Entrepreneurs and business owners that prefer to hide from the fact that risk exists are not doing themselves any favours.
Pretending risk does not exist, or taking a “wait and see” approach, shrinks the number of available options should disaster occur while simultaneously raising the cost of any solution.
If you’ve ever turned a blind eye, you’re not alone.
Even Microsoft’s Bing was caught short when a fire in the building housing their data center disrupted service, because it did not build any redundancy measures into its system.
Investors need you to understand risk
If your banker took that same approach with risk — i.e. refused to consider the ramifications when considering investments, sought out only those deals that sounded romantic (“I have a tower in Paris to sell you”) — would you partner with her?
Of course not, yet entrepreneurs ask venture capitalists to consider them as superior investment candidates with no comprehension of the risk they represent to investors.
How can you expect to successfully pass a due-diligence review if you have no knowledge of what risks potential investors might find?
A better approach would be to demonstrate that you know your company’s risk and that you have a mitigation plan in place and have taken steps to reduce that risk’s impact. Plus, if you address the risks, you are better positioned to frame the facts.
I am not suggesting twisting the truth, but by taking the lead you can position the story in a way that is most advantageous to your company.
How to identify your risks
Risk management is one of those things that can be as simple or as complicated as management desires, but for a company starting from scratch the following proposed method is a good start.
The initial process can be as simple as brainstorming with a pen and paper. I’d suggest making some categories first to ensure that all areas of risk are considered.
Look at customer issues, sales, environmental, supply chain, succession, you get the idea, and start listing everything you can think of. Don’t worry how big or small they are, just list them, get them noted.
Also, forget about doing this exercise on your own. Bring in your team as they will have insights you may not have considered, both in what qualifies as a risk and what steps might be taken to mitigate them.
Calculate the ‘risk factor’
Next to each risk identify, if you can, the highest likelihood and cost. It’s ok to start with very rough numbers, as the exercise helps you identify fuzzy areas in your knowledge.
Continuing on the Bing theme, one example could be where your data center loses power in a typhoon, and you have no provisions in place for temporary power. First consider the likelihood of that occurring during typhoon season, and not some average factoring in time off-season: say 8% likehood of that happening. Then consider the cost for the downtime this will cause, lost revenue, and any downtime fees built into contracts with customers: say $750,000 in lost revenues.
These factors will be refined as better estimates are developed but they give you a starting point to select the risks with the greatest impact.
The “risk factor” is the result of taking those two numbers and multiplying them together.
In this case 8% x $750,000 equals $60,000.
Once all the risks have an associated risk factor, this number should help you quickly identify where to focus your resources, as the higher the risk factor the greater the potential impact to your company.
You’ll probably notice that some risks that seemed significant may not have scored as expected because the odds of them happening are low, and relatively weaker risks might score higher because they are more likely to occur.
Datacenter down due to typhoon: 8% x $750,000 = $60,000
Sales team defects to competition: 40% x $150,000 = $60,000
Strike by union building vital widget: 80% x $125,000 = $100,000
Set Yourself Free
The risk factor helps the entrepreneur focus on her immediate priorities. In the risk list above, a strike has the greatest potential to affect the company and steps may be considered prior to a strike, such as finding some alternative sources for that key widget, or other creative work around that mitigate that impact and reduce the anticipated cost.
After addressing the most critical risks, determine if there are ways to mitigate other risks on your list.
In the case of the data center, a retainer like agreement with a generator supplier might be the ideal interim solution to cover the down period between when the center’s batteries are drained and the restoral of power. The cost would be nominal and protect against lost revenue, spoiled reputation, and contractual fines.
Time to Go
Risks are not stagnant, they’re not lurking in the coat closet waiting to leap out. Their likelihood ebbs and flows depending on the conditions; sometimes given the stage of the company, they may be “retired”- never to tarnish the list again. Others might be seasonal, consider a florist worried about having enough roses for Valentine’s Day.
You cannot afford to be complacent and think that risk decrease as time progresses. Nothing could be further from the truth. Companies go through stages and cycles, new risks should be continuously added to the list.
LouAnn Conner is Managing Director of Sagacious Consulting, a global consultancy that helps companies achieve operational excellence. Sagacious Consulting is head-quartered in San Francisco, California.