Managing Strategic Risk

What is Strategic RISK

Many business leaders do not understand the strategic risks within their business. Risk analysis often focuses solely on management and operational risks but fail to mention or underestimate the likelihood to possible impact of strategic risk on their business. Strategic risks though are far more critical in the determining the success or failure of an enterprise.

When leaders think about risk management in business they are too often talking about legal compliance or about the operational risks around issues such as health and safety.  

Drawing up lots of rules and making sure that all employees follow them on the other hand can solve operational risk. Many such rules, of course, are sensible and do reduce some risks that could severely damage a company. But rules-based risk management focuses on legal requirements, not complete risk management. 

Management and operational risks have attracted leaders attention for obviously important reasons around safety and compliance, but the risks have become over prominent in leadership thinking about risk. This is a common misunderstanding of risk by leaders, not seeing risk as primarily a strategic issue in business. This view of risk misses the strategic elements of risk, which leaders need to actively consider in defining their business model and in making strategic decisions. From start-up to exit risk is a strategic issue, which should underpin all strategic thinking.  

Risk is an essential element of strategic thinking. Every business idea creates and must deal with strategic risks. When someone comes to me with an idea and their opening phase goes along the lines of "no-one has done this before, that's why it will succeed" immediately gets me thinking is there an obvious reason about why no-one has done this before? In the real world there are no natural vacuums. So why has no-one else done this before.   

Strategic risk must be the first risks which entrepreneurs, owners, leaders and stakeholders (the shareholders, NED's, advisors and accountants etc) need to identify and identify and scrutinise. Strategic risk defines the real opportunity a business has to succeed, as an entity or within any chosen opportunity it sets to undertake, from a new product or service through to entering a new market.

Risk v Opportunity

All opportunities carry a risk. The two elements are tangibly linked, there are no opportunities that do carry risk, and the direct link between the two means the greater the opportunity so the greater the risk.  Too few business leaders identify that clearly and develop a clear plan to deal with those strategic risks. In Dragon's Den the reason why the dragons often want so much of the shares for their investment is to deal with that risk. I the risk is low (clear market, clear routes to that market, experienced and viable leadership team and clear plans to get to market with an plausible exit strategy) then they fall over themselves (trample over each other) to make corresponding offers for a far smaller share of the pie. This is a simple example of the value of understanding strategic risk in setting up a new business. But this is what experienced consultants like myself assess when we strategically plan a business. 

As an independent experienced strategic planner identifying the strategic risks, profiling these and then assessing these risks is critical for leaders to understand and actively overcome in their strategic thinking.     

Developing leadership risk skills is an important element for leaders to understand that their approach to risk defines how the lead and what they lead. Strategic risk defines the type of business model that leaders develop through to which markets and where in them they choose to operate. 

Understanding strategic risk and learning to how to manage key business risks throughout your business is an important skill set for leaders to develop in establishing their judgment in risk considerations and ensure they are integrated into strategic thinking.  There are two parts to risk, firstly identifying your strategic risk and then secondly how to actively manage the identified risks, which this article covers. If you would like to know more about strategic business planning then click this link here.

Here are some key questions to consider in identifying strategic risk:  

1. Risk Appetite 

The first stage in managing risk is to look at the leadership team and its surrounding stakeholders, both formal (Board, NED, shareholders) and informal (employees, advisors, channel partners) to map out the appetite to risk. The leaderships' risk appetite determines the overall approach the business will take to risk. Risk is always directly linked to opportunity and therefore reward, take no risk and you take no reward. Conversely take high risks and you could achieve high rewards (think Amazon), but equally exposes the business to potential high failure. 

The more the leadership diversifies from its core skill sets so it increases the risk it is likely to face. This is why investors want to see both  the leadership teams track record but also their relevance to the market. Diversity in its self is also vitally important, too many people from within a narrow field often limits risk taking due to lack o wide and group think mentality. Leadership diversity increases risk, and lack of diversity reduces risk appetite.

Risk appetite is also directly correlated to the experience of the sector you are operating in, the more established and known the sector is to the leadership team has so the lower risk the leadership team sees in operating with in it. than emerging and unknown.       

