automate them today?
  • Maker-checker tasks – how do we ensure controls are in place when remote working?
  • Client handoffs – how do we help them improve their processes?
  • Reporting – are there any non-standard reports that should have better governance?
  • Redundant processes – what do we not *have* to do that we’re wasting time doing?
  • Work allocation – how are we responding to peaks and troughs in transaction volume appropriately?

Systems are the technology and applications that power the processes and are increasingly an enormous proportion of a value stream’s commercial value. They are also complicated and costly, as many firms are still struggling with legacy systems. How do you sort out longlasting problems during a crisis?

  • End-user experience – can everyone work from home? If not, why not? Where’s the gear?
  • Video conferencing – what can we leverage? Please no free services for an enterprise
  • Cybersecurity – what controls do we have in place around remote working?
  • Change – is there a change freeze? What about vendors?
  • Test – what ready-for-business checks aren’t already automated
  • Real-time analytics and dashboards – where are they? If they aren’t, why aren’t they available?
  • Capability – do we have the right systems to enable value to be delivered? If not, why not?

Locations include offices, factories, retail stores, or distribution warehouses. They now definitely include people’s homes!

  • Office space – how much are we going to need if we reduce FTE and more people work from home?
  • Factories – how is our offshoring strategy going with border closures?
  • Retail stores – what is the margin contribution of a physical store vs same sales online?
  • Distribution warehouses – how efficient are we? What optionality is there for growth?

Suppliers are critical parts of your value chain. For many firms whose target operating model included a lot of outsourcing, external suppliers are responsible for many capabilities. The interlocks between a firm and its suppliers are critical to managing risk. Key considerations include:

  • ESG risk – how are they treating *their* customers, employees, suppliers and community during this crisis?
  • Controversy – has the supplier caused any controversy during COVID-19 with their actions or words?
  • Capability – has the supplier been able to deliver what it has to?
  • Business continuity plan – if the supplier invoked their BCP, how did they communicate and had they previously tested this with you?
  • Continuous improvement – are they partnering with your teams to enable efficiency wherever possible?
  • Above and beyond – have they been a partner or a contractual counterparty throughout COVID-19?

The Post COVID-19 New Normal

There will be many changes in how firms operate because of COVID-19. I believe that a higher focus on remote working, efficiency, automation, simple product and service lines with lower complexity to deliver and focus on value-for-money will emerge on the other side of the bridge.

Many firms will be working on these changes already with some sort of crisis response team. The smart ones will be using the crisis to implement accelerated transformation wherever possible to take advantage of lower internal resistance to change and politics. They will emerge much stronger once this health crisis is under control.

The new normal will be similar to what best practice was before the crisis – your target operating model design has to incorporate delivering excellent outcomes for your stakeholders. You have to consider risk management and plan for the tail risks.

The relentless drive for cost control and efficiency can sometimes forget that over-optimising and leaving no slack in the system means a firm is unable to respond fast in a crisis. A lean operating model doesn’t mean zero slack. You still need to be prepared for emergencies and have substantial risk mitigants in place for the risks your particular business faces.

Once this COVID-19 pandemic has died down, the level of risk aversion will increase at board level. Directors will hold senior executives to account for their mistakes in managing the firm’s COVID-19 response and give a due endorsement of their successes where that is warranted. The post-COVID-19 new normal will lead to serious consideration of offshoring, outsourcing of critical functions, and the genuine demand for office space.

COVID-19 isn’t a crisis like many others – the sudden shock to economic activity has caused many to challenge their assumptions about a suitable response. A focus on delivering value not just to customers but to a broad group of stakeholders, while maintaining their trust and support, is not an easy task. But boards and senior executives will need to simplify and optimise their operating model because the level of competition for winning new business after this crisis subsides will be enormous because of the output gap in the economy. Only the most robust and most responsible will prosper.

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Operating Models And Cost Cutting In A Pandemic

The spread of COVID-19 and its impact on business means that many firms will be looking at cutting costs. One of the issues with indiscriminately cutting costs is that throughout an organisation, particularly a big and complex one, lots of processes happen every day and they’re not always clean and automated. A lot of documentation, controls and risk mitigation can help you manage your operations, but institutional knowledge kept inside people’s heads is what gets lost during massive layoffs.

