By Janamitra Devan, Abhijeet Dwivedi, and Tsun-yan Hsieh

“God himself could not sink this ship!”
– Unknown Titanic crew member

“BP Shuts Down Largest U.S. Oil Field,”[1] “Fire Risk Makes Dell Recall 4m Batteries,”[2] “FSA Tells Citibank to Withdraw from Private Banking Business,”[3] “Recall Hurts Bridgestone,”[4] “SARS Sends Singapore Airlines into Loss,”[5] “A Fine Mess for Shell.”[6]

What’s going on in these headlines? These are a few examples of an increasingly important economic reality of our times – the prevalence of shocks, by which we mean incidents whose magnitude and timing are such that the impact of them exceeds the organization’s ability to respond effectively.[7] Our empirical research reveals that the frequency and severity of such shocks has increasedover the past decade. With the prevalence of shocks rising and their magnitude increasing, leaders need to devote more time, energy, and resources to preparing their companies for shocks.

We note also that the shocks we are talking about differ substantially from just the mere volatility and/or cyclicality that typically characterizes markets. What we’re talking about here are specific incidents that deeply impact a company. They do so by generating crises of confidence, driving customers away, destroying monetary value, tarnishing reputations, and ultimately causing serious declines in performance. Even some of the best companies in an industry are susceptible to shocks – take Singapore Airlines as an example. Singapore Airlines reported its first-ever loss at the height of the outbreak of Severe Acute Respiratory Syndrome (SARS). The SARS shock did to Singapore Airlines what the industry and the competition could not – i.e., send its revenues tumbling down 35% in the same quarter.

Experience shows us that often leaders fail to move decisively, thereby prolonging their organizations’ exposure to shocks and rendering them susceptible to even more pernicious aftershocks, which, as with earthquakes, frequently cause additional destruction after the main shock. Therefore, from our experience base and from innumerous stories that we can uncover, it is important that executives are prepared to mitigate against shocks and be able to minimize aftershocks as well.

Shocks generate great uncertainty in their wake, but as insidious as shocks can be, leaders are by no means powerless. Our belief is that leadership ultimately sets the tone on how to respond to a shock. Indeed, shocks test the skill, organizational expertise, and character of leaders. How leaders respond in such situations can often make or break the organizations they lead. Leaders can both prepare their organizations for the unexpected and teach their management to respond in a manner that not only minimizes the fallout but may actually position them for greater success in the future.

We do not separate out leadership as a separate dependent variable in our analysis. This is because we believe that leadership is an important given. Without the right set of leaders who have the instinctive capabilities to respond in the face of pressure, who have the capabilities to identify the right set of leaders to deal with crises or shocks, or who have the ability to step aside for others to step up in the face of adversity, the organization will likely spiral uncontrollably toward disaster. We therefore acknowledge up front that leadership skills required for crisis management are a prerequisite of shock mitigation. Instead, based on a number of recent client experiences and an extensive literature review, we have concluded that leaders’ abilities to prepare for and respond to a shock depend largely on two additional and critical factors which in many ways are the make or break of organizational survival during shocks. First, it depends on leadership doing the “right thing.” Applying company values actively and assiduously, regardless of their legal or financial implications, is obviously important and necessary. But as we show below, transparency, boldness, and reacting with integrity – doing the “right thing” – is the additional critical element that no value system can guarantee. Second, it depends on leadership and how they organize for shocks. This means investing to build the necessary organizational structures to deal with not only the most likely but also the most unlikely shocks a company might face.

Leadership and values

Today it’s virtually impossible to find a company without an articulate and coherent set of values. Visit any company Web site and values are everywhere. But having values is not the same thing as living by them. In good times, values come easily to most leaders. But what about when times are tough? What place do values have in the midst of a potentially catastrophic shock? What role do they play when the world has seemingly turned upside down for an executive, when the media spotlight is focused firmly on her, when politicians are demanding punitive actions be taken against her? Or when trial lawyers are salivating to take potshots at her, and customers are beginning to flee her company? In the face of such extraordinary pressure, when all the facts are not yet in (and may never be), doing the “right” thing is not simply difficult; it would seem to be near impossible to do. And yet it is precisely in the midst of such shocks that doing the “right” thing can make all the difference.