2. How well is your strategy defined? 

Without a defined strategy your business is at high risk. If the leadership does not have a clear and articulated strategy, which is shared and owned, then the business is vulnerable to strategic drift, living in a dream without clarity and purpose. Having a strategy in place, provides the context of the business, with strategic goals, intent in positioning and outcomes defined which enable the business to drive forward. To learn more about strategy click here.

Inside a good strategic plan the strategic risk must be identified, clarified and clearly mitigated, with realistic, affordable and attainable mitigations in place.  A great strategy does not avoid risk but embraces it.  Many of the leading and successful businesses were begun by entrepreneurs who fully embraced strategic risks.   

3. Strategic Risk Analysis

A business strategy must define the risk environment within which it operates. Strategic risk starts by looking at the risks that exist within a market (and defining why and how you will succeed despite them) as we as the strategic risk in entering a market compared to the risk of not entering a market. Strategic risk management should compare not only the risks of the strategy but the reverse risks of not doing the strategy, the gap risk of missing the opportunity. Why are we going here not there is a classic question which I ask, and so often hear no coherent argument as an answer.

Strategic risk also covers risk analysis of the leadership and its approach to risk, how comfortable it is with risk reflects in how leadership teams actively manage risk which reflects its established risk skill set and appetite to risk across the board. How well can the senior team deal with risk, and to just ignore it, is an important element of risk analysis. 




4. Strategic Risk Assessment

Risk, any risk is defined by the potential impact of the consequences from it. The manifestation of its likelihood of occurring is the assessment which must be undertaken, this is often scrutinized by undertaking scenario analysis (driven by board, NED and expert support and advisors) will encourage the leadership to consider a range of scenarios that can result in significant adverse consequences for the business and assist the leadership to make sure full width and depth analysis of strategic risk is undertaken.

This assessment provides the basis of mapping the risk and determining the investment in mitigation required to reduce or remove that risk. Often risks are not seen across the business, the strategic risk assessment fails to understand that a company is a whole entity not just a product or service, so its IT, people, location and environment  are as vulnerable to strategic risk as is the market it operates within. Strategic risk is as (and often more) likely to occur within the infrastructure of a business as it is within a market. 

The other strategic risk assessment that is often under assessed (if at all) are global risks. The era of global issues from terrorist attacks, natural disasters or global pandemics are now part of strategic risk assessment.




5. Strategic Risk Mapping

The
leaders must see risk in the context of how shareholders or stakeholders measure value in the organization. This essential mapping of risk enables the leadership to articulate to stakeholders how the risks they are taking or the risks the business is exposed to may affect the organization’s ability to realize its strategic goals. By identifying common metrics for risk and performance also allows the leadership to define the priorities of risk management activities and focus on the mitigation of relevant and important and decision defining risks the board.

Defining Strategic Risk

The second step, in creating an effective strategic risk management system is to understand the qualitative distinctions among the types of risks that a business could face and determining how to actively manage those risk. Risks typically fall into one of three categories and here's how leaders should be managing them:

1. Managing: Strategic risks.

The leadership having determined the level of risk it is willing to take in order to generate the returns from its strategy, its risk and reward profile, leaders must then develop appropriate channel partners to achieve that strategy. From its bankers credit risk, its strategy of launching new products through to its channel partner selection, all these decisions impact upon the strategic risk strategy. 

Strategic risks are quite different from operational risks because they are not inherently undesirable; they are quite the reverse they are deliberately accepted as part of operating within that industry. A strategy with high returns requires the business to take on higher risks, and actively managing those risks is a key driver in achieving those potential gains.

Strategic risks cannot be managed through a rules-based control models, such as compliance to legislation. Instead, the leadership must install a risk-management system designed to reduce the probability that the assumed risks actually materialize and to improve the company’s ability to manage or contain the risk events should they occur. Such systems enable companies to take on higher-risk, higher-reward ventures by identifying drivers of strategic risk, most often these are identified through 5 Forces analysis within markets and systems usually include primary (and secondary fallback) detailed objectives which must be achieved which underpin the strategy to actively manage the strategic risks.    

2. Managing: External risk factors

Certain strategic risks arise from events outside the company and are beyond its influence or control, often identified through PESTLE analysis. These major macroeconomic risks are outside the market but directly influence it. PESTLE identification and analysis enable leaders to manage the external risks effectively, through proactive identification and mitigation of their impact. For example changing economic conditions may raise global interest rates, which put pressures on even successful businesses, which impacts upon costs and profits.