Understanding your current operating model pre-pandemic is critical before making any rash decisions. What are the top value streams you deliver to your customers? Are there any that are redundant during these shutdowns? Is hibernation of a business unit or factory location even realistic under such high uncertainty? An operating model can equally apply to a team, a business unit, a division or an entire business group.

The core components of any operating model are the people, processes, and systems that combine to enable capabilities that let a business unit deliver value to its customers.

The way a business makes money is by selling the value its capabilities create to customers at a higher price than it costs to deliver that value stream. If any of the three core components are not optimised, there is a risk that competitors will be able to deliver more value for less than you can. Thus, there is a competitive impulse that requires continuous improvement of your operating model.

The capabilities that an operating model enables to deliver value do not exist in a vacuum. Governance of the operating model has to have control and regulatory compliance built into how capabilities are designed and implemented.

The point is that if you want to cut costs during a pandemic, there’s an awful lot of upfront work and analysis that should already be accessible to boards and senior leaders. Your business continuity plan should have different scenarios of “bare minimum” capabilities required. When you suddenly have no revenue, there’s not much point keeping the lights on unless you have a fortress balance sheet and can cope with a few months of zero income.

The operating margin that your business earns drives these decisions. It should not surprise anyone that lower margin industries were the first to shut their doors and layoff staff. If you own a bar that has a turnover of $1,000,000 and a net income of $100,000, then you have monthly costs of $75,000. By definition, you can’t survive longer than six weeks ((100/75)*4.33).

The big policy response question is that if the government has shut you down in the name of public health, is a wage subsidy and the possibility of a select loan going to compensate you for your losses fully? No, it’s not! Business owners and their newly unemployed or stood down workers are partially reimbursed shock absorbers for this health crisis.

Why would a business owner borrow more money from the bank, if they even let them, when there is so much uncertainty? If they have leased premises, and their landlord is obstinate, they aren’t guaranteed to have a rent waiver while the government has closed their doors. That liability is still accruing.

Making changes to safe harbour rules doesn’t change rational behaviour in this situation – when you’re in a hole, you stop digging! Many business owners aren’t even bothering to get JobKeeper because they can use it as an opportunity to make layoffs in the heat of the crisis gambling that Fair Work will never catch up to them.

On the other side of the bridge, your target operating model is going to have to change. It will need to focus on value streams that offer real value to customers and is in line with shifts in consumer preferences in a Great Depression 2.0 environment. It will need to be highly automated and efficient because the competitive pressures on the other side of the bridge will be enormous because of the size of the output gap.

The offshore business processing centres will face pressure to open onshore offices and hire local workers. This risk was already an issue in highly regulated industries, but this trend will spread across the entire economy. The multi-jurisdictional value chain is going to be out of pattern for a while.

This crisis will drive significant changes in the standard corporate playbook. The transformation of your business during and after COVID-19 will require enormous changes in how you do business.

Cost-cutting isn’t just about laying workers off. That’s something anyone with a calculator can figure out. It doesn’t solve your broader business problem – why was your operating model so fragile in the first place? What is your firm’s purpose? Why do you exist? What is your strategy, and how do you design a target operating model that enables the delivery of real value to your customers while keeping a demanding group of stakeholders onside and on your team?

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The Industry Composition Changes From COVID-19 Fallout

The industry composition changes from the COVID-19 fallout will be enormous. The firms with the most robust operating models that deliver value without people needing to leave their homes will emerge in a dominant position. The firms that rely on in-person service delivery will struggle to rebuild their revenue once social distancing becomes a new way of life. The impact on households will be dark as many stores closing now will never reopen.

The rapid spread of COVID-19 and the accompanying public health restrictions have caused millions of job losses globally. The speed of the economic collapse of the entire industry sectors of tourism, air travel, retail, hospitality and personal services is unprecedented. Different countries have responded with varying policy responses to slow the spread of the virus.

Some have focused on the banks and business. Others have focused on jobs and wage subsidies. Some have tried to balance a mixture of support across the economy. This human tragedy is a real-time policy experiment across countries where everyone can see the different outcomes of different ideological belief systems.

We are dealing with both a health and an economic crisis. It is juvenile to ignore that there are tradeoffs governments are making, whether we agree with them or not. There is some modelling behind their decisions to move from one level of restrictions to a higher level. One of the things politicians are responsible for is making the calls based on the advice they receive. That’s part of what modern Westminister democracy entails – outsourcing political judgment to politicians, supported by the public service.

