Inspiration for this article comes predominantly from something I read in the finance papers earlier this month. It was an article on greed: specifically the greed of the modern banker and focused on two aspects of this high profile phenomenon. The writer provided the short account of the process he encountered in attempting to raise funding in the early 1990s for a new business venture. I too did this. My own experience was more productive than his, it seems, but the principles were highly consistent. Essentially, his conversation with his local bank manager concluded as follows;
“Of course you’ll offer your properties as collateral?”
“No,” I replied. “We’re not giving personal guarantees. We have a good business plan and we’re offering a small stake. You’ll have to take the risk with us, if you want the reward.” The idea that his bank should take an entrepreneurial risk left the bank manager hardly able to contemplate the horror of it.
As I mentioned, I was slightly more fortunate in that my own bank manager at the time was a competent seasoned, qualified professional with an understanding not only of the local economy, but also of his role in providing support to new businesses, and his clients in general. Nowadays, as perfectly represented in the Little Britain series, invariably, it is impossible to discuss and negotiate directly with your branch as the tendency to centralise the decision-making process and to populate branches with inexperienced, under-qualified, doubtlessly less-expensive “business managers” means that the computer, more often than not, says “no”.
I agreed with other statements made in the article I read, such as “Banks are not so much risk-averse as risk-free. Run a successful business and they make money. Fail and they throw your children on the street and take your house. Nice work if you can get it.” The writer was left with a distinctly sour taste in his mouth, coming to the conclusion that banks these days, no longer understand the proper relationship between risk and reward to the point where their original, entrepreneurial mediaeval roots have been forgotten and is dismissed, leaving the individual, be that a citizen or a businessman, to carry the entire risk of any new venture. He concluded that the payments of over £30 million of bonuses to Barclay’s investment bankers is not of itself distasteful; they are, after all, performing within the terms of their own personal contract with their employer, and most of us can relate to this. The problem, however, is that these extortionate bonuses are at the direct cost and expense of those of us who wish to stimulate and develop our own private enterprises and indeed at the expense of the entire British economy.
The point, I feel, can be extended even further. There was a time in the not too distant past, where there was always a long term guaranteed safety net for most of us in Britain; namely, that of a pension. Not only was there in existence a reasonable and fair state pension scheme, but increasingly employers were offering their own private pension schemes to employees. We were also working with knowledge that we could retire at a reasonable and agreed age and use these funds, created by our own contributions, to live comfortably during our later years. We now know this is not to be true. Not only have we seen pension funds, abused, mis-spent and just plain lost, but we now face an extended worklife, where the retirement age is being increasingly pushed back. Even in Australia, noted for being marginally less impacted by the current global recession, the retirement age is being considered for further extension to the ages of 67 and 70.
Let’s be honest, how many of us actually considered that we would have to work longer during the early years of the 21st-century? How many of us didn’t realise that the low risk, guarantee fund that we’ve contributed into directly for all or most of our working lives lay in the hands of incompetent and non-accountable financiers in the City hedging funds and taking risks with little or no consequence to themselves.
So back to the topic of this article, that of risk. What is risk and how do we deal with it? I have two favoured definitions. The first made an impression on me during my formative years in a Cheshire grammar school. I have since learned that this may be, in fact, anecdotal, but it’s still both makes me smile and serves to illustrate the point. In the annual exams for entry into Oxford and Cambridge, the school’s accepted young genius and protégé was posed the question “What is risk?” as part of the entry examination. His response, as the story goes, was simply “This”, leaving the rest of the Oxbridge examination paper, blank. Whilst I do accept that this may not be an adequate definition, it does, however, capture what many more words could not say. But, for the sake of completeness, I shall add a more expansive definition;
‘Risk’ – exposure to the chance of injury or loss; a hazard or dangerous chance.
