Weathering The Business Climate

By Rebecca Winters

"Everybody talks about the weather, but nobody does anything about it." --Hartford Courant, 1897

Once upon a time, many businesses blamed a convenient scapegoat whenever profits went south--Mother Nature. Too hot. Too cold. Too rainy. Too sunny. When your product didn't sell, your losses grew and you lost market share, it was easier to point the finger at meteorology than management. But those days are over. Thanks to a blossoming of private firms that make sense of weather data in business terms, and a new financial tool called a weather derivative, a variety of industries are using forecasts to fine-tune corporate performance. "Weather may still be an act of God," says Allan Eustis, director of digital earth and space applications for the National Oceanic and Atmospheric Administration, "but we know a little more about what God wants to do these days."

American industry has always used weather forecasts to gain a competitive edge. Farmers started relying on predictions in the Old Farmer's Almanac as far back as 1792. But as the 21st century starts, the use of weather data as a business resource has been propelled by trends in the competitive marketplace, such as just-in-time inventory and the barely-in-time demands of dual-income family shoppers who wait till the first chilly day to buy a coat. Then there are industry changes, such as the growth of a few key airline hubs and the deregulation of utilities. Together they have spurred demand for better data, faster, in more usable form.

Today there are about 150 commercial weather companies that provide services to business. Their offerings range from short-term forecasts tailored to a company's specific vulnerabilities to long-range predictions of how a company should prepare for the next season. The industry's growth is not closely tracked, but Jeff Wimmer, chairman of the Commercial Weather Services Association, a trade group, estimates that sales have quadrupled in the past decade. A few companies' client bases have exploded in that time.

Take a Wayne, Pa., company called Planalytics, for example. A division of Strategic Weather Services, Planalytics helps businesses understand how weather drives consumer behavior. Four years ago, Duraflame, makers of manufactured fire logs better known for setting the mood than heating the house, prepared for winter by stocking 20% more inventory in its warehouses than the firm thought it would need. With weather affecting its average sales volume up to 15%, Duraflame couldn't afford to miss out on a cold snap. But unseasonably mild weather in one part of the country could mean inventory would sit useless for weeks. At the time, Duraflame executives made short-term decisions based on a daily USA Today weather map plastered to an office wall.

Now Duraflame personnel access color-coded charts online that help them determine how many logs they can expect to need in Atlanta in January or in Denver in November. The model, created by Planalytics, tracks Duraflame's historical sales against weather data for the same time period and then makes projections from long-range weather forecasts. The formula is a lot more complex than the simple deduction that cold weather equals sales. Regional buying habits, for example, are taken into account. In Jacksonville, Fla., fire logs sell when temperatures dip into the 60s. In San Francisco, people buy when it's rainy. And in hardy Chicago, the mercury has to drop below 39[degrees]F for folks to gather round the hearth. "Before, it was tough to know whether a shift of 4[degrees] in temperature made any difference in sales," says Chris Caron, Duraflame's vice president of marketing. "Now we know it can make a tremendous difference." And the company has saved several hundred thousand dollars, Caron notes.

"Business practices that have evolved in the past decade make intelligent use of weather data a necessity," says Mike Smith, president of WeatherData, a commercial meteorology firm in Wichita, Kans. Smith cites the development of just-in-time inventory--a system in which businesses keep little or no overstock on hand. Instead, they place orders as needed, relying on speedy delivery to meet demand. The practice saves on storage costs and expensive markdowns, but it leaves companies at the mercy of delivery systems and the weather that can, literally, derail them. When a huge airline hub like Chicago is slowed down by inclement weather, companies feel it across the country.

Smith's company provides tailored forecasts to several transportation clients, including General Motors and Union Pacific. WeatherData helps GM determine when a storm is serious enough to warrant a plant shutdown, a costly decision not taken lightly. For the railroad, WeatherData makes a forecast "13 feet wide and 30,000 miles long," Smith says.

While some businesses hedge their bets with the help of private weather firms, others guard against Mother Nature's whim with a financial tool--the weather derivative. Created little more than 2 1/2 years ago, weather derivatives are now a $5 billion industry. They are essentially futures contracts ensuring that if certain meteorological conditions unfavorable to sales occur, the company that purchased the contract will be paid without having to prove any losses. And in some cases, companies actually pay the issuer of the derivative if weather ends up being favorable to sales. Either way, the company gets a guaranteed revenue stream that provides a buffer against climatic vagaries.

Lynda Clemmons, vice president at Enron, a Houston energy concern that buys and sells weather derivatives, says the concept emerged when companies' needs weren't being met by traditional insurance. "Insurance companies were saying, 'We can help you if a hurricane blows down your factory but not if it's 6[degrees] warmer this winter and your revenue drops,'" Clemmons says. The deregulation of the energy industry in 1995 meant that a new category of highly weather-sensitive businesses was suddenly forced to make a profit and became very interested in a product that could protect it from weather risks.

But utilities are not the only businesses using derivatives. In the winter of 1998, Montreal transportation-equipment giant Bombardier offered Midwestern buyers a $1,000 rebate on its Ski-Doo snowmobiles if a set amount of snow didn't fall that season. Bombardier backed the promise with a weather derivative, and with the help of other promotions, saw its Ski-Doo sales in the region jump 38% over the previous year's. "In a market driven 100% by weather, it's a little insurance for us and for the customer," says David Thompson, a Ski-Doo spokesman. This winter, Ski-Doo expanded the offer throughout the U.S.

Companies like Bombardier are getting more creative about managing weather risk because the quickening pace of business competition requires it. As globalization adds new pressures, competition will only become tougher. But at least when it comes to weather, industry won't have to get soaked.