One concerning aspect of the policy response so far is that the crisis has highlighted the weaknesses of many existing business models. Typically, a recession would lead to those businesses closing down as part of the normal business cycle of creative destruction. In this case, a rapid collapse in economic activity in some cases because of government decisions means that many businesses are closing well ahead of where they would have failed in the next economic downturn.

The rational response of many boards and senior executives has been to lobby the government to secure an industry-specific support or bailout package. Small businesses don’t have that option. The support offered to banks to extend lending terms or provide low-interest bridging finance for an indeterminate period looks good at first blush but doesn’t pass the real-world test.

The reason why many businesses won’t take on additional debt in a time of high uncertainty is that if their revenue has gone to zero, they are still incurring fixed costs. They will try and reduce as many of those fixed costs as possible, and may not have the cash to be able to top up wages for a wage subsidy or even let people take annual leave or sick leave for a month.

Hence, many layoffs and redundancies have happened already irrespective of whatever policy response the government has deployed. The likely announcement of a wage subsidy in Australia today is too late for all the people already lining up at Centrelink. In New Zealand, every second day, MBIE announces little tweaks to the wage subsidy in perhaps the best example of iterative policy implementation in the country’s history.

When it comes to identifying industry composition changes from COVID-19, strong balance sheets are a crucial factor. In the hospitality sector, a clearout of small businesses is likely, leaving many countries with national chains and franchises the last ones standing on the other side of the bridge. Unless retail landlords give rent holidays, lots of cafes, bars and restaurants will have no choice but to close down. Given that very few own their premises, the prospects for independently owned hospitality operators is bleak.

Because of the uncertainty of the COVID-19 pandemic, it’s unlikely many small business owners will take on more debt other than out of pure desperation. If you trace back the impact of zero revenue and work backwards to who loses, generally it is property owners and the banks. Their tenants may default, and their borrowers may default. This reality is how a health crisis becomes a financial crisis.

There are now three crises – health, economic, financial. All three are interlinked, but the primary focus of many governments has been the economic and financial crisis. The health crisis has had far less government money directed to it. There will be real-world consequences from this approach.

For example, the purchase of residential mortgage-backed securities by the central bank is a significant change in the expected behaviour of a central bank. If the central bank is becoming the entity holding the credit risk hot potato, what is the point of the banking sector? What was the justification of the enormous investment in higher regulatory standards since the Global Financial Crisis if a stress event of 1 month changes everything?

The US Federal Reserve mainly spent a decade doing and then trying to rewind quantitative easing. Now it is going full speed on quantitative easing again. How can you price risk responsibly in such an environment? There are enormous problems that will stem from the panicked responses to this crisis. Those who most need a bailout don’t have a hope of getting nearly as much as they may require through no fault of their own.

The impact of COVID-19 on the retail sector is another one to watch. With physical retail stores closed, and staff stood down, how likely is it that firms will reopen them on the other side of the bridge? Already, retail in Australia was struggling. Many firms will use this crisis as an opportunity to accelerate plans to reduce store numbers and increase online shopping share of their revenue.

Some will use the crisis to close underperforming brands or chains and exit onerous lease obligations wherever they can. The face of retail will never be the same again. The impact on major landlords such as shopping centres will be grave. In the USA, commercial mortgage-backed securities could be in deep trouble. How many rent payments will they receive on April 1? Many retail chains there have told their landlords they would not pay the rent for the duration of this crisis.

The most challenging impact so far is the people who have already lost work because of this crisis. Recessions are particularly brutal because a proportion of people who become unemployed in downturns never work again.

Many parts of the economy will “bounce back” from this crisis. However, lots of people will lose their lives due to COVID-19 complications, and many will have ongoing issues like lung scarring and respiratory problems. The human cost will be enormous, and the overall human tragedy will be higher if the economic situation keeps accelerating towards a global Great Depression.

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Sustainable Economic Growth And ESG Risk Management

An environment of ever-increasing expectations on corporate leaders to do the right thing when it comes to sustainable business means it’s an issue to be taken seriously from the board-level down. The identification, active management, mitigation, or elimination of ESG risk from your operating model is a vital part of building a sustainable business that makes a positive social impact as well as delivering a profitable business for shareholders.

The UN Sustainable Development Goals provide a useful high-level framework for assessing your firm’s ability to deliver sustainability outcomes and is increasingly used by global firms as the core 17 areas for reporting their sustainability focus in their annual report.

