Business Risks

US News and World Report had a recent feature “20 Companies that Cratered in 2010“.

Reading their article, I can only come up with four reasons why the 20 firms went bankrupt:

  1. Overconcentration in the mortgage backed securities market.  (Ambac)
  2. Failed to adapt to competition with a new approach to the business (Affiliated Media, Mareican Media, Penton Media, Blockbuster, Movie Gallery, Newsweek, Oriental Trading)
  3. Insufficient New Products (Hummer, Mercury, Pontiac, MGM)
  4. Insufficient resilience to recession due to excess debt (Inkeepers USA, Jennifer Convertibles, Loehmann’s, Mesa Air, Uno Restuarant Holdings, Urban Brands, Swoozies, A&P)

Fully 95%, 19 out of 20 of these bankruptcies are caused by business risks.

Meanwhile, risk managers in the insurance industry are off building risk management systems that assure that there is no more than a 1/200 chance of a loss large enough to cause a bankruptcy.

But Business Risk is not on the list of risks that are being considered in the Solvency II or Basel III regimes.

Fully 95% of US bankruptcies in 2010 were caused by business risks.  Does that mean that we are building a system that assures that we are 99.5% safe from 5% of the risks?

Does this give risk managers a hint as to why top management may only want to devote a small amount of their attention to the management of those 5% risks?

Are top management spending their time paying attention to those pesky risks of Competition, Products and Resilience?

Risk Managers can and should address those risks as well.  But rather than moving away from the risk management discipline, risk managers should be looking to see how the risk management processes can be of help with those risks.

Now, for the folks who think of risk management purely as a modeling exercize, this discussion is largely over.  But if you see your risk management program as a management control system, then there is much for you to bring to help with these risks.

These risks can be handled like any of the Operational risks that are difficult to model.  Key Risk indicators are identified and monitored.  Triggers can be set to initiate actions.  And actions taken to react to increasing indication of risks.

For the three big Business Risks that took down companies in 2010, there are particular concerns:

  • Competition – Business managers must move away from sports analogies.  They make companies particularly at risk for this type of competition.  In sports, the opposing team rarely starts playing a totally different game.  The football team will not be opposed by a hockey club.  But in business, there is often not anything to stop a competitor from starting to play a totally different game.  Risk management needs to be built from te premise that there really are very few rules restricting competitors.
  • Product Risk – in many cases that largest source of product risk is a successful product.  Especially a highly profitable successful product.  Firms with such often find it extremely difficult to justify the cost and risk and low profitability of new products.  The risk manager needs to consider addressing this risk from the point of view of revenue diversification.  Concentrations are often the most profitable and the most risky in the long term.
  • Resilience – This comes closer to regular risk management territory.  But often a major change in business volume either up or down is not a scenario that is factored into the risk model.  Most often, the level of business activity is taken as a constant!  How totally unrealistic is that?  The level of business activity is definitely NOT constant and NOT predictable.  It is at least as uncertain as any of the things that ARE being modeled.  Risk models can be used to evaluate the impact of simultaneous changes in the level of business along with other adverse events.   Perhaps it might make sense to also assume that if volumes are going up beyond a certain range, that selectivity might be going down.  Or that if volumes are decreasing, that margins might be squeezed in addition to the expense squeeze because of competition for the lower amount of business.

Risk managers can bring something to the table for discussions of Business Risk.  But it will take breaking out of their sometimes self imposed bounds.

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One Comment on “Business Risks”

  1. Sonia Jaspal Says:

    Excellent analysis and very at points mentioned. Risk managers should be focusing on business risks if they wish to come to CXO’s radar


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