The board’s role in building resilience

Resilience means both protecting against the downside of potential shocks and preparing to capture the upside. In this episode of the Inside the Strategy Room podcast, three experts discuss the board’s role in building that resilience to weather the current volatility. Asutosh Padhi, McKinsey’s managing partner for North America, is joined by Celia Huber, who leads our board services work in the region, and Ida Kristensen, coleader of McKinsey’s risk and resilience practice in North America and leader of the global cybersecurity practice. This is an edited transcript of the discussion. For more conversations on the strategy issues that matter, follow the series on your preferred podcast platform.

Sean Brown: Why is resilience on the board agenda now?

Ida Kristensen: We’re facing an amazing set of disruptions. First, the highest inflation since the 1970s, and while energy receives a lot of attention, core inflation is also high, and it is unclear what governments and other institutions will do. GDP slowdowns seem to be continuing, but how deep will it be and for how long? There is a lot of volatility in the capital markets as well, and while they are quite robust, access to capital and credit is tightening, which is particularly important for growth-oriented companies.

We see continued supply chain challenges. In our surveys, we see increasingly negative sentiment from consumers and businesses. We see job growth, which normally would not be consistent with recessionary trends, but the tight labor market is paired with decreased productivity in many countries. On top of all these macroeconomic elements, we have continuing uncertainty around the pandemic and geopolitical tensions. In conversations with CEOs and boards, uncertainty is the number-one topic that comes up. But there is a lot more resilience built into the system today than in previous times of volatility.

Asutosh Padhi: Yes, it’s not all gloom and doom. Consumer sentiment is at an all-time low, but consumer balance sheets continue to be extraordinarily strong, totaling $3 trillion of cash in the US. CEOs likewise report strong balance sheets. Innovation is alive and well, and this is a moment when everyone is thinking through how to take advantage of digital, improve productivity levels, and drive innovation and growth. We are getting mixed signals on the economy, but we believe that moments of high uncertainty are when institutions have to differentiate. In previous downturns, the actions that companies took made a tenfold difference in share price over a seven- to ten-year period. Likewise, the actions that leaders take today matter, and boards can enable them.

Sean Brown: Are boards well prepared to address a potential new series of negative events? They generally rose to the COVID-19 challenge.

Celia Huber: In our global board director surveys, boards say they are very prepared to deal with some challenges close to home, such as employee safety, but they feel unprepared for larger-scale forces. Major crises, macroeconomic shocks, climate change—directors find these challenges ambiguous. But boards have learned over the past two years that their clock speed and ability to make decisions need to increase to match the environment. I don’t know many boards that are just doing quarterly meetings anymore. They have added ad hoc phone and virtual meetings in between regularly scheduled ones.

It was also interesting that board members see opportunities to improve their efficiency and effectiveness during crises. One piece I found surprising is that only 7 percent of the respondents believe that over the past year their board was “most effective” at risk management, but 40 percent said their organizations are currently well prepared for the next large crisis. That still leaves 60 percent of board members feeling unprepared.

Ida Kristensen: And there are ways boards can prepare. For example, we sometimes stage war games around potential crises, and I recently participated in one with a North American company, a joint session for board members and the executive management. It was a ransomware-attack scenario played out over 3.5 hours, and it was more gripping than the latest James Bond movie, a really high-intensity situation. At the end, the CEO turned to the chair of the board and said, “If this had been real, I would now resign from the company.” When you do these exercises and play through the decisions you would have to make, it brings them to life and that gives you some muscle memory.

Sean Brown: Given those mixed economic signals, what are some ways, aside from war games, that boards and management teams can plan for different eventualities?

Ida Kristensen: Financial and geopolitical volatility will likely be with us for a long time; it may be the new normal. So, one thing we advise clients is to not rely on forecasts. The only thing you know about your forecast is that it will be wrong. You need to think about scenarios and interdependencies and plan for what you would do in those situations.

Many board members have experienced more economic cycles than the current management, so they can ask: How do we create a new playbook that builds on everything we have learned from the past? Secondly, boards can help ensure that the focus is not just on short-term protection of the business. There is a higher premium on short-term earnings and profitability given the rising interest rates, but this recession may be shallower and shorter than past downturns, which means that planning an exit from the slowdown should start now. Board members should make sure that management is focused on both defense and offense. What measures should we take to protect the firm in the short term? What opportunities can we find to improve our business portfolio?

Finally, talent is an important topic. Amidst talent shortages, some of our clients are considering not filling open positions, but our advice is to not cut to the bone. Manage your talent, because you will need all of them soon.

