30/04/2024
How can Corporates Manage Geopolitical Risk? Some Thoughts
Horizon Scanning; spotting key business impacts; implementing practical responses.
- Geopolitical risk matters for business leaders – increasingly.
- Identifying which risks are truly significant can be hard – particularly future risks.
- Implement proactive response strategies based on impact not assessed probability.
Geopolitical risk is an increasingly central focus of business concern. Numerous articles in the broadsheet press over the last year attest to this. Statements by senior business leaders, Jamie Dimon of J P Morgan among them, reinforce the point. A July 2023 EY CEO Pulse Survey indicated that 99% of the 1,200 CEOs surveyed were proactively shifting strategic investments in response to geopolitical challenges.
Major geopolitical uncertainties loom large right now: the continuing war in Ukraine; conflict in the Middle East; tensions between China and the West and other repercussions of growing multipolarity; plebiscites this year in which half the population of the planet can exercise some form of vote, above all the US Presidential elections and the cascade of repercussions this could bring for businesses across diverse jurisdictions and spheres.
The need for business leaders to understand and apply the lessons of geopolitical risk is nothing new. Recent decades of relative geopolitical calm are, if anything, an aberration. What is new is the volume of information, both reliable and unreliable, that bombards business decision makers. New also is the level of interconnectedness, from thirty years of globalisation, amplifying knock-on effects of events in one country across multiple regions and sectors.
Above all are the difficulties business leaders continue to face in integrating geopolitical risk into their strategic plans and decisions. They struggle with three aspects:
- Designing an effective process for horizon scanning.
- Spotting key, business relevant takeaways amidst all the background noise.
- Implementing proactive response strategies to identified geopolitical concerns.
Tracking and synthesising geopolitical events to identify potential threats or opportunities is not a trivial task. Distilling the “so what?” and developing appropriate responses and mitigations requires time and focus. The risks may seem hypothetical and unquantifiable, so how can they merit management attention? Far easier to plan for what can be predicted and measured than for a nebulous range of apparently chaotic events.
Assessing Geopolitical Risk – Considerations for Business Leaders
So how do business leaders deal with political risks and apply them on a practical level? Here are some thoughts that help to inform Aperio’s approach to predictive geopolitical planning and response.
The role of AI – necessary but not sufficient
AI technology has a growing place in monitoring geopolitical risk, but as an aid to collation rather than prediction. AI can crawl data feeds to highlight events of potential interest or concern. It can produce fast and updatable summaries of geopolitical trends – providing that the data sources are regularly curated and assessed for reliability. In short, AI can be a valuable enabler for research (and Aperio has already developed tools and processes to help clients do this).
What AI cannot do at present is “think outside the box” – to challenge consensus or provide the analysis, perspective and experience to draw truly insightful conclusions. There are too many variables, hidden forces and irrational human motivations for AI to replace human intelligence in assessing and forecasting geopolitical risk. If you are looking for a pure AI predictive model, you may have a long wait. It is an aid to horizon scanning, not a way to look beyond the horizon.
Government Affairs and Geopolitical Risk are Not the Same Thing
Many companies conflate Government Affairs and Geopolitical Risk – “we have a Government Affairs team. They do all our geopolitical analysis”. The problem here is that the interests and focus of the two functions is different. The role of government affairs is to get alongside existing government structures and work with them. The geopolitical risk analyst is thinking beyond this – how long will the current government be in power? What will replace them? Will they be benign or adverse to us? Will a transition be predictable or disruptive? What events could be out there that make our relationship with the current government irrelevant? It is a much wider and more heretical approach – looking out for icebergs, rather than oiling the engines.
Not all geopolitical risks are clearly signposted
Perhaps an obvious one, but to spot the icebergs, you must be looking in the right direction. This might not be where the icebergs have appeared previously – or it may not involve icebergs at all.
There is a risk that companies draw up a risk register. Each year it is tweaked and updated, but rarely is there a rigorous consideration of whether the risks are still current or the most acute. Less thought is given to what new political risks may be brewing which may have no relation to past risks or are consequences of other, non-direct, risks.
The most acute political risks to a business may not be highlighted in the media. There are plenty of issues which do not hit the headlines, or have not yet reached international consciousness, which business leaders need to know about. Companies may be overlooking second or third tier risks. What will a change in US policy in one area have on non-adjacent sectors and regions, on commodity prices, on distribution and sales? How will activism in one country impact wider operations? How will political uncertainty in a region affect global supply chain security and prices?
The “Risk-o-Tron” Fallacy
Some analysts love a “Risk-o-Tron”- a black box of metrics and values which spits out spurious ratings for geopolitical risk. The concern with this approach is that it can breed a false sense of scientific rigour and an unmerited sense of complacency.
