Creating a More Effective Risk Assessment Strategy

When creating a risk assessment strategy, companies spend a lot of time focusing on direct risks. Indirect risks, which are often overlooked, can have a serious impact on your business. These risks can cause issues with securing raw materials, limit revenue and your ability to compete in the market place.

For example, according to the McKinsey Review, in 2000 there was a lightening storm in New Mexico. It caused a fire which damaged a technology company that produced chips. Millions of mobile phone chips were damaged.

The technology company didn’t just supply one mobile company, it supplied chips to several. All of the companies were scrambling to shift production to suppliers in Japan. However, not all companies were able to make the adjustment quickly. Companies who didn’t move quickly lost serious revenue.

Regardless of your industry, indirect threats cause a ripple effect. It’s not realistic to eliminate these risks altogether, but with proper planning, you can minimize them.

Target the Value Chain

Most companies have a process in place for evaluating their value chain risk. However, companies need to incorporate processes for targeting the most common indirect risks. According to the McKinsey Review, there are four areas that should be examined (called risk cascades), including: competitors, supply chains, distribution channels and customer responses.

Evaluate the Risk of Competitors

When a company has a structure that is seriously different from competitors, they are at higher risk. Although you don’t want to “copy” competitors, if you plan on varying your strategy substantially, you must pay more attention to indirect risks.

Having a completely different strategy from your competitors means if you’re hit by an indirect risk, the competition may be able to capture your share of the market (because their strategy is much different). This can drive down revenue and hurt the company long-term.

Consider Supply Chain Exposure

When creating a strategy, focus on areas of weakness in your supply chain. Are there indirect threats that could interrupt your ability to secure parts and materials? If so, it could create pricing and supply issues. These issues can affect the customer’s ability to access your product, which can drive down sales.

Look out for Distribution Channel Risks

Managers should also spend some time evaluating potential distribution channel risks. These risks can hinder your ability to reach customers, interfere with costs and even pose a threat to your existing business model. For example, the McKinsey Review discuses the bankruptcy of Circuit City in 2008. As the electronic company liquidated, it created price pressure for other companies.

These companies were holding more then $600 million in unpaid receivables at the time. Customers were in “bargain hunting” mode which directly affected other retailers. Companies were forced to drop prices to make sales.

Anticipate Customer Response

Anticipating the response of customers is difficult. With so many factors involved in a purchasing decision, there are plenty of indirect risks associated with this category.

For example, consider the increase in gasoline prices. As this occurred, customers changed their vehicle purchasing behavior. There was a steady decline in the purchase of large vehicles. Automobiles with the ability to achieve better gas mileage experienced an increase in sales. Customers were also more willing to purchase new alternatives, like the Hybrid.

Evaluating your Risk Profile

When creating risk strategies, companies should carefully consider the risk cascades. Anticipating how direct and indirect risks move through the value chain can help companies prevent the “ripple effect” that occurs when indirect risks aren’t considered.

For example, most industrial companies believe they’re in trouble when the price of carbon increases. The McKinsey Review, however, argues that carbon price increases doesn’t always hurt business. In fact, some companies may benefit.

If carbon was more expensive, aluminum would become the material of choice, which could positively impact automobile manufacturing companies. Therefore, some companies might be negatively impacted, while others (like the automotive companies) would see positive results.

Although companies can’t see around every corner, they can be as prepared as possible. Creating the best possible risk assessment by identifying indirect threats can help create more effective, corporate strategies. Risk cascades can help your company create more effective strategies for anticipating future changes and getting ahead of the curve.

Resources:
Eric Lamarre and Martin Pergler. “Risk: Seeing Around the Corner.” The McKinsey Review, October 2009.

Mark Jordan is the Managing Principal of VERCOR, an investment bank that creates liquidity for middle market business owners. He is the author of “Driving Business Value in an Uncertain Economy”, “Selling Your Business the Hard Easy Way”, “Enhancing Your Business Value…The Climb to the Top” and co-author of “The Business Sale…A Business Owner’s Most Perilous Expedition.” For more information, contact him at 770.399.9512 or click here to email Mark.