Asutosh Padhi: The decisions that boards now support and influence will have an impact on their companies for the next three, ten, 20 years. This is a moment to simultaneously focus on both growth and productivity. Productivity alone can help get you through, but on the other side of the business cycle you may lose strategic distance.

Secondly, most management teams and boards have a view on the businesses they want to be in today and in the future, and we think this is a time to accelerate both divestitures and acquisitions. The third element boards should pay attention to is strategic optionality, which comes from the health of the balance sheet. What is our fixed-cost position? How can we strengthen and deepen our talent bench?

Sean Brown: What is the board’s role in developing this new playbook?

Celia Huber: It is not unusual for companies to have an M&A playbook, and the management team has approval to move forward within that playbook, but boards understand that may adjust given the context. We are talking about something analogous [on broader strategy]. The board doesn’t need to be in the details but to understand the playbook’s framing and underlying assumptions. If these were to change due to the macroeconomic environment, that would change the management’s playbook as well.

Ida Kristensen: A board member can say, “Help us understand the playbook we are deploying. What are the key insights we are relying on? What scenarios could require us to mobilize quickly, what would be the board’s role, and how are you preparing us for that? What is our balance between defensive and offensive moves?” There will be some telltale signs if the company is retracting too much to short-term management of expenses and not sufficiently looking ahead.

Talent is another topic board members should probe. “In an increasingly competitive talent market, how are we differentiating ourselves? What is our value proposition, and what are indicators telling us about our ability to attract and retain talent?” Board members should also ensure a cyber playbook exists, because a cyber crisis plays out quite differently from most other crises.

Sean Brown: Are boards changing their approach to managing cyberrisk, maybe appointing a dedicated director or establishing new reporting structures?

Ida Kristensen: Some boards are making sure that at least a couple of directors have the right technical experience. We are also seeing boards, both in regulated industries like banking and nonregulated industries, say, “This is now such a critical threat to the company that we as a board need to understand and prepare for it.” Gone are the days when the chief information security office would tell the board, “We have a 99 percent patching rate, we’ve got it under control.” We are seeing a much more honest and substantive conversation about the threat landscape. What do we know about who is coming into our systems? What are they looking at? What are our greatest vulnerabilities and how are we addressing them?

Sean Brown: The word “resilience” is used a lot these days. What does it mean to be resilient in the current environment?

Ida Kristensen: Fundamentally, it is the ability to pivot when a disruption strikes, both by preparing the company for what is happening now and strengthening it for what’s ahead. We see three elements to that: foresight, response, and adaptation. Everything begins with information. Do we understand the likelihood of different things happening, their complexities and interdependencies, and the implications for our company? Tactically, it means looking not at forecasts but scenarios, with stress testing, early-warning systems, and some clear management decision processes around what you would do if X, Y, or Z were to happen. Take the supply chain: What kind of disruption would trigger the need for a decision, and are you clear on what that decision would be?

Response is all about the near to medium term. What levers are we pulling in response? That can be expense management, pricing changes, or operational adjustments, as we saw during the pandemic, where brick and mortar stores had to change their processes. Then adaptation might require more long-term changes to diversify your suppliers so you are less vulnerable to any one disruption. It could mean building up the resilience muscles within the company, institutionalizing war games and tabletop exercises, and preparing longer-term playbooks in response to more systemic changes.

Asutosh Padhi: The questions board members should consider are, one, what is the speed of the response? During the pandemic, we saw companies that used to launch products in four to five years doing that in three to six months. Number two is the effectiveness of the response. What results from these actions? And what is an enduring aspect of the response? What are we learning that is not just an in-the-moment exercise but can change how we run the institution? An example is board and management interactions: long presentations versus much more bite-sized, problem-solving topics. How does the CEO communicate with customers and with employees? You want to use this as a moment to accelerate.

Ida Kristensen: It reminds me of something JPMorgan Chase chair and CEO Jamie Dimon shared in the CEO Excellence book. During the 2008 financial crisis, he thought talking theoretically about what was happening at board meetings wasn’t the best use of his time. Instead, he pulled the board members out to the trading floor so they could see in real time. During crises, the board plays a different role around foresight, response, and adaptation. Rather than debating the response, it is probably more helpful to tell management, “Go run with it and tell us what you need.” But the board can play an important role in ensuring the organization learns from the crisis.

Sean Brown: What is the board’s role on each of those three aspects of resilience—foresight, response, and adaptation?

