Understanding the McKinsey Climate Risk report
THE ADAPTIVE CO: I’ts the most important 120 pages you will ever read. (No, really. It’s true.)
McKinsey’s landmark Climate Risk report was finally published last week, and it got good press and reviews. Judging, though, from social-media buzz and some influencer conversations I’ve had, I’m afraid it might be cast as merely the latest in a growing string of frightening climate studies and get lost in the midst.
And wouldn’t that be a damn shame. Because this one is clearly different. I see it as a potential game changer in the world of business. But yes, it does suffer from the same malady as all the others that end up read by too few executives and managers: it is too technical and dense, and worse, it fails to break through the human biases that block business readers, any reader frankly, from embracing frightening futures and taking effective adaptive action — in the case of this report (and this column), effective action to make your company adaptive to whatever the climate throws your way.
So I feel compelled to translate it for the report’s (and the column’s) business audience, in the hope more of you will dive into those 144 pages (120, actually, if you don’t count the bibliography and other notes). Let’s break it down, then, shall we, in four easy-to-follow sections, and do please turn this into a great results-driving memo or working paper to jumpstart game-changing action at your company, or to raise your game if you’ve already launched an adaptation process.
Of Science and Models
The very first thing that jumps off the page is the report’s 2020–2050 time frame — from the immediate to the near term, making clear this is a today challenge, not something to be delegated to the distant future — and its reliance on the UN IPCC’s worst-case projection (technically called RCP 8.5), something no other report like this that I’ve seen has dared do.
Consider it a sign of the times, because RCP 8.5 is, indeed, the right path, the one the world is on, and therefore the one your business must plan for, particularly considering, which McKinsey also does better than other reports I’ve seen, that RCP 8.5 is being rapidly boosted by climate tipping points.
“Climate models omit potentially important biotic feedbacks, including greenhouse gas emissions from thawing permafrost, which will tend to increase warming.”
Yikes. The tech-speak McKinsey could have avoided. Yes, they’re biotic feedbacks, but the phrase tipping points is so much easier to grasp. They’re climate points, or thresholds, that tip, like the domino effect.
And no, they’re not “potentially important” and “will tend to increase warming.” They are happening already, are known to be massively important, and are increasing warming as we speak. COVID-19 is but the latest event. So readers, please, do not allow such cautious language in this or any other report to take your eye off the ball.
Scientists have in fact been notoriously cautious about projecting the domino, cascading, knock-on effects as these points tip each other into worse consequences, but they’ve grown far more confident as tipping points begin to happen and outcomes become clearer, empirical and inescapable.
The critical point for you as a business leader who must protect and adapt your company is that the climate models you may be relying on, as McKinsey says, generally omit tipping points. But you mustn’t commit the same omission. I address the point in my previous Adaptive Company column. Here’s how McKinsey explains it:
“One of the biggest challenges [stems] from using the wrong models to quantify risk. These range from financial models used to make capital allocation decisions to engineering models used to design structures. Continued reliance on models [that use] stable historical climate and economic data presents an even higher ‘model risk.’”
To be sure, next year the IPCC will update RCP and throw in a new parallel scale that assesses how socioeconomic forces affect projections. These two Carbon Brief links tell you all you need to know about that process, including that results thus far point to even higher temperatures than projected by today’s RCP modeling.
Hmm. Why is that? Oh, yes. Tipping points, at least in part. But a close reading of Carbon Brief makes clear that next year’s update will still leave tipping points largely out of the picture, keeping the model risk dangerously high — unless you, the modeling user, factor it in. IPCC won’t do it for you.
So yes, tipping points definitely heighten climate uncertainty, but that is all the more reason to understand them fully, reduce your model risk, and insert them into risk management to make your company far more adaptive than competitors and others that fail to go there.
One other thing about the science. McKinsey does a fantastic job summarizing the seven characteristics that make preparing for climate change so hard, but that also make it so indispensable as a 2020s best practice you will want to embed:
- It is worsening everywhere fast. RCP 8.5 combined with tipping points means, simply, that climate change can in all probability no longer be solved, so temperatures will rise uninterruptedly at least through the end of the century and probably for some time beyond. That will make this the most challenging 80-or-so years of your company’s future, starting today. Now. Already.
- It is hyperlocal—spatial, as McKinsey technically calls it. We’ll be diving into risks you can manage effectively at an HQ, core-team level, but know you’ll also need to engage and empower local stakeholders in unprecedented ways, in every place your business relies on.
- It is systemic, amplified by interconnected cascades you must track constantly. The coronavirus has become a case study on how cascades happen.
