How To Evaluate Business Risk

Yes, You Must Take Risk to Succeed

Risk is part of business. If you do not like risk, you probably will not like business. Taking risk can bring rewards or disappointment. Here are some risk-evaluating steps:

  1. Who else is taking risk? Your competitors! I was at a conference in Miami years ago where an executive from one of America’s greatest companies told of how not taking risk can put you out of business. He showed an example of Company A not taking a risk because of a projected small return. Company B, the competitor, took the risk because they could see a huge return. And where was that return? It was in capturing Company A’s market. Company A failed to evaluate the possibility of Company B taking the same risk. The question was related to new manufacturing technologies, which were available to BOTH companies. Company A was forced to upgrade their factories because Company B upgraded their factories. While they were trying to catch up, they lost a good share of their market.

    Let me say this another way. Company A decided that upgrading their factories would not increase their market share. The returns would not justify the cost. Company B with their more antiquated manufacturing methods could see a large reduction in their production cost which would allow them to lower their prices significantly—which would guarantee more market share. Company A overlooked this possibility.

  2. How good are the assumptions you are making about a risk venture? Many manufacturing changes are predicted to increase quality, capacity, and yield. It is easy to let that same "exuberance" that Mr. Greenspan talked about take over realistic thinking. An increase in product yield can make a risk worth taking. But if the yield expectations are not met, you can actually lose money because you were not able to reduce the cost of manufacturing your product. Capital expenditures don’t go away just because the factory is not producing up to expectation.

    I was involved in many risky projects during my working career. I found it very common for executives to overlook the reservations that manufacturing supervisors might have about production yield. Well, that is part of their job—to overcome objections. If executives think that they must overcome every objection to a project before proceeding, nothing will ever be accomplished. The problems come when objections are overlooked or not evaluated.

  3. What if the projections of a risky project are not met? There will be problems with the startup of any project. When the project is finished and expectations where not met, the "I told you so" crowd will step up to the plate to display how "right" they were and therefore they should receive some glory. These can be the dark days of a project.

    When evaluating a risk, realize that things may not go well at first. Therefore, you need to have contingency plans in your evaluation. If this happens, we will do this. If that happens, we will do that. One way to reduce risk is to not shut anyone out of the evaluation that will play a role in the final outcome.

  4. Will consultants help in this risk evaluation? Consultants are often used in industry. Some are very competent; others don’t know apples from oranges. A long resume does not make a consultant. A long history of related experience in risk management does. Often when a consultant comes to a company, he overwhelms top management with B.S. He then creates a disaster. Consultants should be evaluated the way a top executive is evaluated before being offered a position in the company. References need to be contacted. Find out what projects he has worked on and then contact the principals involved and ask how successful the project was, how much input the consultant actually had on the project, and if they would hire the consultant again. Consultants are expensive but to not consider using consultants on an important project can be more costly. What is the risk?
  5. Should extra cash be put into a project when expectations are not met? Sometimes to correct problems in a new process, changes must be made. These may be minor or major engineering changes. I’ve visited a number of engineering disasters in my day. It’s sad to walk into a factory that is not operating because of problems. Barely-used machinery sits idle while the company continues to pay for the cost.

    Too often, failure stops all thinking. It may be possible to resurrect a dead plant by modification. That takes money which management is reluctant to spend. Having said that, a major fiasco may not be fixable, so judgment is required before any expenditures are made. Anybody know a good consultant?

  6. Why do projects fail? One way is to listen to a consultant, engineer, manufacturer’s representative, or such, that doesn’t know what he or she is talking about. For example, to sell equipment, a salesman will say just about anything to make the sale. Big mouth experts are a real danger. These know-it-alls are pushing their own agenda, not yours. Always get the opinions of others who do know what they are talking about.
  7. What can I do to reduce risk? Consider requiring your equipment and raw material vendors to guarantee that if their materials or equipment do not meet expectations, they will pay all penalties. Get it in writing. In general, it is always a good idea to require suppliers to help pay for the losses that occur because of their negligence. That is why companies have lawyers and why vendors have liability insurance.

 

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