From this more practicable definition it appears that it is not so much the risk that we address, but more the potential for loss or injury. During my many years in the world of corporate management I made decisions that included some form of risk on a daily basis. It was clear to me from early in my career that while risk was inherent in business activity it was often avoidable. In order to effectively assess and mitigate the potential for loss, I assessed the risk in the simplest terms possible and I adopted this simple strategy.
You can do, one of four things with risk. Or rather, there are four things that you can do to reduce the potential for incurring loss or injury; Prevent it; Pass it on; Protect it; Pay it.
In order to maintain the spirit of both the magazine and this article, I shall not at this stage dwell too much on the element of risk prevention. After all, inherent in the decision to take a risk one has already accepted many of the elements of potential profits and losses. Price, product, quality, service, market conditions, competitive activity, exchange rates, returns on investment, fitness for purpose, logistics, production, etc etc all contain elements of risk as they all contain the potential for increased expense, reduced margins or higher operating costs. Additionally, there are literally hundreds of risk assessment consultants, businesses, training courses, skills and techniques that will provide formal methods and techniques for the prevention of many business risks. I have added several links at the end of this article that will hopefully direct you to such courses and agencies. And after all, in business as in life, prevention is invariably better than cure. Continuing on the basis that every decision contains an inherent amount of risk I shall elaborate on my other three categories.
Pass it on.
Keeping things as simple as possible, there is generally only two places to pass on your risk; you can either pass it forward to your customers or pass it back to your suppliers. As a brief aside, my experience of corporate world frequently adopted a different approach and one which I strongly recommend that you avoid – at all costs! Departmental Managers incessantly attempted to pass on risks internally between departments rather than address the actual issues at source. For example, the risk of early product release to the market. This happened almost annually with the inherent product performance risks being passed on to the sales division and thus incorporated into both the budget planning process and the sales targeting system with the predictable, if not inevitable, result of a permanent shortfall to budget, frustrated and de-motivated sales teams, undertrained installation and service engineers and increased numbers of dissatisfied customers! This detached marketing perspective, based on an independent assessment of the product in the marketplace, lead to further indirect costs in the form of innumerable management meetings, personnel issues for both the increased numbers of sales staff leaving and the associated, unplanned costs of recruitment, as well as the direct costs and losses of unpaid invoices, lost service contracts and the uptake of general business provisions released to the profit margin in an attempt to patch over the cracks.
Essentially, passing on risk in the context of this article means managing the entire supply chain. This entails the integration of all suppliers into the production or manufacturing cycle; enabling them to understand and contribute positively to your requirements to mitigate or minimize your own risks. By making your suppliers aware of the quality standards, market conditions and, where feasible, your sales and marketing strategy, you can ensure that their performance within the supply chain meet all the criteria you require before you release your product or service to customers. The other option, of course, is to pass this risk on to your customers. Undoubtedly, an element of the financial risk could be contained within the profit margins of your sales, but it goes without saying that if you require all of your business risk to be paid for by your customers then, within a relatively short period of time, your pricing becomes less competitive and your competitors more attractive. This does not mean however that your customers may not be completely averse to sharing some of your risks. By ensuring that the customers requirements are specifically incorporated into your offering and by ensuring that the environment into which your product or service is being taken meets with any environmental and technical requirements you are effectively placing an element of the risk within the customer, without necessarily charging him a direct premium in the price.
Protecting against risk is a moot point. In my opinion, by doing so you have effectively admitted your inability to either prevent it or pass it on. There are, I am certain, such random, unlikely or abstract circumstances that none of us would be able to predict; a certain set of events that could, in principle, lead to injury or loss. We actually encounter such potential conditions everyday driving to and from place of work. Despite the incessant advertising for reduced car insurance, multi-car policies, payment-free windows and the like, the cost of car insurance has generally increased over the last decade. This is not necessarily because we ourselves are worse drivers and a greater risk but is a combination of external factors such as more traffic on the roads, more uninsured drivers, a general propensity to car rage etc. We are even now encouraged to insure against our insurance; that is to increase premiums even further and to protect against the fact that we haven’t had to claim against our previous premiums. That is, to protect no claims bonuses. I may well be in the minority here, but to me, paying additional insurance to protect our previous lack of claims against the insurance that we have already paid is bordering on the insane. But, in these times, popular and practical nonetheless!!