Celia Huber: On foresight, the board’s role is thinking about the main areas of uncertainty. Many boards I work with use scenario planning as a tool to understand the main drivers of uncertainty and the early-warning indicators that you are heading into that scenario. On response, the board’s role depends on the specifics of the crisis, and whether it is a moment to be seized. Most companies that came out of the 2008 recession in a strong position had used that downturn to make bold strategic moves. So, boards can ask, what are those moves for our company and what strategic decisions need to be made or business model changes implemented? For example, in the industry I work in, which is healthcare, one of the necessary business model changes recently was more digital delivery, particularly of primary care, and that had to happen almost overnight. As for the adaptation questions, how can we expand those capabilities? Can we take that virtual health offering and turn it into something bigger and bolder?

Ida Kristensen: Fundamentally, the board members can think about the balance between defensive versus offensive responses to crisis, short-term versus long-term trade-offs, and appropriately challenging management. Once you understand the main areas of uncertainty, ask management how they can help you prepare for the moment when you get into one of the scenarios when you have to make quick decisions.

Asutosh Padhi: I start with the notion of one team. I see the CEO and the management team as the player-coaches and the board as non-playing coaches. For this team to win, collaboration and faster two-way information exchange need to be in place, and joint problem solving as opposed to 100-page presentations. When I work with institutions, we recognize that there are three to five big questions that will determine the future of the institution, so what are those questions and are you spending enough time on them?

Sean Brown: What aspects of resilience should boards pay the most attention to?

Ida Kristensen: When we talk about resilience, people often focus immediately on financial resilience. How strong is our balance sheet? What are our pricing levers? What can we hedge? There’s no doubt that financial resilience is important, but we think other elements of resilience are also critical. Thinking systematically around six dimensions can help ensure that the company is prepared for whatever might happen. Aside from financial, there is operational resilience, which covers the inner workings of supply chains and production channels and how diversified or concentrated they are, how subject to disruption. Technology comes back to our cyberrisk discussion as well as other potential technology disruptions. How are we prepared and what backup systems are in place? How quickly can we get up and running again?

Resilience in brand, reputation, and ESG [environmental, social, and governance considerations] is about how you manage both internal and external stakeholders, and how you think about your societal commitments. On business model and innovation, resilience is about how quickly you can pivot. Asutosh talked about making production times shorter but what are the areas where it is critical to innovate quickly? Finally, organizational resilience is both the leadership—the board’s and the management team’s ability to decide and act quickly—and ensuring the talent value proposition.

Sean Brown: Which of those do you find boards and management teams are most focused on—or should focus on most?

Asutosh Padhi: I think talent is a top-three topic for boards and CEOs now, especially around leadership development and how to strengthen the leadership bench.

Celia Huber: It depends on the industry, but brand, reputation, and ESG are big topics in healthcare. The conversation about health equity became important even prior to the pandemic, with boards worrying about access and quality of care for underserved communities. Even if you are a privately held, for-profit healthcare business, you still need to think about, what is your customer base? What do those stakeholders need, and how are you creating the ecosystem to serve them?

Sean Brown: Is this increased need for strategic and operational resilience changing the structure of boards, such as more independent directors?

Celia Huber: Board seats change slowly, so we haven’t seen a huge uptick in the number of independent directors. I do think shareholders, and particularly institutional investors, are looking more closely at the backgrounds of independent directors and whether those directors are on too many boards. We are seeing more time on the agenda for the chief risk officer and outside experts in different risks. Board members are also demanding more time on the agenda for discussion after the presentations. Boards are using executive committees more as well, be they on supply chains and operations or technology.

Sean Brown: One aspect of resilience we haven’t talked about is climate change. How are boards ensuring that executive teams manage environmental risks, especially around catastrophic events like floods?

Asutosh Padhi: That falls into the bucket of operational resilience. For example, with industrial companies, supply chain resilience first became a board-level topic during the pandemic. I liken it to having been to the emergency room and now it’s time to go to the gym—to reimagine what the supply chains should look like in the future.

Sean Brown: What aspect of the evolution in the board’s role are you most excited about?

Celia Huber: I’m most excited about the board becoming a catalyst, bringing those independent, outside viewpoints to raise the ambition of the management.

Ida Kristensen: I would say the long-term perspective and the commitment to long-term strategy and innovation, making sure that course is clear and maintained even in the stormiest of weathers.

Asutosh Padhi: I think there is no better time to be a board member. This is a time when the actions you take will matter more than what you did five years ago and even in aggregate. Resilience is a new muscle for everyone and how boards and management teams work together to build that muscle is going to be extremely important.