You can map the 17 UN SDGs against your current operating model to identify the areas where your firm is making a positive or negative social impact. This exercise could assist in the analysis work before a transformation programme begins, ensuring that the development and deployment of the target operating model incorporate sustainability outcomes.

Ever-increasing community expectations around what businesses are doing to reduce ESG risks and deliver a positive social impact for a full group of stakeholders means that thinking about what a responsible operating model for your business incorporates can help the process of positioning your firm ahead of the curve.

Boards and senior executives might consider assessing their current risk management framework to identify whether the broad array of ESG risks as some choose to define them are present in their existing risk register.

Environmental, social, and governance risks can be much harder to quantify than many financial or operational risks. Firms should develop a defensible framework for estimating the cost of these risks and the severity of their impact on the operations of the business.

The business case for making significant investments into projects that reduce these risks and enhance the enterprise value of your business is clear. Increasingly, firms that do not take these issues seriously or engage in a press-release driven approach will find it difficult or impossible to raise capital.

Institutional investors in 2020 expect well-aligned corporate behaviours and communications on sustainability issues with their preferred responsible investing frameworks than even five years ago. Investor relations and corporate access teams at investment banks will have higher rates of inquiry from stakeholders who may previously never have engaged with them, and that means that the operating model for an investor relations function or corporate sustainability function needs to adapt and improve as part of the core operating model of the business, instead of being tucked away in a small department.

Goal 8: Promote inclusive and sustainable economic growth, employment and decent work for all

Goal 8 is about sustainable growth that cares about people. Eradicating global poverty depends on increasing the quality and compensation levels of workers around the world through raising productivity and sharing some of those gains.

In many developing countries, having a job doesn’t mean that your family is out of poverty. Roughly half of the world’s population lives on less than US$2 a day even with global unemployment around 5.7% according to the UN.

“Sustainable economic growth will require societies to create the conditions that allow people to have quality jobs that stimulate the economy while not harming the environment. Job opportunities and decent working conditions are also required for the whole working age population. There needs to be increased access to financial services to manage incomes, accumulate assets and make productive investments. Increased commitments to trade, banking and agriculture infrastructure will also help increase productivity and reduce unemployment levels in the world’s most impoverished regions.”

Some of the detailed sub-goals associated with Goal 8 include per capita economic growth, higher levels of productivity supported by investment in technology, a focus on high-value-added services, implementation of development-oriented policies, and eradicating forced labour and modern slavery.

8.1 Sustain per capita economic growth in accordance with national circumstances and, in particular, at least 7 per cent gross domestic product growth per annum in the least developed countries

8.2 Achieve higher levels of economic productivity through diversification, technological upgrading and innovation, including through a focus on high-value added and labour-intensive sectors

8.3 Promote development-oriented policies that support productive activities, decent job creation, entrepreneurship, creativity and innovation, and encourage the formalization and growth of micro-, small- and medium-sized enterprises, including through access to financial services

8.4 Improve progressively, through 2030, global resource efficiency in consumption and production and endeavour to decouple economic growth from environmental degradation, in accordance with the 10-year framework of programmes on sustainable consumption and production, with developed countries taking the lead

8.5 By 2030, achieve full and productive employment and decent work for all women and men, including for young people and persons with disabilities, and equal pay for work of equal value

8.6 By 2020, substantially reduce the proportion of youth not in employment, education or training

8.7 Take immediate and effective measures to eradicate forced labour, end modern slavery and human trafficking and secure the prohibition and elimination of the worst forms of child labour, including recruitment and use of child soldiers, and by 2025 end child labour in all its forms

8.8 Protect labour rights and promote safe and secure working environments for all workers, including migrant workers, in particular women migrants, and those in precarious employment

8.9 By 2030, devise and implement policies to promote sustainable tourism that creates jobs and promotes local culture and products

8.10 Strengthen the capacity of domestic financial institutions to encourage and expand access to banking, insurance and financial services for all

8.A: Increase Aid for Trade support for developing countries, in particular least developed countries, including through the Enhanced Integrated Framework for Trade-Related Technical Assistance to Least Developed Countries

8.B: By 2020, develop and operationalize a global strategy for youth employment and implement the Global Jobs Pact of the International Labour Organization

https://www.un.org/sustainabledevelopment/economic-growth/

Board and Senior Executive Considerations

Boards and senior leaders will see that, like the other SDGs, there are several areas where any business can make a positive social impact. Procurement processes need to ensure that risks such as forced labour and modern slavery are not in your supply chain.

