GROWTH SECRETS: Managing risk

Business owners often neglect to uncover and analyse potential risks to their businesses. It is almost as though the budget itself is expected to look after all the possible things which could happen to the business.

More sophisticated firms undertake sensitivity analysis on the revenue numbers to estimate the impact of unusual growth or decline in sales and then work this back through their budgets to ensure they can cope with any situation those scenarios might produce. Few businesses, however, go to the trouble to look deeper into their external environment and internal operations to uncover those risks which could substantially damage their business.

Every business is built on a set of assumptions about their external environment and their internal operations. While some things might be obvious, any number of external events can impact the business, some of which are man-made while others are natural occurrences. Few businesses bother to plan for large man-made or natural disasters unless these are a regular feature of their local environment.

Thus businesses located in Florida should plan for periodic hurricanes.

However, businesses should be sensitive to economic, social and technological trends which could impact their operations. For example, for many businesses the rate of interest can have a long-term impact if it changes quickly in either direction, while some are impacted immediately with just small increases. A business which is sensitive to such changes should review the impact on the business of possible changes. Similar scenarios might be undertaken with oil price movement, commodity price changes and/or currency fluctuations.

Some underlying trends will impact a business over a longer period. Thus the aging population, or the levels of immigration, may impact the location and type of housing required or the demand for certain types of leisure activities. Some changes in technology are obvious, such as increases in computer power, capacity of internet channels and the capabilities of mobile phones. Others are possible but will not impact the marketplace in the short term, such as breakthroughs in medical science. The business needs to monitor those aspects of its environment which can impact its ability to achieve its targeted revenue numbers. Any change in trends or dramatic shifts in conditions which effect their industry should be examined for impact.

In closer proximity to the firm are the operations of its major customers, suppliers and competitors. The actions of major customers, if they go out of business, get relocated or are acquired, relocate major parts of their business or
undertake a major change in direction, can be very damaging to a firm. What was at one time an assured flow of business, can dry up in a relatively short period.

Thus monitoring the health of major customers is an important part of risk management of the firm. Most businesses are sensitive to their dependence on a large customer but few take action to spread their risks or to work with the customer to arrive at a risk reduction strategy. Also, the business should look at its exposure to any one project or customer to ensure that it is managing the risk of default on an agreement.

At the same time, the business will be dependent on a number of suppliers, some critical to the on-going operations of the business. If any major supplier should go out of business, have their operations significantly disrupted or be acquired by a competitor, it could present a significant risk to the operations of the firm.

While dual sourcing has been used by many companies, this may not always be feasible, but at least the firm needs to review the impact of such events and consider what action could be taken to reduce the disruption.

The business may have a number of strategic partners which work with it on joint sales or implementation activities or generate sales leads. With any external
business there is no guarantee that they will continue an arrangement indefinitely.

Where levels of activity are critical to the firm’s performance, such arrangements should be put on a formal basis so that obligations of each party are clearly understood. If the firm is unable to secure adequate assurances of continued joint activities, management should seriously look at other avenues for business.

Distributors are another area of potential risk. They need to be carefully monitored to ensure they are devoting adequate resources to the firm’s business and that they are willing, able and capable of securing the level of business necessary to meet their targets. A business which is overly dependent on one, or a few distributors, is really not in control of its own destiny. Actions should be taken to secure additional distributors, build an internal capability or enter into some level of guarantees with the major distributors.

Businesses which deal with importing or exporting of products also need to be sensitive to delays in transport. Shipping is notorious for delays through weather, dock workers disputes, changes in government regulations and natural disasters.

Possible delays should be simulated to show the impact on the operations of the business and the most likely disruptions planned for. Competitors can have the greatest impact on the future profitability of the firm, whether it is a price war, the introduction of a new product, the impact of a new innovation on their cost of sales or the impact on their reputation of winning a major account or performance prize, their activities will impact the firm. Monitoring competitor activity and trends is an important part of risk management. Since much of the information is in the public domain, such as their website, their published brochures, product information, press releases and annual reports, much information can be collected about their operations. From this information and industry rumors, much of their strategy can be ascertained.

This information needs to be fed into the strategy plan of the firm. Failure to achieve targets is often the result of internal mismanagement or disruptions. These are mostly under the control of the business and therefore the firm has much less excuse for not predicting their occurrence and thus planning for them.

