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It’s an interesting and thought-provoking read, to say the least. Quoting a few of the key, and surely memorable, statements in that paper:

• “Storms, fire and floods are nothing new, but climate change is increasing their frequency and making their timing and location less predictable. This has severe implications for business. (…) And now there is a compound effect, because recent trends in business practices make companies even more vulnerable to climate change. Today, they rely on extended supply chains and ‘just in time’ delivery. There is more scope for disruption, and less tolerance for it.”
• “A year ago, our respondents placed climate risk relatively low down on their priorities, but it is now expected to become a more immediate concern over the coming year.”
• “One of the difficulties companies face in confronting climate risk is understanding the ways in which climate events can affect them.”
• “There is little value in having a sophisticated strategy to head off reputational damage if a supplier is exposed to climate risk beyond those central controls. When the Deepwater Horizon oil rig failed catastrophically in the Gulf of Mexico in 2010, it was BP’s ‘gross negligence’ judges blamed for the disaster, despite the fact that the rig was owned by a contractor, Transocean, and the faulty cement at the heart of the failure was produced by Halliburton, another contractor.”
• “…climate [risk] mitigation is a new area of technological development and innovation…”
• “The most popular climate risk strategy is lowering energy consumption and becoming more efficient, and it is not hard to see why – it is a strategy that both saves them money and makes their brand look good.”

So, paraphrasing what the TIC Council survey says about the topic:

• Storms, fires and floods will tear apart global supply chains, and companies will be blamed for causing global warming. That is ‘climate risk’.
• While completely neglecting the topic last year, executives are now really, really worried about this…
• … even though they don’t know what it is and what its impact could be.
• One example for a major climate risk is faulty construction and operation of oil rigs that causes oil spills, because if we all didn’t need the oil to burn in our fancy streaker-lightning cars, it wouldn’t have happened (or so)
• Dazzling new technologies will be needed to deal with all this
• At the moment though, saving energy e.g. by replacing light bulbs and turning down the heating is the most popular business strategy – whatever the logical connection of that “strategy” to the original “risk” of disrupted supply chains and tarnished reputations might be

In addition, in contrast to this gretesque climate panicking, macroeconomic risks are disregarded as a low-risk “also-ran” - despite the Sino-American trade dispute, despite worsening economic indicators in all major economies that prompted central banks to cut interest rates, despite Brexit and the still unsolved Eurozone calamities. A balanced and informed risk assessment, certainly.

/Irony off: Did someone, either at the TIC Council or at Longitude, read this outright nonsense before it went into publication and online? And does anyone there believe that such a botch job will be taken seriously and position the TIC industry as a trustworthy partner for mitigating risks?

Rather, this vexing effort, to us a comical blend of apocalyptic prophecy, logical inconsistency and stylistic inability based on poorly designed research, still illustrates the TIC industry’s intellectual and strategic tragedy.

In the survey, as far as discernible in all the wordiness, “climate risk” seems to be comprised of two aspects: An “operational risk arising from severe weather events” and a “reputational risk arising from angry consumers blaming companies for destroying Earth”.

Dealing with the former would require helping clients identifying critical elements in their operational setups, restructuring their supply chains and footprints to make them more resilient and slowly transforming their business systems. Leaving aside for a moment that this is the job and the domain of consultants, not of inspectors and auditors, it above all requires being sufficiently competent and not just delivering data sets. It would require to be on par with clients, understanding how their businesses and the technologies they employ work.

Dealing with the latter, if really addressing the problem beyond PR, requires pushing that transformation even further, with carbon-free production, completely new products, recycling schemes etc. – a major design, engineering and managerial effort that requires even deeper,  more comprehensive and quite industry-specific competence. If supposed to go beyond generalized statements, this would mean e.g. to tell Automotive OEMs which type of vehicles are most eco-friendly over the life-cycle, how to minimize the resource requirements for producing these, where to ethically source required materials and how to organize a more climate-friendly manufacturing.

In short: Playing an active role in fighting climate change requires being competent enough to guide others through a complete transformation of their businesses. Does TIC really have the competence to guide e.g. the Automotive industry to this end and act as a sparring partner? Doubtful.  

Moreover, TIC never played this role. In their role as impartial experts, TIC companies judge how well others have done something in hindsight and do not tell them how to do it in the first place. This separates the auditor from the consultant, and distinguishes the 3^rd party from the 2^nd party. Both roles are hard to reconcile and difficult to balance in a single enterprise.

Of course, if some TIC companies or even the industry in its entirety feels compelled to move into this new direction, who are we to stop them? But probably, it might make sense to think twice before abandoning one of the most successful service industry business models without a cause, only to chase the buzzword of 2019 based on a flawed study, and meeting such benevolent and pleasant competition as McKinsey or Accenture.