Another example, that we encounter daily, is that of property insurance; for example, I can take out home and contents insurance and include my mobile phone, get specific insurance from my mobile phone provider, obtain additional travel insurance in case I damaged my mobile phone while travelling, more contents insurance within my car insurance for the theft of my mobile phone from my car, premiums from my service provider to protect for the loss of the phone, etc etc. I may not be the world’s most intelligent man, but I am certain that five different insurance policies for my mobile phone will not be likely to prevent me from dropping it as I step out the car! Insurance against risk is part of Western civilization. Effectively, you can insure against virtually anything. In fact, some insurance protection is now required legally and is incorporated into many of our laws and statutes; it is in an unavoidable aspect of modern day life; and so modern day business. Insurance against loss, and therefore insurance to protect risks, is at best, a necessary evil; far better surely to understand your product, your customers, your suppliers, your market and your strategies than to give away hard earned profits to nameless insurance agencies, who have little or no interest in you or your business but, like today’s banks, have only their own interests at heart. No risk share but all of the rewards for your unflawed performance.
Pay for it.
If all else has failed and the inevitable result of mis-managed risk is carrying the burden of loss. In business terms, this quite simply means that these losses reduce the amount of profit available for spending or investment elsewhere. Once more falling back on to my corporate experience, I found a far more palatable way of dealing with such losses was to find some way to predict them, and therefore in the absence of any other solution to defer the payment of these losses over as long a period as possible; namely through the use of reserves and provisions. Reserves and provisions are little pots of money tucked away in the various company accounts (legally I may stress!!) that are built up over a period of time and utilised/released as and when particular risks manifest into losses or additional costs. By topping up these little pockets of savings, I managed to create some protection to the profits on an ongoing basis. These provisions and reserves may be specific, yet unquantifiable, for example, bad debt, or they may be quantifiable but the timeframe unknown. By using simple algorithms, models and experience and by incorporating the trends and practices of the business over a period of time I created and grew these little piggy banks. Provisions can only be created from profits generated from sales, and so it could be argued that I was simply under-declaring profits. In fact, having been confronted by overzealous corporate auditors and accountants and had many stimulating, and indeed exasperating conversations with respect to provisions and reserves, I attempted to adopt a pragmatic approach.
As a commercial manager my role was heavily involved in risk management in the context of protecting profits. I was responsible not only for the creation of a sales and conditions contracts with my customers but also responsible for the budgets, profits and losses, and for the order process. To me it was far more relevant and appropriate to understand the context of the risk as well as the likelihood of the loss actually materialising. Simply adopting a legal approach to a business transaction blinded me to the implications of the pricing and the market. Simply adopting an accounting approach, removed me from the specifics of the contract with my customers and indeed my suppliers.
My control of the order process meant that my internal resources, responsible for the delivery of the product and service and therefore for the satisfaction of my customers, gave me a rounded perspective for the management of risks. I would recommend you approach risk in your business in the same way. Don’t just opt for the easy option and pay ridiculous, irrelevant insurance premiums. Equally, don’t ignore the risks altogether. Work with your supply chain. Train your staff. Invest in quality. Know your market.
In conclusion, risk is a necessary element to life and business. Even if we wish to permanently and completely avoid risk of any kind by, for example, sitting comfortably in an easy chair during the day and carefully climbing the stairs to bed in the evening, we may still run the risk of inadvertently biting our tongue during mealtimes, dropping the mobile phone in the bath or developing bed sores. Risk in business has a similar inevitability; what protects us, and indeed makes any successful business creative and unique is their ability to predict and manage risk and avoid exhaustive losses by good training, good practice and no small amount of good fortune.