The Harbour Pilot

Why start with business and risk? After all, how many entrepreneurs sit down and decide ‘Well, today I am going to start some risk-taking…’. Fair enough – darn few. Yet, when you actually sit down and discuss with them the aspirations of their new venture, that is how they think, in slightly different words, and a number of various levels. Risk is fun, risk is romantic, risk is dramatic, risk keeps your blood pumping… Doing battle with the many-headed hydra of business risk!

Fine, a little over the top?

Decisions and Risk

We are starting with risk because it works. Every decision you make explicitly involves risk.

Will I make this a proprietorship or should I incorporate it? Should it be a single owned undertaking, or do I want a partner? What if the partnership does not work? What if the partnership agreement proves to be unworkable?

How much capital should I invest? Should I use equity or some component of debt? If debt, to what extent should I pledge my personal assets?

Should I arrange premises? If so, how much space do I need, with what facilities, and where? Should I lease or should I buy? What equipment do I need, and what can I live without for now? What equipment can I put-off acquiring, by using a subcontractor?

What about staff? Does my skill set need supplementing with an operations manager, an accounting-office manager, a marketing or selling manager, a technology specialist… What expertise can I acquire now, what is mission critical and needs to be in house, what are the key performance considerations of any staff brought on, and how to I recruit, train and remunerate them? How does the benefit show up – market penetration, competitiveness, or time to market?

Every decision that is made entails risk, and changes the risk function of the venture. That’s why its time to step back for a couple of hours and consider the nature of risk, how to analyze it, manage it, and make money from it. It will effect how you manage the business, what your information systems will look like, and what your daily routines will be. It pervades everything. Failure to understand risk leads to terrible decisions, unspeakable stress at best, and business failure at worst. So on the basis that an ounce of prevention….

Developing Advice on Risk Analysis

We will be looking, over a sequence of some 30 or more posts, at categories of risk – systemic, systematic, and specific risks. We will look at some of the techniques for modeling risk mathematically for an understanding of how to analyze it. We will look at management approaches to risk in a number of sectors for insight (and what NOT to do). We will look at broad classes of risk management tactics including avoidance, reduction, transfers, and retention, and which categories of risks they work best with.

Lastly we will apply all of the above to the question of risk in independent business. We will apply some of the ideas used in investment portfolio management to small and medium sized businesses, viewing the business as a synergistic bundle. The focus will be turned on, in succession, business as a bundle of products, a bundle of projects, a bundle of assets, intellectual capital assets, relationship assets, technology assets, and key skills (amongst others). Confused yet?

A New Venture Embraces Risk

Here’s an example. Ludovic is 22 and handy with his hands, and enjoyed playing with the shop tools when he went through high school. While there, he also had the chance to work on computer equipment in his shop, that permitted him to draft on a computer. His friend recently opened a small retail outlet, and before opening asked Ludovic for some help doing some simple leasehold improvements, installing some furnishings and fixtures for the new operation. Ludovic was aghast. None of the cabinets fit. They had to be taken apart and rebuilt on the premises, and then finishes and laminates had to be re-done. The store was 6 weeks late in opening, and the friendship was in deep trouble. Ludovic sat down over drinks with his friend and discovered that the friend had paid the fixturer more than $80,000 for fixtures that did not fit the space.

Ludovic now sees an opportunity to use his skills to see to it that other new retailers did not suffer the same experiences. Ludovic’s Levitating Laminates will invest in 3-dimensional computer technology to do the design work, using floor and space plans that are developed using laser technology that will automate the plan development. Into these plans, Ludovic will develop the specifications of the various fixturing elements, and the plans will generate the instructions passed directly to numerically controlled saws, routers and planers, together with manufacturing process flow sheets. From these, bills of material will be automatically generated, that will also provide the costing and pricing information, as well as the delivery cycle. The products will consist of storage fixtures (mostly laminated particle board), display fixtures (mostly frame and glass), service fixtures (mostly shaped and finished hardwoods), and ornamental elements (crafted plaster and metal and other materials). Some of the fixture products will be sold on a custom design basis, others on a standard item basis, and others on a fully installed basis.

Is this business a collection of products? Is it a portfolio of projects? Is it a series of investments in technology? If Ludovic approaches six chain retailers and pitches his business to them, is it a portfolio of key client relationships instead? Any of these approaches could work from a risk perspective.

In each case, there are specific assets that have been invested in. Each product line has different manufacturing techniques, associated equipment and inventory requirements. Each present a certain spectrum of manufacturing risks, competitive factors, obsolescence risks, skill risks and profitability opportunities. Similarly, each client store is a new project, with a risk set of credit, product spectrum risks, working capital invested, and potential profitability. For that matter, Ludovic has invested in a numerical control saw and a vacuum laminating system. He does not really care what end use the laminated material is destined for, so much as he is interested in the risk represented by acquiring the machinery, and the potential profitability available from the investment. He also has invested in a plastic extrusion machine and the dies to form channeling stock to frame glass for display cabinets. He can also use that machine for making a line of home ornamental pieces also made of glass. He is interested in making money from the machine as a reward for the investment in the machine. Ludovic has a relationship with his friend the new retailer, who is a member of the Retailers Association of Upper LaminaLand, and has access to promote his new service through the association. In return for his investment in time helping his friend, and the $500 per annum membership fee, he can generate leads for selling his products, projects, asset output, and technical skills that would otherwise have cost him tens of thousands in promotional costs. This too is a risk management perspective. Ludovic also has a relationship with the teachers from his high school, two of whom also have businesses specializing in specific techniques, and who also have access to a steady stream of younger Ludovic’s with skill sets of value to the new business. This relationship is an asset that cost time to create, and might cost money to extend, but will also provide benefits in reducing the risks of new recruitment of employees.

We could go on and on. Here is the main point. Businesses are organic, and function at multiple levels, integrating assets of broad scope. Each of these assets is an investment, and every investment is a risk. Before you start making decisions, start recognizing, managing and embracing the right risks for the business.

Don’t Believe me? - Ask Yourself

‘Would I invest money in a mutual fund without knowing the risks?’