PS: We encourage our readers to consider alternative views on the topic, e.g. http://perspectives.occstrategy.com/post/102fn90/can-tic-solve-climate-change, and to share their opinions with us. Let’s discuss!

Much has been said about the political dimension and importance of this “Battle for Hong Kong”, but (in our view surprisingly) little attention has been paid to the territory’s key role in China’s current economic setup:

• Hong Kong is China’s “financial window to the world”. Not only is it, according to the UNCTAD World Investment Report, the 3^rd largest global destination for FDI – with half of that being directly re-routed to mainland China. It is also the by-far most important clearing center for international renminbi transactions, with 75% of all offshore RMB payments transiting via Hong Kong (source: SWIFT). And it plays an important role in international wealth management, ranked fourth globally with USD 0.8tn of international assets being managed there (Deloitte; Switzerland as largest global wealth management center: USD 1.84tn).

• In addition, Hong Kong’s ports and airport serve as a vital trade hub for China, with 20% of Chinese exports being handled there.

In other words: The domestic political fallout of a rebellious Hong Kong might be unpleasant albeit probably controllable, but an economically dysfunctional HK would be a severe problem for, if not threaten the very existence of China’s hybrid capitalist-communist system. It is therefore vital for the Chinese government to get the situation back under control.

Essentially, this leaves Beijing with a choice between the devil and the deep blue sea: Intervene in Hong Kong and let the People’s  Liberation Army “restore order” – and subsequently face tough, Iran-style economic sanctions and a collapse of the export-oriented parts of the Chinese economy. Or do not escalate things further, trying to get the protests under control with the means and forces already deployed – with the likely outcome of failure to this end and continuing, probably further intensifying protests that will continue to hamper economic activity and may spill over to mainland China.

The course of events unfolds nicely for the Trump administration, with the Chinese government apparently slowly losing its temper and exhibiting willingness to retaliate. So nicely that some, such as former HK Chief Executive Tung Chee-hwa, have rumored that the CIA might have instigated and organized the protests. Despite such speculations, it indeed appears that the Trump administration carefully prepared the scene for such a major confrontation with China, e.g. by creating even stronger bonds with vital allies such as Saudi-Arabia and using the Iran nuclear deal cancellation to illustrate the power of Western economic sanctions.

In our earlier blog posts on the “trade dispute”, we have noted that the underlying conflict between the U.S and China runs much deeper, and that it remains to be seen how long the Chinese government will be able to stay composed. To us, it is neither a surprise that the confrontation worsened nor that the Chinese government is starting to fight back before beginning to lose face, the ultimate humiliation in Chinese culture. Recent events, such as the episode around Cathay Pacific (cp. i.a. the Straits Times’ coverage), have again demonstrated that Beijing is willing to use brutal political, economic and intelligence force in a concerted effort if necessary.

For the reasons pointed out, we believe that a Chinese intervention in Hong Kong is more likely than unlikely, if other attempts to get the situation back under control (from a Chinese government point of view) fail. Some view October 1^st as the ultimate deadline to this end, as the Communist Party might not be willing to let anything overshadow its nationwide celebrations for the 70th anniversary of Communist rule in China.

In that case, tough U.S. economic sanctions would follow immediately, and any country that wished to maintain orderly ties to the United States would have to join this sanction regime. Not even Germany would be able to abstain, despite having to take the biggest economic hit – supporting a brave fight for freedom, democracy and human rights would be a too compelling case, after all. Not participating would be portrayed as siding with an unteachable authoritarian regime repeating Tiananmen. And in sharp contrast to 2003, there wouldn’t be a need for fabricated evidence to coerce allies. Rather, the case would be crystal-clear, and no Western government could continue to sit on the fence without completely losing any credibility.

What does all that mean for the TIC industry?

• Write-off the further opening of the domestic Chinese TIC market

• Instead, expect worsening conditions of doing business there – e.g. through the extension of the “social credit system” to companies, planned for January 2020. Not only is the system going to be complex with up to 300 specific rules and KPIs, driving up compliance cost (arduous introduction and maintenance). It moreover creates a perfect platform for seemingly data-substantiated official arbitrariness, e.g. special audits, fines and even blacklisting. And as employee-related data will have to be included, expect interesting discussions especially with European works councils.

• Factor in that the Chinese export business could really be at risk and could collapse suddenly – make sure that the impact of that can be handled and that the network is able to adjust to sudden shifts in trade/supply patterns.

• Non-U.S. TIC players: expect to come under intensified scrutiny in the U.S., depending on your China exposure.

Hard times and choppy waters – if they have not done so already, TIC players now need to hurry up to prepare their houses for the storm and improve the resilience of their business models.

