Entrepreneurs are defined by their willingness to bear risk particularly the risk of business failure. This is especially true for those starting new companies, because more than half of start-ups fail within the first five years. Lesser risks in established businesses include the possible failure of new products, or damage to the brand or a manager’s reputation. Whatever the level or type, however, risk is something that all businesses need to be aware of and manage carefully. US businessman Andrew Carnegie was pondering these issues when he suggested that in terms of managing risk, it might be best to put all your eggs in one basket, then watch that basket.
From the collapse of Lehman Brothers (2008), to BP’s Deepwater Horizon disaster (2010), events of the early 21st century fundamentally changed how organizations perceive risk. Companies now think in terms of two factors: oversight and management. “Risk oversight” is how a company’s owners govern the processes for identifying, prioritizing, and managing critical risks, and for ensuring that these processes are continually reviewed. “Risk management” refers to the detailed procedures and policies for avoiding or reducing risks..
Inherent risks
Risk is inherent in all business activity. Start-ups, for example, face the risk of too few customers, and therefore insufficient revenue to cover costs. There is also the risk that a competitor will copy the company’s idea, and perhaps offer a better alternative. When a company has borrowed money from a bank there is a risk that interest rates will rise, and repayments will become too burdensome to afford. Start-ups that rely on overseas trade are also exposed to exchange rate risk.
Moreover, new businesses in particular may be exposed to the risk of operating in only one market. Whereas large companies often diversify their operations to spread risk, the success of small companies is often linked to the success of one idea (the original genesis for the start-up) or one geographic region, such as the local area. A decline in that market or area can lead to failure. It is essential that new businesses are mindful of market changes, and position themselves to adapt to those changes.
The Instagram image-sharing social-media application, for example, started life as a location-based service called Burbn. Faced with competition, the business changed track into image-sharing. Had Instagram not reacted to the risks, and been savvy enough to diversify its offering (regularly adding new features), it may not have survived.
At its heart, risk is a strategic issue. Business owners must carefully weigh the operational risk of start-up, or the risks of a new product or new project, against potential profits or losses—in other words, the strategic consequences of action vs. inaction. Risk must be quantified and managed; and it poses a constant strategic challenge. Fortune favors the brave, but with people’s lives and the success of the business at stake, caution cannot simply be thrown to the wind.
In deep water
Even large and diverse organizations can find it hard to successfully balance risk against potential financial reward. On April 20, 2010, Deepwater Horizon, an offshore oil rig chartered by British Petroleum (BP), exploded, killing 11 workers and spilling tens of thousands of barrels of crude oil into the Gulf of Mexico.
The incident was blamed on management failure to adequately quantify and manage risk; the official hearing cited a culture of “every dollar counts.” Analysts who examined the disaster claimed that BP had prioritized financial return over operational risk. Chief executive Tony Hayward, who took the post in 2007, had suggested that the organization’s poor performance at the time was due to excessive caution. Coupled with increasing pressure from shareholders for better returns, the bullish approach that followed led to significant cost cutting and, eventually, riskmanagement failures.