Businesses need to build a defined risk management processes to these different PESTLE categories. By identifying key drivers of external change leaders can devise stress testing through scenario planning and devise alternative strategic options should external risk factors come into play.

3. Managing: Preventable internal risks. 

Conversely internal risks, arising from within the organization, that are controllable and ought to be eliminated or avoided. Businesses should have well defined internal risk systems in place which includes a tolerance level, such as 95% of all calls must be answered within 3 calls, in other areas health and safety for example mandatory 100% requirements for the use of PPE and operating systems must always be in place.  

Businesses should seek to eliminate these risks since they get no strategic benefits from taking them on. This risk category is managed through active prevention by monitoring operational processes and guiding people’s behaviors and decisions toward desired norms.

Identifying and managing preventable risks is about good management of existing best practices within the legal and industry best practice.  Companies cannot anticipate every circumstance or conflict of interest that an employee might encounter, so ensuring that risk is talked about, reviewed and assessed against best practice. 

Managing Risk effectively

Risk is a difficult subject for leaders, precisely because it is seen as an operational detail rather than strategic in nature. Business planning sets over optimistic forecasts, from unrealistic timescales to launch new products and services through over inflated revenue streams.  This form of linear extrapolations, how leaders have done it before will be immediately repeatable with something new is compounded by the use of conformation bias, selectively picking supportive data and ignoring unsupportive data. This form of groupthink often limits the risk discussion by narrowing the discussion down to it will happen rather than taking a holistic approach to risk.

Other key drivers of strategic risk failure come from leaders ignoring industry activity, how fast and quickly competitors will react to any new strategic initiatives to minimize their impact upon the status quo and how channel partners and customers will sound supportive but will measure the risk to them and mitigate it by limiting their exposure to risk. How industries react to change is one important consideration from an effective 5 forces analysis of any market. How do they players react to change is often analyzed by war-gaming with scenarios played out in theoretical games to see the impact of industry competition.

By strategy mapping your business leaders can often assess all risks linked to objective setting, looking at risk events associated with each objective and generate a risk profile for each risk and associated mitigation strategy.

Recently the adoption of the balanced scorecard has become a major way of mitigating risk, by linking mitigation to performance driver indicators of behavior within the organization. This highly effective risk management tool enables companies to engineer risk out of departments through positive mitigation strategies.  

For areas of risk which cannot be mitigated from within the company, such as natural disasters or acts of terrorism, then developing contingency plans act as mitigation to unforeseeable external risks. Not putting all leaders on the same plane is a simple example of contingency planning as is having secondary operational site, should your primary site be unusable from either natural causes such as flooding or from acts of terrorism.

Like to know more about strategic business planning then learn more through my video course on strategic business planning, which will reduce your risk in succeeding within your market, then click this link.

Good leaders embrace risk, they do not avoid it and investing time and skills into understanding and actively managing risk is an important element of leadership.  Good strategic planning encompasses strategic risk assessment and leadership teams need to invest in understanding their risk if they wish to succeed in their market.  

The TOP TWELVE Business Planning Mistakes

Business planning is often talked about as a challenging process to go through either to start a new business or as the essential process of taking ownership of an existing business. Many business plans fail to achieve their objective, not because they represent a bad idea but because they fall into classic business planning pitfalls or fall over blinding obvious credibility cliffs.

The business-planning process is in itself a very worthwhile pursuit, while they take a lot of effort and resources they are an excellent way for business owners to undergo. A business plan's primary purpose is to convey an idea with a view to achieving a specific goal, most typically in securing funding. 

What makes a good business plan is less clearly defined. 

Always remember that a business plan needs to be tailored to its target audience, if you have different audiences you will need to be able to flex your plan to that audiences specific needs. That means shaping it, edit it and amending it to achieve your objective. 

If you would like to know how to avoid these top ten pitfalls and credibility cliff edges then click on the subject titles which are links at any time to see my step-by-step videos on how to avoid these pitfalls and credibility cliff edges. I have over the last 30 years been involved with hundreds of business developing business strategy, reviewing business plans and advising clients on how to implement a business plan. Below are my top 12 business planning mistakes business owners most often make, along with my thoughts on how to avoid them happening. 