- Speaking of constantly, climate change is non-stationary. It changes every day in places around the world, and it will change daily over time as temperatures rise. So the risk management we’ll be looking at next must be always-on. This isn’t something for which you can simply write a static protocol, conduct a training, and update infrequently. It’s more like the constant, automatic app-update model in the digital world, or a sort of war room. You’ll want to set up your team accordingly.
- It is non-gradual, non-linear when it crosses thresholds and tipping points. Anticipating, preparing for, and reacting to this new reality takes a different operational and psychological constitution at your company.
- It is regressive, creating multiple social inequities within and across societies, I would add even among your very own employees! This calls for a new level of humanity, a different understanding of your corporate social responsibility.
- It’s catching most companies under-prepared, with dangerously insufficient adaptation. But then again, that is precisely the purpose of this exercise, for all of you to react and PREPARE ON TIME.
To that we now turn.
Of Mindsets and Biases
I said at the outset that human biases keep people from reading a report like this and reacting with urgent, effective action. But to its boundless credit, McKinsey at the very least acknowledges this primal, foundational challenge.
“Changes in mindset will be needed to integrate climate risk into decision making effectively. Experiences and heuristics of the past are no longer a reliable guide to the future.”
This is so mission-critical I wrote a separate column on it, because unless you first break through this mental, emotional and organizational barrier, you will likely neither embrace the science fully, given how daunting it is, nor, worse, will your board, people and teams up and down the line, and less so your suppliers, investors, insurers, bankers and other vital external stakeholders.
You all have to get on the same mindset page, and standing in the way are those naughty biases that refuse to bend, even in the face of existential threats. That’s why this is a primal and foundational risk that must be addressed first.
Other than acknowledge it, McKinsey doesn’t elaborate. It’s beyond the scope of this particular report, focused as it is on physical and socioeconomic risks. So it is up to you to elaborate. This Adaptive Company piece helps by giving you what you need to know, but for now, know this. For McKinsey’s exposition of physical and socioeconomic risks, you’ll be relying on your risk-management, facilities-management, and marketing teams, plus your local managers around the world.
For this mindset and biases challenge, by contrast — to bring your people and stakeholders totally, not perhaps-maybe-halfway on board, therefore making the risk- and facilities management best practice at all possible — you’ll be integrating your communications, HR and organizational culture teams.
So what are we talking about here? As humans, when facing a daunting, growing threat that is difficult to understand or that appears likely to produce pain, our natural, instinctive reaction is to not even go there and instead stay in our comfort zones. That’s called the Ambiguity Bias, combined with the Status Quo Bias. The first defaults us to the second. Even when you know you’re ill but can’t figure out what you have, you often avoid going to the doctor. Laziness and fear are powerful things.
Another big one. If you’ve convinced yourself that climate change isn’t happening, or it is but can’t possibly be “that bad” or you think it’s far into the future or won’t happen to you, you suffer from Confirmation Bias and will read and listen only or mainly to sources that confirm that view, as well as Optimism Bias that absolutely blocks most thoughts that point to an outcome less rosy than you’ve convinced yourself is part of your future.
There are a bunch of others. The Precautionary Principle, for one, keeps you from weighing smart probabilities, or a broader cone of possibilities, and instead binds you to one or two outcomes your mind recognizes. Remember the non-linear, non-stationary nature of climate change above? Put that through this bias!
Now, imagine your board, senior team, middle management, local-site managers, other key staff, investors, bankers, insurers and suppliers, stuck in any combination of these mindset biases and heuristics, when you send them a memo with new climate-risk procedures or meet to direct adaptation pathways. Yup. That’s right. Not gonna happen.
How will it happen? With an integrated two-pronged approach. First, an enterprise-wide culture, strategic planning, and change-management project. Do not limit this to HQ-level core-team tasks. This is a first-tier initiative where you embed adaptation in corporate values, strategy, systems and structure, so you may move people and stakeholders across the organization to join the adaptation effort with the highest possible engagement and as-needed empowerment.
Second, internal communications with all executives, managers and employees, and direct comm with all relevant external stakeholders. Breaking ingrained biases and heuristics, to the extent required to fully execute adaptation in the short time you have, is a framing, messaging, training, content, storytelling, inspiration and creative challenge of the highest order, with smart deployment of existing and innovative communications and HR channels and approaches.
The very first folks who must go through this process are those in the lead team, the ones who will be figuring out the physical and socioeconomic risks and adaptation opportunities McKinsey details, for they are the first who must abandon or redirect their biases, embrace the most accurate science, and lead the rest of the company toward the best-practice action agenda.