When you assess your current operating model, the key areas to explore when considering Goal 8 include people and culture processes and policies. If you are in financial services, finding what actions you could take to support the achievement of goal 8.10 would be a key focus. If you are in transportation or travel, exploring sustainable tourism such as going beyond net-zero or carbon neutral and thinking about carbon-negative operating models that create local jobs where you operate your business would be worth consideration.

The use of the UN SDGs as a high-level framework to map your current operating model against the ability of your business to deliver a positive social impact is a useful exercise for businesses. Many leading global firms already incorporate this reporting in their annual reports.

The decade ahead will be necessary for firms as they strategically position themselves to be ahead of their competitors on ESG issues. Moving beyond reporting and engagement to actively choose where your operating model (people, processes and systems) can adjust to improve positive outcomes or reduce adverse consequences will be tables stakes.

Institutional and retail investors are growing their awareness of ESG risks and expectations of the pace at which boards and senior executives will respond decisively if any controversies arise. Waiting it out or sending out a press release won’t cut it. Resignations and ending supplier relationships will become far more frequent and building a responsible operating model with in-built flexibility that can respond if a critical supplier needs to be changed because of an unacceptable level of ESG risk will increasingly mark the leaders in this space distinctly from the laggards.

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ESG Issues, Social License To Operate And Your Target Operating Model

The rise of environmental, social and governance (ESG) issues as a priority for business leaders was a theme of the past decade. To ensure that your firm’s social license to operate continues to be renewed by the community, embedding a positive social impact into your operating model is essential.

A firm’s social license to operate has to adapt to changing community expectations of corporate behaviour. In the fallout from the revelations during the Financial Services Royal Commission in Australia, the extent to which community expectations can drastically shift against any industry is evident.

Ever-increasing considerations and requirements of businesses and how they manage ESG risks mean that balancing scarce resources is more complicated than ever before. Firms have to worry about legislation, regulation, environmental concerns, social impact, social risks, governance issues, operational issues, technological disruption, climate change, responsible investment disclosures, and more.

Designing and implementing a target operating model to deliver a firm’s strategy is vital. A firm needs to focus its purpose and concentrate on the core capabilities required to provide value to customers and other stakeholders.

The UN Sustainable Development Goals provide a useful high-level framework for considering a firm’s global social impact. Are you doing anything that could lead to negative headlines? Are there any small changes to your operating model that could support any of these goals and be an example of how your business is delivering above community expectations?

The Sustainable Development Goals are:

  • No Poverty
  • Zero Hunger
  • Good Health and Well-being
  • Quality Education
  • Gender Equality
  • Clean Water and Sanitation
  • Affordable and Clean Energy
  • Decent Work and Economic Growth
  • Industry, Innovation, and Infrastructure
  • Reducing Inequality
  • Sustainable Cities and Communities
  • Responsible Consumption and Production
  • Climate Action
  • Life Below Water
  • Life On Land
  • Peace, Justice, and Strong Institutions
  • Partnerships for the Goals

The UN Sustainable Development Goals certainly aren’t the only framework for thinking about building a sustainable business or considering how to provide comfort to your stakeholders that your operating model is in line with community expectations. Many companies will be able to make a positive social impact on at least 1-2 of the goals.

How Do Companies Deal With This?

There are ever-increasing pressures from the media, from regulators, from industry bodies, from politicians, and from peers in your industry that mean that a few pages in the annual report no longer cut it – a genuine commitment from the board level down to the operating teams of the business has to be “baked in”.

In this new era, can you ever do enough to satisfy your stakeholders? I’m not sure it’s realistic. The level of constant change in the regulation of financial services, for example, has radically shifted how banks and wealth providers need to spend their investment budgets each year.

If the current level of investment on regulatory and compliance change is half of the spend, and investment in digital transformation or operating model change represents the other half, then which projects need to end to finance spending on sustainability projects?

This reality is where the rubber hits the road – the intersection of idealism around sustainable capitalism with tradeoffs in a commercial context. If a business has to be all things to all stakeholders, then radical simplification of the entire operating model is a high-probability method to ensure that the right trade-offs will happen at executive-level and operational-level.