Here's the top twelve business planning mistakes I come across:- 

1. Lack of Viable Opportunity

Every business plan needs to describe the opportunity in detail. It must also detail how that opportunity can, and will by this plan, be exploited profitably, effectively and successfully.  A good business plan can visualise the opportunity and articulate the company’s ability to reach a viable opportunity, this is a credibility cliff.

Tomorrow is a difficult place to plan for, but being able to identify and make that opportunity viable is the most critical test any business plan has. It is also the most common reason they fail. Your executive summary and the wider plan describes the viability of the opportunity in terms such as:-

1. What is the problem which people  will pay to have solved?
2. Does your solution solve this issue for a specific target market?
3. Why would someone buy your solution over someone else's?
4. Why are the benefits of your offering so compelling?
5. Can you reach that target market with a compelling message quickly and directly?

2. Unbelievable / Unsupported Financial Numbers

Where any assessment of a business starts and often finishes is at the numbers, specifically on the projected Income Statement or Profit & Loss. Projections are just that, but they are vital and must be based upon clearly stated assumptions. Many business plans are written with numbers which just do not stand up even to a first glance. 

Dream numbers: in overestimating income and understating costs. 

Your numbers have to make sense and be realistic, if you are a new start-up then they must grow rationally from nothing, but costs will be incurred before turnover is generated, these need to be realised and recognised in your financials.

The financials must also make sense and be presented in a format which presents a clear case for the investment and the return you will deliver. Ultimately, they need to be credible, defensible and consistent. 

3. No Accessible Route(s) to Market

All opportunities are only prospective ones without evidence that the target market can be accessed profitably, this is a big cliff to fall over.

Entrepreneurs are inherently product focused, concentrating their energies on ‘the winning idea’ to the exclusion of many other important elements such as how they intend to access their customer base, a classic cliff edge for any plan.

"Built and they will come" is a great dream but a poor plan. 

A business plan must include a comprehensive, credible and costed analysis of how the company is going to access their target market in a cost effective manner. 

For that to happen your plan needs to really understand the target customers, their needs, and purchasing priorities. Turning historical data into information and drawing knowledge from it ascertain insight into their future purchasing habits. Only then can you demonstrate cost effective routes to market within a business plan.

4. Executive Summaries Which Aren't

Somewhere between a pitfall and a cliff edge, is the failure of the Executive Summary, to be either a summary or aimed at executives. The only part of any plan that will certainly be read is the Executive Summary and yet they rarely provide an effective summary of the business plan. A good plan highlights the key proposition of the plan and sells the proposal. 

Too many Executive Summaries either throw everything down in a jumbled mess, making them pages long and randomly pulling facts together, or they are so bland they say nothing!  

What's a good Executive Summary, one that states the proposition clearly and succinctly, a page is sufficient for any plan. The Executive Summary should clearly explain the whole picture including what investment is required and what it will deliver. The point of an Executive Summary is to inform the executives, so many it punchy, outcome focused and only ever write it at the end.  
     

5. Over Estimating Turnover 

Another associated key element of the plan which relates to this element is the estimations of projected turnover. 

While every business plan talks in positive terms (hopefully), the obvious and persistent danger is that the innate optimism of all entrepreneurs and their tendency to exaggerate every business opportunity. 

This pitfall is most easily managed using a realistic method for estimating income is to calculate the number of customers the business intends to capture and the average revenues. These two averaged inputs are easier to calculate and also to justify within a business plan.

6. Absence of Clear Objectives 

I could have put this pitfall at number one very easily. What is the main purpose of the plan?

If the plan's objective is to seek funding then it is vitally important to clearly describe the investment opportunity. While the plan describes the concept in detail, it must also address the primary purpose of the plan. So many plans fail to make it explicitly clear what the company's needs to be successful or what the investment will mean to the company.

A good business plan answers:

• Why investors should investing in this business rather than anywhere else?
• When will they recoup their initial investment and how and when it can be realised?
• What is their expected return on investment?
• How the company has managed all aspects of risk? 
• Is the investment merely cash or do they need to bring other assets such as expertise to the table?

If you can answer these key questions, the intended audience will feel comfortable and be able to recognise that they fit the brief.

7. Non-Existent Cashflow Management

Particularly relevant to a new business, this is often an invisible cliff edge which business plans fall over on, is the ability of the business to articulate the differences between cash and profit. Running out of cash is the highest risk any new business or re-engineered business faces.

