Consulting Simulation Case: Climate Change Operations

Prompt

A mid-sized manufacturing company is concerned about the potential impacts of climate change on its operations. The company has a number of factories located in coastal regions that are vulnerable to flooding and other weather-related events, and it is concerned about the potential financial and reputational risks associated with these events. The company's leadership team has asked your consulting firm to help them understand the risks they face and develop a plan to mitigate those risks.

•    Our client’s objective is to maintain long-term profitability
•    Our client’s factories are located throughout the US

Part 1: Identifying Risk Areas

The candidate should understand that the most important area to look into is where risk lies. If they ask for information regarding costal flood prone areas in the United States, you may provide them with Exhibit 1.

The candidate should identify California and the Southeast of the US as the areas most as risk, followed by the south (Texas, Louisiana, etc.).

The candidate should naturally inquire as to where our factories are located, in order to better determine where our risk lies.

You may provide them with Exhibit 2.

 

The candidate should note that Factories A, H, and I are at extreme risk and we will likely need to take action to reduce the risk of disruption to our operations.

They should also note that Factory E and G are also at risk, though in less immediate risk and with less impact than Factories A, H, and I.

Part 2: Risk Mitigation - Brainstorming

The candidate should recognize that now we need to work to mitigate the risk of operation disruption at the factory. When the candidate asks for information regarding this, prompt them to brainstorm solutions.

Ideally, the candidate will have a structured answer in key themes.  The main options at our disposal are:

1.    Flood protection: This can involve building physical structures, such as seawalls or levees, to protect the factory from incoming water. Other flood protection measures might include raising the elevation of the factory or installing pumps or drainage systems to remove water from the site.  The company can also consider modifying the design of the factory to make it more resistant to flooding. This could include using flood-resistant materials, such as concrete or steel, in the construction of the building and installing systems to mitigate water damage, such as watertight doors and elevated electrical systems. The company can implement internal adaptations measures to help it cope with the impacts of coastal flooding. This could include investing in backup systems and processes to ensure business continuity in the event of a flood, or taking steps to reduce the company's dependence on operations that are located in flood-prone areas.

2.    Insurance: The company can also consider purchasing insurance to protect against the financial losses that might result from coastal flooding. This could include both property insurance to cover damage to the factory and business interruption insurance to cover lost revenue.

3.    Relocation: If it is not feasible to protect the factory from flooding, and insurance will not be adequate the company might consider moving the factory to a safer location. This could involve identifying a new site that is better protected from coastal flooding, and relocating the entire factory, or just the critical operations and equipment, to the new site.

After the candidate has brainstormed options, ask them how they might evaluate them. A strong candidate will recommend a cost-benefit analysis, contrasting the cost of implementing each option with the expected value of the risk mitigation. A cost, effectiveness, and feasibility framework is also a strong answer.

1.    Cost: The cost of each option should be carefully evaluated to determine if it is financially feasible for the company. This might include not only the upfront costs, but also ongoing costs, such as the cost of maintenance and repair for flood protection structures, or the cost of relocating operations and equipment to a new site.

2.    Effectiveness: The effectiveness of each option in mitigating the risks posed by coastal flooding should be evaluated. This might include considering the likelihood of the option to reduce the frequency and severity of flooding, as well as the level of protection provided by the option.

3.    Feasibility: The feasibility of each option should be considered, taking into account any regulatory, policy, or technical constraints that may impact the ability of the company to implement the option. For example, some flood protection measures may not be possible in certain locations due to zoning restrictions or the presence of other infrastructure.

Part 3: Risk Mitigation – Data

You may show the candidate the following information once satisfied with their brainstorming answer.

The candidate should recognize that different options may work better for different factories than others. A particularly strong candidate will note the correlation between both the cost to insure and to modify a factory and the location of that factory (high risk area = higher mitigation costs).

If the candidates asks whether profits will remain the same when moving the factory, you can confirm that all profits will remain the same no matter the mitigation option.
If the candidates asks whether we can implement multiple items, clarify that only 1 option can be selected for each factory.

The candidate should note/clarify that modification and moving costs are one-time upfront costs, while insurance costs are annual. If they ask, you may confirm that the discount rate is 10%.

Calculations

The candidate should recognize here that a series of cost-benefit calculations needs to be performed.

To get the net benefit of the Modification cost they will need to calculate the NPV of the annual profit and subtract that from the Modification cost

Likewise, to get the net benefit of the Moving cost they will need to calculate the NPV of the annual profit and subtract that from the Modification cost.

In contrast, to get the insurance benefit, they will need to subtract the annual profit from the annual insurance cost, and then calculate the NPV for that new annual profit number.

Benefit of Modifying = Cost of Annual Profit / Discount Rate – Cost to Modify

Benefit of Moving = Cost of Annual Profit / Discount Rate – Cost to Move

Benefit of Insuring = (Cost of Annual Profit – Cost to Insure) / Discount Rate

The candidate should identify Modifying as the best option for Factory E. Insuring is the best option for Factory G. Finally, Moving is the best option for Factory A and H.
The candidate should note that there is no good option for Factory I (all lose money) and should ask whether closing the factory is an option. You may confirm that it is, in which can the candidate should note that this is the choice for Factory I (or, let the factory run until a flooding event).

These actions across Factory A, E, G, and H will save the company $60M in today’s dollars.

Solution

After conducting an assessment of the company's operations and the potential impacts of climate change, we recommend that we invest in climate change proofing modification for Factory E. We recommend that we purchase a coastal floor insurance plan for Factory G, and that we begin plans to move Factory A and H to safer locations.  Finally, we recommend that no action is taken on Factory I, or that it be shut down before an adverse weather event.

Risks:

•    One risk of investing in flood protection infrastructure is that it may not be sufficient to protect against the worst-case scenario. It will be important for the company to consider the likelihood and potential impact of extreme weather events, and ensure that its investments are commensurate with the level of risk.

•    Another risk is that the company may face challenges in securing the necessary approvals or permits to build flood protection infrastructure, especially if it is located in a sensitive environmental area.

•    Moving factories poses its own risks, in particular, that we may be moving into other climate change-impacted areas (tornadoes, fires, non-coastal flooding, etc.)

Next Steps:

•    Develop a detailed plan for implementing the recommendations, including timelines, budgets, and roles and responsibilities for each step.

•    Consider seeking external expertise or support to help with the implementation of the recommendations, particularly if the company lacks in-house expertise in areas such as renewable energy or flood protection.

•    Assess rest of US for other climate change risks not limited to coastal flooding