The fascinating thing about the rise of responsible investment or ESG awareness when making investment decisions is that the light is rarely shone back on the operating models of the asset managers and data providers making these decisions themselves.

Public market investors and everyday people with their retirement savings in their 401(k), superannuation, Kiwisaver or pension increasingly tell market research companies and their providers that they care about not investing in companies that could have a negative social impact.

The plethora of filters available to asset managers means that what one asset manager believes is “responsible investing” is not necessarily what another asset manager defines it as unless they are using the same principles, framework and processes in their investment due diligence process.

When companies make disclosures around ESG issues to their investors, many have done a fantastic job in articulating where they see the risks in their businesses and how they are changing their business to reduce, better manage or eliminate those environmental and social risks.

Key Considerations For Boards And Executives

A key consideration for boards and executives here is that while you can compile an initial list of ESG risks and potential mitigations in a half-day workshop, that is only the beginning of the journey. An ongoing programme of work for some businesses – another substantial investment in people, processes and technology in addition to existing regulatory and compliance programmes of work.

Almost all boards and executive teams are aware of this, but balancing the pressures from shareholders and regulators can be a delicate act. There are earnings pressures, regulatory deadline pressures, and interpretation problems when it comes to how your operating model can deliver compliance with some requirements.

Without deeply examining the purpose of the business itself and going line-by-line through each operating division, hidden risks can remain that emerge at the least convenient time and undermine any previous efforts to promote that the business was trying to make a positive social impact.

The sorts of questions that I would be asking include: what is the purpose of our business? How complicated is our current operating model? How do I have confidence in the data and conclusions in the board reports I receive? How do we know we are ready for the “next” ESG issue that emerges in our industry? Who owns ESG risk in our business? If it is the audit and risk committee, are all members actively engaged in professional development on these issues?

One of the saddening things about reading some of the data attached to each of the UN Sustainable Development Goals is the realisation of how fortunate many of us are to live in highly developed countries. In a sense, many of the issues around managing these risks are “first-world problems”. However, that doesn’t mean that taking such a broad view is unhelpful to a business in an OECD country.

The critical consideration for boards and corporate leaders when it comes to social license to operate is recognising the need to be ahead of the curve on these issues. What is currently acceptable commercial practice today in one of your most profitable service lines or products could be completely unacceptable after a poorly served customer explains their poor customer experience.

A real-time feedback loop now exists between customers and businesses. Regulators, the media and politicians are always watching and listening. Empowering front-line people to do the right thing by customers and removing conflicts and any potential negative perceptions around your value chain are now an essential part of running and optimising your operating model.

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Ending Global Poverty And Your Operating Model

The Sustainable Development Goals are the blueprint to achieve a better and more sustainable future for all. They address the global challenges we face, including those related to poverty, inequality, climate change, environmental degradation, peace and justice. The 17 Goals are all interconnected, and in order to leave no one behind, it is important that we achieve them all by 2030. 

https://www.un.org/sustainabledevelopment/sustainable-development-goals/

A decade ago, few business leaders would have accepted that ending global poverty had anything to do with their business. But the recent decade has shown that social license and community expectations are a critical part of the external factors to your operating model.

A decade ago, understanding and taking action as a business on something like the UN Sustainable Development Goals, would be accomplished with a press release. Now, investors and regulators expect full disclosure of environmental, social and governance issues.

Understanding your current operating model – the value proposition, the principles, the people, the processes and the technology – is complicated enough for many firms. If you are embarking on a transformation, defining the new target operating model and building out the supporting processes and frameworks is tricky too.

The growing pressure from more regulation, legislation and industry standards increases the complexity faced by business leaders. There are so many potential frameworks that you could use to assess where your business stands, that going back to basics is a helpful approach.

Because of the rise of globalised firms, it makes sense to take a global approach to assess the social impact of the components of your operating model. Helpfully, the UN Sustainable Development Goals can provide businesses with an extensive set of considerations to incorporate into an operating model review and target operating model development.

If you aren’t a global business, there is still value in considering how your business can make a positive social impact. If there is a lesson from the past decade, it’s that whatever you previously thought was the boundary of social, regulatory or legislative pressure on business, it is now far more demanding on business than it has ever been.

Many businesses may only be able to impact 1 or 2 of the sustainable development goals, but there is still value in considering all 17 to see if there are areas of your operating model that could change to make a difference.