Good, positive, and conservative cash flow management is vital when businesses pursue investment opportunities where there are significant cash flows out, in advance of the cash flows coming in. This is the classic business plan cliff, which sends potential investors running.

If a business plan’s financial model is based upon selling on credit, then they receive the cash in the future, but need cask to pay expenses before that income hits their account, then they have a cashflow risk. This outflow of cash is the single biggest reason companies fail, its not margin, its rarely the product, it is invariably that they run out of cash.     

8. Non existent Management Teams

Throwing a few CV's into a business plan does not create a delivery team. Likewise a generic organisational chart with missing pieces and TBC (To Be Confirmed) is not going to inspire confidence  with investors to part with their cash.

Entrepreneurs can often sell an idea but they do not always inspire they can select a balanced team of people with the right skill mix, from the financial management to key leadership roles and the right operational team to deliver your ambitious plan.

Having a structured management team with operational structures is essential for success. Track records matter, as much as having clear roles and responsibilities laid out in delivering the operational plan which underpins the business plan.  

9. Poor Evidence of Demand

A significant area of concern when planning is justifying the sales forecast or demand levels for a product or service. This breaks down into the two main elements used in forecasting: the use of historical facts and the dependency of subjective assessment.

Sales forecasting, is the vital tool to identify the basis of all projected revenue figures that can be considered credible in the wider context of the plan. Unless there is verifiable demand for the idea, the risks grow out of all proportion, particularly if the initial start-up or investment costs are high.

Minimising risk in a business plan is all about gaining an understanding the potential demand and how the company will with this plan create or drive that demand rather than concentrate on ‘the product or the idea’. This classic cliff edge is a silent killer for investors, they don't believe in it.

10. Gaping Inconsistencies

An effective business plan needs to be consistent throughout as all the various strands are brought together into one single entity, the plan. It is pitfall which entrepreneurs gloss over, but investors relentlessly prod before committing to any plan.

If there are multiple authors of the plan the risks of inconsistencies will exponentially increase. Extrapolating data can also cause problems, using research data and then jumping from possible market size to sales potential and then sales forecast are classic pitfalls which need to be thought through. 

Presenters of the plan must have a simple narrative that runs through their plan, using key facts and staying ‘on script’ so as to ensure that a cohesive story is communicated. The numbers must also be consistent with the broader content so that there are no contradictions between them.

11. Not Appreciating the Competition 

There is always competition. Yet the number of times the phrase “there are  no competitors” appears in plans is considerable.

It does not matter how unique the proposition is there will also be some other business competing for people’s money. While there may not be a direct competitor it will certainly be a transfer investment that customers will be making. The business plan must recognise where the customers invest is coming from. If competitors are not identified in a business plan then the only credible assessment is that the company has not been diligent enough in its research.

Also remember that no company lives in a vacuum, as soon as you launch (or before) the marketplace will change. What will the competitive landscape look like in a few days, weeks, months or years? Can you create or establish significant barriers to entry, or is it likely that a successful market entry will be followed by better-placed competitors with greater resources, etc

12. Throwing Your Plan Out Too Soon

You never get a second chance to make a great first impression. Your plan needs to be right the first time and the content needs to be accurate, clear, concise and correct.

More often than not business plans need to be completed by a certain date and hence the final stages can be rushed, a classic pitfall.

Consequently, in many instances the final output does not do justice to the plan. Attention to detail at the end is vital, so ensure you have a completed plan with references and formatted correctly. Also ensure the content of the plan has been edited down to a digestible size, use appendices for details.

Get someone removed from the process to proof the plan. If a presentation is part of the process, it should reflect the Executive Summary.

In Summary

Business plans by definition have a purpose of communicating a course of action so make sure they do that primary role. Support inevitably means resources with the primary aim of the plan often being to secure financial investment. Explain the invest what it will be used for and how it will be protected from these classic pitfalls and cliff edges.

Writing a successful business plan is all about preparation, about being as thorough in your research and planning as is possible. By avoiding the cliff edges and pitfalls above, the chances of the plan objectives being met increase substantially.

Read more or get in touch to learn how Richard Gourlay can support your business growth. Or read more about strategic planning and business planning in my blog.