How prepared is your operation for a disaster?

BY RICH SCHMITT
Management specialist

I attended the HARDI meeting in November and was, as always, impressed by their continued success -- as well as their value to their members, their associate members and their industry. While other groups struggle to define a purpose, hardi moves forward with quality programs, increasing attendance and growing membership. Bravo!

I attended one of the panel discussions on the topic of disaster planning and recovery. The panel included Jim Truesdell of Brauer Supply, A.J. Maloney Jr. of Coburn Supply, Michael Meier of Meier Supply, and Ken Ackerman of K.B. Ackerman, a warehousing consultant who helps companies with, among other things, disaster planning. Ken also publishes a newsletter, Warehousing Forum. Ken and the three wholesaler panelists have given me permission to share their insights -- along with a few of my own -- in the hope that your companies will not face the same challenges that these three wholesalers did when disaster hit their operations. 

As a little background, Jim’s company had a fire in one of their larger branches when an electrical problem created sparks that ignited their inventory. The branch was a total loss. A.J.’s company had several Gulf Coast branches in the path of Hurricane Katrina and shortly after that had their main location -- which houses their main computer system -- hit by Hurricane Rita. Michael’s company was hit by a flash flood that, overnight, put 40 inches of water through their main location and distribution center.

How important is disaster planning?  Just looking at the economics, the importance is determined by the loss-rate that you will endure for the outage period. In a past life, one of my customers calculated their loss-rate at $60,000 per hour for any unplanned outage. With a burn-rate approaching $1.5 million per day, it is pretty clear that a whole lot of planning is appropriate. It was also clear to me as a vendor that I didn’t want to be the cause of any kind of outage for this customer. 

Most wholesalers’ burn-rate is far lower -- but it is probably more significant than they understand. So let’s do the math. Say you are a single-location, $25-million wholesaler with gross margins of 25% and net profits of 3%. I know that the business impact does depend upon when the disaster hits. (In wholesaling, a business outage the week after Thanksgiving will generally cause less of an impact than the same-length outage during the heart of your busiest season. In retailing, an outage during the same period might be fatal.) 

For this example though, let’s assume that your business is spread evenly across every day that you are open. Also, let’s assume that you are open 250 days in the year doing $100,000 sales per day.  That means $25,000 (at 25% gm) of gross margin is expected and required per day.

In a disaster, this gross margin flow stops. In most disasters, the flow of expenses probably increases. So in a week, the hit to your bottom line will be $125,000. The impact will probably not be fatal but, as they say, it will leave a mark. The whole year’s profits are probably gone in less than 30 business days.  In addition to the loss of gross margin, customers start to abandon you as the outage continues. While most will want to be loyal, you can’t really blame them -- they have commitments to their employees and customers.

You might, naively, say that a major disaster is unlikely to happen to you. A.J. Maloney, whose company operates in hurricane country, indicated that over the years many people along the Gulf Coast took a 48-hour view of the impact of hurricanes. The impact from Katrina, however, is sure to be measured in years -- and probably in decades. A.J. indicated that after Katrina, Coburn’s could not even get into their New Orleans facilities to assess the situation for two weeks. After Rita, their headquarters was not hit but they were without power for two weeks. Their emergency generator kept the computer running so they were able to operate their other branches and send out statements. Their new, revised plan has a complete data center in another location since a direct hit on their main building would have been a major business impact. 

In St. Louis, this year we saw two major power outages from summer and winter storms that left some families and businesses without power for a week. Meier Supply was in a 300-year flood plain, but didn’t know that it was “year-300” until the wave of water hit their building. 

The common threads in these natural disasters are that they were unlikely to occur; many people, including the local and federal governments, were underprepared; and this lack of preparation greatly increased the impact of the disaster. Many business owners think that they will scramble to deal with the problems if and when they happen. For businesses of any significant size, this casual attitude is irresponsible as disasters are life-threatening to your people and the company.

All of the panelists agreed with Michael Meier’s three steps to reducing the impact of a disaster, in priority order:

• Have a plan
• Have a plan
• Have a plan. 
  

He estimated that their costs could have been reduced by 75% with better planning. Some thoughts presented by  the panel and from my experience

You need a real plan -- forget the lip-service plan where you pretend to have a plan or spend five minutes asking your computer guy whether you have file backups. This plan will take time, thought -- and probably some expense -- to create, test and maintain. 

Some of Ken’s recommendations combined with suggestions from the other panelists follow:

• Convene a group of your key people to create a list of the potential problems that you can imagine.
• Group the problems into natural and human events. The natural events include like rain, lightening, wind, flood, fire and earthquakes. Human events include work stoppages, utility failures, civil disturbances, terrorism, robbery, accidents and the loss of key people. 
• Rate each possible event as to its probability (how likely it is to happen) and its criticality (if it occurs how much damage it will cause).
• Build plans to address the most probable and critical events.
• Create an action plan for each event.
• Test the plan.
  