Four minutes after midnight on March 24, 1989, the Exxon Valdez struck Bligh Reef in Alaska’s Prince William Sound. In a matter of minutes, 11 million gallons of oil began spewing into one of the world’s most bountiful marine ecosystems, killing birds, marine mammals, and fish and devastating the region’s ecosystem. As an U.S. EPA report later concluded, “Exxon was not prepared for a spill of this magnitude.”[8] The report indicated that Exxon’s efforts to get on the scene were unreasonably slow and that once deployed, their equipment could not cope with the magnitude of the environmental shock.

Along with tarnishing a once pristine ecosystem, the spill cost Exxon $5 billion in punitive damages – the largest fine ever leveled against a company for corporate irresponsibility. More significant than the company’s financial losses, however, was the damage to its reputation. To this day, media representation of the incident evokes images of corporate arrogance and irresponsibility and continues to remain fodder for several case studies designed to illustrate how not to behave in the midst of a shock.

Imagine how different the result might have been had the leadership at Exxon drawn lessons from J&J’s response to the Tylenol crisis earlier that decade. J&J leadership chose a dramatically different course. As Tamara Kaplan explains, “… the leadership immediately alerted consumers across the nation, via the media, not to consume any type of Tylenol product. They told consumers not to resume using the product until the extent of the tampering could be determined. Johnson & Johnson, along with stopping the production and advertising of Tylenol, recalled all Tylenol capsules from the market. The recall included approximately 31 million bottles of Tylenol, with a retail value of more than 100 million dollars.”[9] And the result: J&J received almost universal kudos for its actions and efforts in addressing the shock. Indeed, the company’s response now stands as the quintessential case study for many courses in business ethics. Ultimately, J&J’s customers were the final arbiters of the response – and, in this regard, the story resoundingly points in one direction: that is, customers became easily motivated to be on the side of J&J during the crisis, and it was not an ambiguous response on their parts.

So what explains the difference in the responses of these two industrial giants, and what can we learn from these two different scenarios? The short answer is values and leadership. Whereas Exxon had a crisis-management plan in place, a highly sophisticated public-relations operation, and extraordinary financial and human capital at its disposal, all of these did not translate to doing the “right” thing. Exxon failed in this instance because it could not deliver a more nuanced, publicly “correct,” socially responsible approach, which was called for. It certainly had never been subject to such requirement in the past and could not muster the right sets of actions when required. In contrast, J&J knew instinctively that customer safety came first and acted accordingly. As Brian Perkins, the director who managed the Tylenol brand at the time of the incident, later explained, “Working for J&J, you don’t walk around reading the credo every day, but you do try to live it every day. I’m convinced that the Tylenol brand and our reputation are better now than before the incident because of the way this case was handled. We tried to do the right thing and the public and the press recognized that.”[10] And, for sure, Exxon had all the right values as well, but that on its own did not translate to “doing the right thing.”

Is your company “conditioned” such that it has the appropriate reflex reaction when faced with a shock? In medical terms, a “simple” reflex reaction is automatic and involves no learning. However, a “conditioned” reflex is a reaction that is “conditioned” through experience and inherent values. The leader needs to think about her company’s “reflex” reaction when faced with shocks. Take the example of a North American client from the paper and pulp industry. In the mid-90s, it was caught flat-footed when suddenly the price of its flagship product declined by 50% to 70% in a space of a few months. With its survival threatened, the leadership of the company reiterated the focus on their values of being the finest company in the industry. The simple question, “What would the finest company do in these circumstances?” underpinned their transformation. Being the “finest” company implied a lot of attributes – and the leadership used this credo to reexamine the company’s operations during the shock. This spurred a turnaround, which fundamentally changed how the company interacted with its customers. Thus the leadership can, in times of crises, articulate (or rearticulate, as the case was with this pulp and paper company) the values that guide the firm’s energies and enable it to succeed during a shock.