Goal 1: End poverty in all its forms everywhere

The structure of the UN Sustainable Development Goals is useful for an assessment exercise. Each goal is high-level, there is a set of accompanying statistics describing the extent of the societal issue, and there are a series of detailed sub-goals.

The goal to end global poverty in all its forms everywhere is aspirational. It would be fantastic if achieved, and an initial impression could be that this is wholly unrealistic.

However, there are small things that businesses can do to help reduce the incidence and severity of global poverty. More than 700 million people worldwide still live on less than US$1.90 per day. Having a job doesn’t guarantee a proper standard of living as 8% of employed workers and their families lived in extreme poverty in 2018.

Poverty has many dimensions, but its causes include unemployment, social exclusion, and high vulnerability of certain populations to disasters, diseases and other phenomena which prevent them from being productive. Growing inequality is detrimental to economic growth and undermines social cohesion, increasing political and social tensions and, in some circumstances, driving instability and conflicts.

https://www.un.org/sustainabledevelopment/poverty/

Assessing Your Strategy And Operating Model

Every business has strategic goals it wants to achieve. The operating model is how it structures its capabilities to deliver on the strategy. These capabilities are groupings of people, processes and technology that create value or support value creation.

For example, your operating model is a crucial driver of decisions to insource or outsource capabilities. When you choose to outsource, your supply chain becomes part of your social impact. Enhanced due diligence on your suppliers and their supply chain is required. You need confidence that your business isn’t inadvertently generating a negative social impact through your supply chain.

The UN Sustainable Development Goals provide an additional set of considerations for business leaders when they are reviewing their overall operating model. There are two areas of questioning – business strategy and operating model.

What is your business strategy? What are your strategic goals? When you are thinking about how to create value, are there aspects of this value creation process that do not align with the UN Sustainable Development Goals?

What is your operating model? What are the key capabilities that you have assembled to deliver value? How do these capabilities create a positive social impact? Can they even contribute to making a positive social impact? Are there negative social impacts from some capabilities that your business has?

How is ending global poverty linked to your strategy and operating model? One helpful mental model is to think about the frontpage rule – is your business doing anything inside its operating model globally that could lead to a headline that accuses your company of perpetuating global poverty?

The location of your physical operations is a crucial consideration when it comes to helping end global poverty. Do you have factories, mines or offices in developing countries? If so, do you have a policy framework for ensuring that you are generating a positive social impact in these countries? Have your risk and compliance teams embarked on enhanced due diligence of your supply chain and recruitment processes in these countries to identify any areas of risk or potential exploitation?

The great news is that almost all global businesses already have robust frameworks in place to ensure that these environmental and social risks are identified and well managed. You can read about these efforts in their annual reports. They regularly engage consultants to benchmark their approach against global standards and identify further remediation required.

The change in thinking for businesses wanting to make a positive social impact is that when making a low level operating model choice, there are multiple competing priorities. Having a principles-based target operating model that gives business leaders the ability to choose different components is essential.

I think that businesses who do not currently use a broad framework like the UN Sustainable Development Goals to explore how they could make a positive social impact are missing something. There is an opportunity to use these goals as a differentiator and to identify how each key capability of your business not only creates value for customers and shareholders but aligns to these goals.

The goals and expectations of your employees matter too. Most millennials care more about the purpose of the work they are doing than the commercial drivers. They understand that a business has to make a profit, but if the operating model that delivers that profit helps create a positive social impact and supports the goal of ending global poverty by 2030, then that is another compelling reason for them to come to work.

Next Steps

  • Take a look at https://www.un.org/sustainabledevelopment/poverty/
  • Think about how your business could help reduce global poverty
  • Think about what your employees expect your social impact to be
  • Think about how your current operating model helps or hinders these goals
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What are the UN Sustainable Development goals?

The UN Sustainable Development Goals are a collection of 17 high-level goals that serve as a blueprint for “a better and more sustainable future for all”. The United Nations General Assembly set them in 2015, and the goal is to achieve them by 2030.

ESG or “environmental, social and governance” issues are top of mind for regulators, legislators, and corporate leaders. The UN Sustainable Development Goals serve as a useful framework for thinking about how your enterprise currently operates and how it could change to enhance its impact on society.

Over the next few weeks, I will outline some considerations for corporate leaders for each of the goals. I will pose many of them as questions around the relevant components of your operating model.