  

From my experience, I think your plans should include the following:

• Prevention - The best plan also includes actions that prevent the event from occurring in the first place. Installation of fire sprinklers or smoke alarms might be prudent for some companies. Some insurance companies will provide recommendations to you regarding high-payoff prevention activities.
• Preparation - Some actions taken in advance can prepare your company for an event if it does occur. Buying a generator and installing the proper wiring might be part of your plan for dealing with power outages. Create agreements with key suppliers for the schedule and replacement of inventory and equipment. Check and read your insurance policies -- you cannot and must not assume that the policy is the same each time it is renewed. You cannot assume that your insurance representative understands and describes your coverage accurately. If your coverage is not in writing, you can expect a big mess as you try to recover from the disaster. Take time to review your coverage.  Michael indicated that they think flood insurance is worth the money even though the next flood isn’t due for another 300 years. Jim suggested that you review all leases to ensure that you are able to abandon your lease if a disaster renders your building unusable. Some standard leases offer the owner a time to cure the situation that will be completely unacceptable to a business scrambling to recover. 
• Proactive procedures  - These are some pre-planned procedures that will be executed if the event is forecast to happen. Michael mentioned that Meier now has a procedure to move material to higher ground when flood warnings are posted. A.J. mentioned that they want to know how to contact all of their people and to have their people know how to contact the company.
• During-the-disaster procedures - Your people need to know what you want them to do when the disaster is happening. I know this sounds like common sense but people don’t always do the correct thing in a crisis. For example, your people need to know that if a guy points a gun at them and says “Give me the money” or, these days, “Give me the truckload of copper pipe,” you want them to give the money or the copper. Or if the building is on fire, you don’t want them to run back into the building to save their pc. I do think that your exit procedure can include having someone grab today’s tickets, close a fire door or other critical tasks on their way out of the building as long as it does not endanger them in any way. Of course, your priority is always the safety of your team.
• Immediately after the disaster procedures - Your team needs to know what you want them to do urgently after the disaster. All the panelists discussed the need to secure the site to prevent further damage or theft, and to protect your people as well as others in the community. They also suggested that you must pre-plan how your team is to communicate with the press, with customers, with vendors and with other employees.  As a reminder, copies of all of the plan documents should be stored away from your facility since a paper or computer copy is little good after it’s been destroyed in a fire or flood.  Another thing to remember is that cash is king. In a major disaster, credit cards will be worthless, checks will quickly be abandoned and cash will be required by many of the people whose help you’ll need.
• Recovery from the disaster - The panelists discussed that some vendors, customers and employees were true heroes as they helped the company get back into operation. The key is to keep everyone focused on the right tasks as they work to recover.The panel discussed the need to keep accurate records of all actions since insurance and government help will require documentation. They also mentioned the need to work closely with your insurance agent to ensure you are reimbursed for everything to which you are entitled. They stressed that the way the damage is described can significantly change the extent to which certain things are covered.
• Back in operation “grand reopening” - Jim mentioned that they had a Grand Reopening after their branch was fully operational. It allowed them to thank all who were involved in the recovery and to remind customers that they were back in operation.
• Test and adjust your plan - When I was involved in running large data centers for McDonnell Douglas, we had major disaster recovery plans, backup equipment and commitments by key suppliers. We tested the plan periodically and, without fail, discovered flaws in the plan or operational changes that had obsoleted portions of our plan. You must test and review the plan at least yearly.

A common thread of the three panelists was that none of the companies was fully prepared for the situation that they faced after a disaster hit. Fortunately, all of the companies survived, but all felt that better planning would have helped them to recover more quickly and to reduce the economic/ business impact on their companies. 

From past columns, you know that I am a proponent of checklists. E-mail me at rich@go-spi.com for a Word doc containing the outline for your disaster plan.  It will help you to begin the process of putting your plan together.

Lilly Tomlin, the comedian, once observed, “When the going gets tough, we’re all in this alone.” When the disaster like a flood, hurricane or power outage hits an entire community, you can assume that getting power and services to supply houses is not at the top of the list. You must be prepared to take control of your destiny and get yourself back in operation. So as you start the new year, I urge you to do some disaster planning within your company. Be prepared so your company can survive a disaster if it ocurs.

              

Rich Schmitt is president of Schmitt Consulting Group Inc., a management consulting firm focused on improving the profitability of distribution and manufacturing clients. Rich is also the co-owner of Schmitt ProfitTools Inc. (SPI), a business producing print, CD-ROM, web and palm-based catalogs as well as pricing management and analysis software for wholesalers.