Importantly, during shocks, leaders especially need to cling tenaciously to their firm’s long-held values and let that guide their response to the shock. In a recent interview with McKinsey, P&G CEO Alan G. Lafley recalled the market’s initial disappointment when he took the helm of the struggling giant in 2000. When asked about the dramatic turnaround between 2000 and 2005, as profits jumped by almost 84% to $10.9 billion and revenues increased by almost 42% to nearly $57 billion, he explained, “I started with P&G values and said, ‘Here’s what’s not going to change. This is our purpose: to improve the everyday lives of people around the world with P&G brands and products that deliver better performance, quality, and value. That’s not going to change. The value system – integrity, trust, ownership, leadership, and a passion for service and winning: not going to change. The six guiding principles, respect for the individual, and so on: not going to change.”[11]

What these examples all reveal is that how companies respond to shocks depends not nearly so much on their expressed values but on how leaders make those values real, how they’re shaped by those values, and how in times of crises they let their companies’ values guide the appropriate response to the shock. So, in summary, what we have learned from research and experience is as follows and is worth emphasizing:

The leadership stands to gain by reiterating the importance of values during a shock, especially when values help to reinforce the right set of behaviors among management and employees. But values by themselves are not the only drivers of the right behavior. There is a set of universal behaviors that go beyond the values that appeal only to companies’ employees. Customers of companies, for example, do not necessarily adhere to the same set of values of the company they deal with. Yet, customers expect a company to behave in a certain way, and they are the ultimate decision makers in whether the company survives a shock. Values mean nothing in the moment of shock unless the leadership reiterates their importance, especially during a shock, contextualizes their relevance to the shock, and in so doing, ensures that the company’s values are the overriding guideposts for all during the shock.

There is more than one way to get out of a shock. The role of the leader is always to ask herself and her team: “Which is the correct way?” and “What is consistent with the values of my company?” And even before the shock happens, the leadership is obligated to ponder: “Are the right values embedded in my company to ensure that my management and leaders do the right thing?” and “What can I, as CEO, do to make it happen?”

Naturally, in choosing leaders, the CEO and the board of directors need to carefully weigh the evidence about a candidate’s ability to face shocks and look for those who can pass muster and have the courage to do the “right” thing.

Leadership and organizing for shocks

Effective response to shocks requires an appropriate infrastructure and unambiguous procedures.[12] With respect to infrastructure, companies must have sufficient risk-management tools and programs in place to anticipate and respond to a wide array of shocks that they are likely to confront in the years to come (e.g., airlines and plane crashes; oil companies and spills; high-tech companies and supply-chain disruptions; and professional-service firms and reputational scandals).

On the basis of this, we have seen several of our clients develop crisis-management teams[13] that are aimed at responding to shocks. However, organizing for shock goes substantially beyond setting up infrastructures and procedures. The ability of a leader to know when and how to effectively shift to “shock mode” is critical.

In April 1995, Greenpeace boarded a Shell oil platform named Brent Spar in the North Sea to protest its scheduled disposal in the Atlantic. This action took the rig operator, Shell Expo (a joint venture between Shell and Esso), totally by surprise. The Greenpeace protest led to a major consumer boycott against Shell, and within weeks, it suffered a significant loss of market share in Central Europe and faced protests from political leaders across Europe. Because Brent Spar was located in a British-controlled area, responsibility for the response rested with Shell U.K. Meanwhile, Greenpeace broadened its public-relations attack in Germany (Shell’s German petrol stations suffered a 50% drop in revenues as a result). There was a total lack of collective action from Shell on this issue. Shell’s organizational matrix, comprising autonomous national BUs, typically did a good job of dealing with problems specific to their business units, but when a shock affected the company as a whole, the leaders found themselves working in different directions.

When the Tylenol shock hit J&J, it quickly amassed a massive corporate effort involving the chairman, PR department, marketing and sales departments, and other divisions – everybody had a hand in responding to the shock. It was precisely this lack of agility amongst BUs to come together quickly that left Shell susceptible to the Brent Spar shock. Why was one company able to deliver while the other floundered?

Then again, take the example of one of our health-care clients based in Singapore. During SARS, they were handling more emergency cases in a few weeks than they had planned for the whole year – they soon found themselves lacking a clear plan for a widespread emergency. They lacked adequate contamination facilities that could handle the volume they were facing. Their chain of command, which involved decentralized units, were fit for an organization geared to run smoothly during “peacetime,” but during a shock their existing structures were failing dismally to cope effectively. So, how did this company organizationally deal with the shock?