Trends in physical activity can certainly be monitored to provide an early warning system of deviations or problems. It is the simulations which should be undertaken before events occur which provide the best weapon against disruptive events. Problems which can be foreseen can be considered and contingency plans developed or other actions taken to reduce the impact of possible problems or avoid them altogether.

Consider delays in research and development as an example. Creative activities and complex activities are difficult to predict with any accuracy, however, staff constantly forecast optimistic completion dates. The role of the strategic planner should be to develop alternative completion dates over a wide range of possible horizons to project the impact of delays on the business. With this in mind, the business can decide to devote more resources to the activity, plan other development activities as back-up or build in buffers for downstream activities in the event of delays. Certainly the firm would be unwise to make contractual commitments on the basis of deadlines which cannot be guaranteed.

Another overall risk in any business is quality, yet many firms fail to monitor quality performance throughout their operations. The overwhelming body of research in this area shows that problems which fail to be uncovered early in value added activities cost many times their monitoring cost if discovered late in a process or in customer use. Recall of products is expensive, fixing problems on customer sites is very time consuming and unproductive and compensating customers for errors which could have been foreseen is simply a waste of shareholders’ funds. Growth businesses can be severely disrupted if quality problems are not caught early in a process. Not only do they waste precious resources, but they can stall the entire business.

Many high growth businesses market high priced products which are sold to other businesses. The sales cycles are often long and the number of new customers in any period is often small, thus any fall in new customers can have a big impact on revenue. High growth businesses are typically very customer centric. They recognise the impact of the loss of an existing customer and the high costs of obtaining new customers. Their marketing strategy and customer support systems concentrate on providing the customer with an outstanding result. They pay close attention to each customer and monitor their relationships with them. Their aim is to ensure a high level of repeat and cross sold business and aim to generate significant new revenue from referrals. In this way, they work to minimise the risk of losing customers but also reduce the cost of gaining additional customers.

Other sales environments carefully monitor the progress of customer contact to ensure that additional effort can be put into situations which are problematic.
Thus the sales activity is monitored from first contact all the way through to closing the deal. This information is used to compare sales performance on an individual salesperson to the firm average. Any deviation stimulates intervention to help recover the situation or to move resources to higher potential prospects.

Risks are, however, not just in activity monitoring. Firms can experience severe disruptions through the loss of key employees through resignations, illness or sometimes death. Succession planning should not be limited to senior executives.

The entire organisation should be undertaking a risk analysis of the impact of the loss of any employee. Activities such as cross training, documentation of knowledge, standardisation of procedures and planned succession paths will alleviate some of the risk. On a more positive side, firms can actively work to retain staff. Individuals can be encouraged to develop their own skills so that they can take up opportunities within the firm. The firm can put resources into building a more open and supportive culture. Human resources staff can work with individuals to discover where they can assist them to achieve their own personal ambitions both inside and outside work. Not only does high turnover
disrupt the business, it is very expensive to recruit and train replacement staff.

This is one of the highest risk areas for any business and yet it seems to receive very low levels of attention.

Another area of high risk to the high growth business is lack of finance. Few
businesses can grow just from internally generated funds, most will require access to debt finance and some will need additional injections of equity. Typically any significant level of external finance will require many months to secure and will take up a significant portion of senior executives’ time. Generally it is difficult if not impossible to secure finance when the business is in trouble.

Business plans need to project financing needs several years into the future and should take into account the different possible levels of business which could be experienced under different assumptions. A business can be equally disrupted having too much business as too little. In the former case, funding is needed to finance increasing levels of working capital and infrastructure investment. In the case of too little business, funding may be needed to cover for work in progress or inventory which is not able to be sold or to pay salaries and other costs while the business is being reduced in size. Funding arrangements need to be put in place well in advance of need so that little delay occurs when funds need to be drawn on.

A big risk for many high growth firms occurs in their acquisition activities.
Many firms grow by acquiring capacity, products or people through an acquisition.

In some cases, this is the only way they can maintain their growth rates. However, only a minority of acquisitions are successfully integrated into the original business. While many senior executives take extensive trouble to find and secure the right acquisition, they seem to think the job is completed with the signing of the deal. However, most acquisitions prove to be highly disruptive due to problems of integration. Without a detailed plan for integration and experienced personnel to handle the risks associated with it, the benefits sought through an acquisition are unlikely to be achieved.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia. A series of free eBooks for entrepreneurs and angel and VC investors can be found at his site here.