Press coverage:

Crew describe climate of fear at Cathay Pacific after Hong Kong sackings: https://www.straitstimes.com/asia/east-asia/crew-describe-climate-of-fear-at-cathay-pacific-fter-hong-kong-sackings

Battered Hong Kong faces economic recession, existential crisis:
https://www.reuters.com/article/us-hongkong-protests-economy-analysis/battered-hong-kong-faces-economic-recession-existential-crisis-idUSKCN1VG007

China to impose ‘social credit’ system on foreign companies: https://www.ft.com/content/726905b6-c8dc-11e9-a1f4-3669401ba76f

Even more important, SGS seems to have been able to finally embark on a path of subtle strategic change. We believe that this was one of main reasons for replacing Carla de Geyseleer with Dominik de Daniel – bringing in a new CFO familiar with capital-light business models. A push into that direction is exactly what can be observed right now.

SGS’ recent scorecard and the fact that Carla was appointed as new CFO of Volvo Cars indicate that her work at SGS wasn’t too bad and is being recognized. But she may not have been able, or at least was perceived not to be able, to deliver the kind of strategic reorientation that SGS’ shareholders are looking for: Abandoning the greasy, at least in TIC terms capital-intensive or margin-weak industrial inspection stuff and moving more into glitzy, super-profitable consulting businesses that only require a bit of IT infrastructure. A strategic shift that, one could add after reviewing SGS’ measures in conjunction with BV’s and Socotec’s recent portfolio adjustments, others are trying to replicate.

The acquisitions of LeanSis and Maine Pointe clearly “demonstrate [SGS’] capital allocation strategy of increasingly moving towards higher value-added services.” But, is this still TIC?

Being perceived and credible as impartial, incorruptible experts for everyone is essential for the business model of the TIC industry. However, TIC companies can stretch the model and their reputation a bit and also offer “clearly 2nd party” services, in particular in “border areas” where the limits to other Business Services such as Engineering Outsourcing Services or Technical Consulting are blurred – where it’s partly TIC and partly something else.

TIC players managed to safely operate in these areas e.g. thanks to internal organizational mechanisms such as the proverbial “Chinese Walls” or codes of conduct that interdict e.g. a sell-on of consulting services directly after an audit. So far, brand extension has not affected their image negatively, which we however rather attribute to the fact that the considerably larger part of the TIC industry’s activities still strictly follows the “neutrality” paradigm and that this shapes how the industry is perceived.

The key question is how far this can be stretched. We believe that further expansion into adjacent areas has limits and can compromise those parts of the TIC business that heavily hinge on neutrality and impartiality, if “2nd party activities” become too important in the portfolio.

In particular in Certification, accreditation rules stipulate in utmost unambiguity that “conformity assessment bodies” must act impartially, must not face any conflict of interest and must have organizational procedures in place to deal with that. A TIC player with considerable “2nd party”-business is likely to fail these requirements, in consequence risking his accreditation to be revoked.

In other words: If SGS’ “CBE” at some point of time is more “BE” than “C”, conflict with accreditation bodies will be inevitable. This means that “accreditation-compatible” growth potentials in this field are limited.

Moreover, SGS pushes into an arena with established heavyweight competition such as Accenture, Capgemini or even McKinsey. While this might be sensible to counter these players’ recent moves into and ambitions in (future) TIC businesses, it raises the question what the chances of success against these professional service behemoths really are.

Finally, we do not buy into the story that this delivers a nice margin uplift – not yet. In our view, recent profit improvements rather result from restructuring efforts, i.e. firing people. We estimate that the approx. 3,000 net layoffs have yielded CHF 50m of savings in H1/2019, with the full year-effect potentially amounting to as much as CHF 150m. Sometimes, the “classic tools” still work well.

In conclusion, do we think that this strategy is wrong? Certainly not – but it’s risky. Do we think that it is going to cut the mustard? To be frank: No, unfortunately. Do we think that SGS would agree to this view? Yes, we do.

As one of a bundle of strategic measures, each delivering a growth and profit improvement increment, this initiative certainly makes sense. But it also points to and illustrates the strategic challenges and limitations the TIC industry faces:

• Realizing growth has become arduous and requires many “baby steps” – sometimes into unknown and potentially dangerous territories beyond the industry’s established limits.

• Such moves beyond the TIC industry’s “splendid isolation” should be contemplated carefully, as it is unclear whether deliberately abandoning the current sweet seclusion would really pay off in the end.
  

• The “splendid isolation” of the TIC industry also has a few downsides – apparently, barriers to entry for outsiders could also be barriers to expansion for insiders.

Implementing such tricky growth strategies, achieving substantial further growth and satisfying shareholder expectations is going to be challenging – a tightrope walk, even for SGS.