The key question then becomes, at what point does an organization’s ability to respond effectively start to “crack”? That is, when the command and control structures become obsolete, reporting structures and authority ceases to matter – at what point does the organization become so overwhelmed by the sheer scale, depth, and duration of the shock that it begins to “crack”? Every organization has that limit. In the case of our health-care client, this limit was clearly exceeded during SARS. They had to rely on a different chain of command during the shock – spot managers were making key decisions, which were completely disproportionate to their role during “peacetime.” Does the leadership in your company know who these people are and who will be most effective during a shock? In our client’s case, even simple things like patient registration, etc., had to be switched to crisis mode. How do you operationalize a plan to operate in crisis mode? Well, lessons are available for us to extract from.

The only organization that we know of that is designed to work in these dual modes is the military. And successful leaders in the military during a crisis possess two key skills. First, they become extremely task-oriented during the crisis. Second, they rely on a clear chain-of-command leadership structure, which has been well rehearsed during “peacetime.” This is exactly what our client in Singapore prepared for during “peacetime.”

The leadership of a company needs to realize and rehearse the “dual mode” for their company and be able to answer the following three critical criteria:

• How would the information/communications flow work during a shock?
• Who are the people in my organization who are most critically suited to take on specific responsibilities during a shock? Indeed, it is not necessary that the highest in the chain of command would be as effective during a shock.
• Do I have an operational plan for putting the company in “shock mode”?

We have found positive impact when leadership at our clients worked out these questions for their company and in the process understood exactly what the dual mode looked like for their company’s effective response during shocks.

Every organization has a limit to which it can operate in “peace mode.” If you believe that your industry is susceptible to shocks, then you as leader need to start thinking about what would happen when the switch to “shock mode” is thrown.

CONCLUSION

Shocks are inevitable. In fact, it would be incorrect to say that shocks are part of the “uncertain” world we live with. Indeed, shocks are as certain as certain can be. Shocks will happen and, therefore, it is critical to be prepared. No doubt, as the popular literature espouses, business continuity systems, contingency plans, etc., are important to have to minimize the impact of shocks. But we believe that leadership plays a more critical role, especially along two dimensions: First, in its ability to do the right thing and optimize the company’s values that guide its response during a shock. Our client experiences of dealing with shocks (as well as experiences from the history book) unambiguously show that it is indeed incumbent upon leadership to do the “right” thing and, where possible, to reiterate the values contextualized to the shock. Second, having the right organizing structure plays an equally critical role to mitigate against shocks. But crafting what this organization structure is requires significant preparation. It is important that leaders set the processes in place to prepare for eventualities, then rehearse every aspect of it in much the same way our modern military organizations prepare for war.

 

[1] AFX International Focus, August 7, 2006

[2] South China Morning Post, August 16, 2006

[3] Japan Weekly Monitor, September 20, 2004

[4] European Rubber Journal, September 12, 2001

[5] Financial Times, July 30, 2003

[6] BusinessWeek, September 6, 2004

[7]Although some people have argued that some shocks, like September 11, the Enron debacle, etc., could have been predicted (see, for example, Max H. Bazerman and Michael D. Watkins, Predictable Surprises – The Disasters You Should Have Seen Coming and How to Prevent Them, Boston: HBS Press, 2004), we believe that these are merely ex-post explorations of, as Philip Rosenzwig says, “a fruitless search for certainty,” Financial Times, April 7, 2006, p. 11.

[8] United States Environmental Protection Agency, “The Exxon Valdez Oil Spill: A Report to the President (Executive Summary)”

[9] Tamara Kaplan, “The Tylenol Crisis: How Effective Public Relations Saved Johnson & Johnson,” Pennsylvania State University

[10] Brian Perkins, “Defining Crisis Management: On the Front Lines of Corporate Responsibility,” Wharton Alumni Magazine, 2000

[11] Rajat K. Gupta and Jim Wendler, “Leading Change: An Interview with the CEO of P&G”

[12]The military is well-known for its many Standard Operating Procedures (SOPs). These are standards that basically allow military units to respond quickly to any situation. Everyone is practiced in the content and practice of these SOPs, from dealing with a jammed weapon to employing defence techniques over a particular terrain.

[13]Virtual crisis management teams include business continuity, legal crisis management, supply-chain redundancy, financial-risk mitigation, crisis-control center, and the like.