Immediate questions include – what do the ratings mean? What are the inputs? How are they weighted? How often are they re-examined, re-tested and changed? How often is the whole engine pulled apart and examined for continued relevancy? How robust is the model at comparing relative risks of differing situations – does a particular risk rating for Chile, for instance, mean the same as it does for Papua New Guinea or Texas? In short, there is a danger that the Risk-o-Tron becomes a totem that is made to carry a weight far greater than it was designed for.
Geopolitics is too complex to be reduced to a model. The number of inputs and assumptions required to reflect these complexities would create results so circumscribed by margins of error as to be of limited value. This does not mean that targeted risk rating models for a specific purpose may not be useful (Aperio, for instance, have created metrics for specific client needs, such as supply chain exposure to forced labour risks). But reliance on a grand, unified model of geopolitical risk is in itself a source of risk.
Absolutes not probabilities
Analysts are often tempted (or instructed) to make a range of predictive outcomes with assigned probabilities. The dangers here are several:
- The range of outcomes can never be exhaustive.
- The probabilities may, to a greater or lesser extent, be pulled out of thin air with no robust methodology behind them.
- The exercise builds a false sense of security.
- Humans are generally bad at assessing the real probability of outcomes.
- Weighted probability estimates are inherently unreliable; focus on absolute impact.
In retrospect every outcome has a 100% probability – however unforeseen in advance. It is better to plan on the basis on a handful of critical outcomes rather than trying to cover all the bases. As Frederick the Great said, “He who defends everything defends nothing”.
Proactive Response Planning
Monitoring and identifying geopolitical risks are only one part of the challenge. More important is how businesses deal with them.
Given that it is impossible to cover off every eventuality, the first step is to know where your key business vulnerabilities lie. Questions to ask include:
- What processes, inputs, logistics chains, customers, projects or facilities are critical for success?
- What is the time horizon of risk for key vulnerabilities? Are we looking at an on the ground facility with a 30-year lifespan or a supply chain which could be substituted (albeit with cost and disruption) in a matter of months?
- Would any disruptions be unique to our business, or would it affect competitors or other industries/sectors? Does this make the disruption more or less critical?
- How could these key operations be disrupted and what geopolitical circumstances could bring this about?
It can be helpful to build a 3×3 risk matrix with broad categories of low/medium/high probability and impact but avoid getting too detailed in quantifying these – especially pointless is a probability weighted cost of impact which only produces a set of numerical values of little practical application. We are really only interested in high probability outcomes and high impact outcomes, what the triggers are likely to be for each and whether and how they can be mitigated.
Mitigation Measures
If geopolitical events can be foreseen, they can all, to a greater or lesser extent, be mitigated through proactive measures. A variety of strategies can be employed, depending on the nature and severity of the identified risk. At a tactical level, these may include:
- Enhancing resilience through diversification of inputs/supply chains/facilities
- Financial hedging arrangements through futures/options etc.
- Engagement strategies with current/future stakeholders
- Proactive legal arrangements
- Strengthened compliance frameworks
- Insurance, where available and appropriate
- Communications campaigns
- Enhanced security arrangements
At the strategic end of the spectrum, the identified geopolitical risk may lead to fundamental resource allocation decisions – withdrawing or divesting from a project or changing a whole operating jurisdiction before a crisis hits and the business finds itself forced to react on the back foot, potentially with multiple other companies trying to do the same thing at the same time. Part of the best mitigation is staying ahead of the pack, not reacting with them.
How can Aperio help?
Aperio’s Strategic Intelligence Practice provides Geopolitical Risk analysis, forecasting and mitigation advisory services to corporate, financial and legal clients. Our services include:
Country Risk Reports
Aperio has the experience and expertise in geopolitical analysis to deliver country risk reports to clients that are predictive and actionable. We do not provide generic country risk reports. Rather we engage with clients to understand their specific objectives and concerns to ensure reports are tailored to their precise requirements.
We can follow up with regular monitoring and update reports, using AI where appropriate, to ensure clients retain visibility of developments in key jurisdictions and areas that may impact their strategic interests and commercial operations.
Geopolitical Risk Audits
An outsider perspective can help organisations to analyse and identify the risks they face, particularly given the level of complexity and uncertainty across today’s geopolitical landscape.
We work alongside clients to help them understand the geopolitical and strategic vulnerabilities in their operations and supply chains. The aim is to:
- Audit current client understanding of geostrategic risks.
- Highlight potential risks and vulnerabilities that they have not identified.
- Develop mitigations to head off potential risks.
- Create proactive response strategies so clients are pre-prepared if things go wrong.
Scenario planning and wargaming
Road testing how an organisation reacts in response to a major adverse event provides valuable lessons. We work with clients to design and build geopolitical scenario planning exercises tailored to each client’s exposures and concerns. We help teams of senior management to wargame possible responses to a significant shift in the organisation’s operating landscape due to geopolitical or other strategic shifts.
Many insights can be generated from such exercises. Confronting corporate leadership teams with unexpected scenarios and leading them to think through potential responses helps to build organisational preparedness, responsiveness and resilience.
Charles Hollis, Director of Strategic Intelligence