Of Risks and Uncertainties
That action agenda, in turn, begins with a full understanding and deft management of certain underlying uncertainties ingrained in any climate-adaptation process, a landscape laid out beautifully in the McKinsey report. Remember the Ambiguity Bias? These are uncertainties that create ambiguity and thereby blur vision and pathways. The communications team will dispel those clouds and create clarity, allowing the change-management and risk-management teams to spring into action and get enterprise-wide buy-in.
McKinsey, as we’ve already seen above, first calls out the scientific uncertainties and model risk. Then it makes a profound contribution to the world’s adaptation thinking. The report lays out, like no other report has, a range of global and local socioeconomic uncertainties you, and every company, must weigh across the countries and regions on which your business depends — production and extraction sites, suppliers, sales, distribution, more.
Ironically, the IPCC 2021 update mentioned above will include socioeconomic trends and how they’ll be impacting temperatures. McKinsey looks at it, as should you, in the other direction: the impact temperature rise will have on socioeconomic and political trends! It doesn’t take a genius to see that McKinsey’s latter will make IPCC’s former largely moot.
As McKinsey documents with poignant 2020–2050 data and projections, acute climate shocks and chronic stresses have already begun disrupting societies — heat waves, fires, storms, floods, droughts, sea-level rise, pandemics, more. They’re leading to resource conflicts, with a food-scarcity crisis looming this new decade. Migration will take off like never before. Governments will lose their tax and revenue base, including the ability to meet pensions and social-safety nets, and therefore grow increasingly unstable. Economies are sure to collapse, likely permanently given that temperatures will keep rising from here, hurting jobs, incomes and stability.
How soon will this drag the global economy as a whole into collapse? Surely a question you’ll want to sink your teeth into, given the fragility inherent in tight global networks and integrated markets.
“Lack of understanding significantly increases risks and potential impacts across financial markets and socioeconomic systems, for example, by driving capital flows to risky assets in risky geographies or increasing the likelihood of stakeholders being caught unprepared.”
Lack of understanding. Yes. This means, for example, that the core team you now have at HQ monitoring political and currency risks on a real-time basis, sending you flare-up alarms when an upheaval threatens your franchise somewhere, triggering the search for new sites and suppliers, getting Legal to iron out contracts and fights, moving HR to figure out what to do with your people there, and Sales & Marketing to do likewise with your brands — each of them must now understand your climate risks and join the plan.
Understanding here, it’s worth repeating, includes cascading, intersecting, knock-on, domino effects, as all of the above worsens, particularly as thresholds breach and trigger non-linear reactions.
One that McKinsey highlights, as did I in my previous Adaptive Company column, is the imminent reaction of your insurance carriers and financial institutions. A full quote here is illuminating:
“Economic and financial systems have been designed and optimized for a certain level of risk. Increasing hazards [means] such systems are vulnerable when they reach systemic thresholds. Supply chains are often designed for efficiency over resiliency, by concentrating production in certain locations and maintaining low inventory levels. Food production is also heavily concentrated; just five regional ‘breadbasket’ areas account for about 60% of global grain production. Rising climate hazards might therefore cause such systems to fail, for example if key production hubs are affected.
“Financial markets [will] bring these risks forward, and the recognition of large future changes [will] lead to price adjustments. Awareness of climate risk [will] make long-duration borrowing more expensive or unavailable and reduce valuations. This recognition [will] happen quickly, with the possibility of cascading consequences.”
I took the liberty of changing can and could to will, because again, McKinsey may not feel comfortable being so probabilistic, but you are in no position to play around with caution. It makes no sense for their researchers to first tell us how dire climate science is, and then wrap their risk language in such guardrails. C’mon. We’re adults here, I think. We can handle both sides of the truth.
Do notice, though, the variety of risks in that quote and the new nature of the risk-management game. That’s what TCFD and CDP help you grasp and manage. McKinsey, in fact, largely adopts the TCFD framework, as CDP did. The McKinsey report uses the “acute” and “chronic” language when describing physical risks, and as we’ll see in the next section below, it embraces TCFD’s vision of adaptation opportunities. Notice also, in this schematic, how it recommends inserting the full construct in Strategic Planning and Risk Management, and it offers a governance structure to do so.
TCFD’s main purpose, though, is financial disclosure. It is, after all, the Task Force on Climate-related Financial Disclosure. The central idea? Disclosing requires that you assess everything, assemble teams, identify the financial implications of all risks and opportunities, and then not stop at disclosure to investors, but instead actually adapt your company (as I explain further in this TCFD analysis and in this one).
