For the past year or so, I have been training for my private pilot license and the recent tragic oil spill events in the Gulf of Mexico got me thinking about risk management. While this post will not be a detailed treatise on aviation, some basic information is needed to frame the problem.
General aviation refers to ‘flying for fun’ (i.e., not for hire). Most of this type of flying happens in small propeller-powered aircraft, like the Cessna 172S I am flying. These types of aircraft are extremely basic in their design and are powered by simple piston engines-the Cessna 172s for example, features a 4-cylinder 1.8L engine very similar to what you would have in your automobile in most parts of the world. This is however where the similarities end. Unlike most modern automobiles, aircraft, even this simple, are not cheap (the approximate cost for a Cessna 172 is over $300,000) and have many built-in redundancy features intended to reduce the risk of an accident.
It is these redundancy features that have impressed me as I have been trying to perfect the art of flying:
Engine: although the engine is very basic (and not that powerful), it has 2 spark plugs per cylinder (whereas only one is needed), and a carburetor heat element in case you get frost at high altitudes.
Electrical: each aircraft comes equipped with 2 batteries, a main and a standby in case the main battery fails. In addition, the electrical bus is configured in such a way that only the most essential equipment is powered by the standby battery to maximize its useful life.
Airframe: the basic design of the aircraft is such that even if you find doing something the aircraft is not designed for, the airplane will always revert by itself to ‘straight and level flight’ once you release the controls. Furthermore, in case of engine failure, the aircraft can continue to glide for 10 miles (at a typical flight altitude of 6,000 ft) and can land on pretty much any flat surface.
Navigation: While our forefathers used to fly by sight (which is still the basic technique taught at most schools), most general aviation aircraft come equipped with 2 navigation radios (yes you got it, in case one fails) and a GPS navigation system that can take you from point A to point B at the click of a button. In addition, each aircraft comes equipped with 2 communication radios that allow the pilot to communicate with Air Traffic Control in case s/he gets in trouble.
Not bad, considering that most general aviation aircraft can carry up to 3 passengers and that less than 0.1% of the world’s population is licensed to fly an aircraft.
Now, what does all of this have to do with the world of business you ask? The point I am trying to make is that while it is extremely difficult to assign a value on human life (I know actuaries are very good at this), general aviation is built on the principles of risk management.
Although in a previous life I spent time researching the topic of risk management (see McKinsey Quarterly article from 2002), I am by no means a risk management expert, and individuals like my colleague Norman Marks are much more qualified than myself to discuss the topic.
Having said that, my view on risk management involves 3 key types of risks:
Market: e.g., market demand and prices, asset availability, exchange rate, customer creditworthiness
Environmental: e.g., regulatory changes, changes in political or social environments
Operational: e.g., accidents, performance service level agreements
According to this definition, the risk associated with the disastrous oil spill in the Gulf of Mexico was predominantly an operational risk. I wonder if BP or its sub-contractors created the internal visibility on the possibility of a catastrophic failure such as the one we are dealing with right now. The loss of 11 innocent lives and the devastating environmental and economic impact that is now being felt across the Gulf of Mexico is of course extremely disturbing. At the same time, no one can argue that BP has suffered immeasurable PR damage that has already wiped more than $75B of its market value. Add to this the $20-40B clean up and compensation cost estimate and the ensuing loss of revenue for BP, and it is not hard to see why BP should have paid more attention to the possibility of such an event occurring and developing the proper mitigation measures to deal with it.
I truly hope the lessons from this disastrous event will cause CEOs across all industries, and not just the oil industry, to re-think their approach to risk management.
I welcome your comments and thoughts.