That’s where McKinsey comes in, because it complements TCFD with a more robust understanding of the science and the model risk, a broader look at socioeconomic cascades, and a stronger focus on adaptation. In this column, we’re expanding on McKinsey by honing in on tipping points, human biases, and more below.
Still, for many of you, TCFD has become a fantastic starting point. CDP reports that about 7,000 of you are at least looking at and assessing your climate risks, if not yet comfortable disclosing. That is the biggest and most encouraging signal we have pointing to the mainstreaming of climate-risk management.
(For a new movement to get ESG portfolio companies on board, see here.)
Physical risks feature prominently therein, including the direct climate impacts suffered by public infrastructure and by your facilities. McKinsey provides great guidelines to help you analyze whether to retain, relocate, repurpose or relinquish (divest) your properties.
The first three, naturally, include fortification of the real estate and protection of your people and other assets, noting that “the economics of adaptation [will] worsen in some geographies over time.” Same with data, as you look at your owned or cloud servers, centers and other technology to take your security beyond the back-ups and redundancy of today.
The fact conditions will worsen throws us back to the mindset and organizational challenge. It won’t be business as usual. Know that going in. You’ll need to unleash your people and consultants to engineer creative processes that factor in this new climate-imposed reality. That is as imperative as it is exciting.
Of Time and Opportunities
And speaking of exciting, McKinsey and TCFD both harken back to the glory days of sustainability, when we were on time to solve climate change and companies introduced all kinds of solutions — wind and solar, permaculture and restorative agro, biodegradable consumer products, circular-economy production processes, LEED buildings, green urbanism, forest harvesting, electric vehicles, and so many more.
Today, so it is with adaptation solutions. Adds McKinsey: “At the same time, opportunities from a changing climate will emerge and require consideration. These [will] arise from a change in the physical environment, such as new places for agricultural production, or for sectors like tourism, as well as through the use of new technologies and approaches to manage risk in a changing climate.”
Adaptation innovation and reinvention, importantly, includes or can incorporate many decarbonization measures, so we can continue capitalizing on the work of the last 20–30 years, today adding resilience-only breakthroughs.
Whatever the particulars, though, adaptation solutions are generally falling short of meeting the climate science McKinsey points to. Non-linear, non-stationary, everywhere-worsening climate change requires another level, one that leads to solutions across the board, covering physical as well as socioeconomic and human risks, and which can pivot rapidly and at fantastic scale.
This is the biggest TCFD gap McKinsey helps fill. We must not allow biases to soften or underestimate where climate is headed, and this makes your challenge at the corporate level, and the collective challenge at the social and global level, all the more vital. The key McKinsey quote:
“The next decade will be decisive, as decision makers fundamentally rethink the infrastructure, assets and systems of the future, and the world collectively sets a path to manage the risk from climate change.”
Read that again. And again. The next decade, we can certainly now agree — the 2020s just begun — will be decisive. We (You!) will have to rethink, practically invent outright, the infrastructure, assets and systems of the future. The infrastructure, assets and systems of the future. And the world (all of us, collectively!) must set a path to manage all climate risks, and we see in this report how diverse and complex they are, given the short time we have.
Notice we’re not talking here about ten years to solve climate change, a common confusion, not to say delusion, in the news media, academia, the UN and the scientific and NGO communities. Rather, ten years to develop adaptation solutions and adaptive companies for the climate change that is coming!
Can there be a more daunting and yet all-important and creative challenge for your company? For your brand relevance? Stock performance? Franchise value? For your people? The communities and places where you do business?
When you read through and distill the McKinsey report, isn’t this, in the end, the very bottom line?
“Recognizing climate risk and integrating an understanding into decision making is an imperative for individuals, businesses, communities and countries. Much as thinking about information systems and cyber-risks has become integrated into corporate decision making, climate change will also need to feature as a major factor in decisions. The pace and scale of adaptation will need to increase significantly.”
Yes. It will.
With this introduction in hand, dive into the most important 120 pages you will ever read, and get on with the most future-defining task before you.
Alex Díaz, a leading thinker and analyst in the fast-emerging field of corporate climate adaptation, has a long career in business journalism, strategic communications, sustainability management, and stakeholder initiatives. He lives in Puerto Rico, at the entrance of the Caribbean hurricane alley, and runs adaptation studio COMMON Future, an affiliate of global social-enterprise collaborative COMMON.