How to Manage Risk

One of the biggest enemies of small business is unacceptable risk. Many business owners can’t identify the risks they face and can’t evaluate the danger the risks pose for the survival of their business. As a result, they don’t take risks which are quite manageable and which would probably give beneficial results while accepting risks which could be fatal. Good risk management protects the business while promoting the interests of its customers.

While there are all kinds of risk, it is business risk which is the most difficult to manage. Business owners deal with risks covered by life insurance, medical insurance, loss-of-income insurance, liability insurance and similar risks on a personal level and they cover risks to the physical assets of the business by purchasing corresponding insurance but there is no insurance against bad business decisions. The business owner has to apply a structured approach to minimize the negative effects of bad decisions and increase the odds that good decisions will result in substantial benefits. He also has to realize and accept the fact that there will be plenty of both and avoid dwelling on the bad decisions which might have been avoided.

A structured approach to business decisions does more than identify risk and allow its management – it also increases the chances that good decisions will be made with regard to other factors such as profitability and quality. A structured approach means taking decisions apart and looking at the components individually, understanding completely what is being decided and what the implications are.

A typical example and the most common of business decisions is the decision to try to obtain and then to accept a contract. A typical example of a common series of bad decisions is the small business owner who goes after an unsuitable contract because he thinks it likely that he can get it. Typically the contract is too big for his business to handle well. He then invests heavily in the bid, doesn’t want to lose his investment and so agrees to unfavourable terms and then can’t perform the work to the satisfaction of the customer.

A structured approach would already at the bidding stage have identified the pitfalls. Such an approach doesn’t deal with the likelihood of the result but with the worst and best likely outcomes. The worst likely result is analyzed for acceptability – the business owner has to be comfortable with this worst case possibility since it reasonably can be expected to take place. In the example given above, the owner has to accept that he may invest heavily in the bid and not get the order. Had he done this analysis and accepted that possibility, he would not have agreed to an unacceptable contract.

The best likely outcome is also analyzed but for a different reason. While the worst likely outcome is looked at from a “protect the company” point of view, the best likely outcome is examined to determine whether the possible benefits are worth taking the risk in the first place. If the best possible outcome is an unfavourable contract, then the owner should not be bidding at all and he would have reached this conclusion if he had done this analysis.Looking at the best case/worst case scenarios to evaluate risk is also useful for comparative analysis. What the business owner is looking for is work whose “best” outcome will result in many benefits while the “worst” outcome will still allow adequate protection of the company. Generally there are several courses of action open to the business owner at any one time and a structured analysis of the different best/worst possibilities will let him balance the risks and chart the optimum course for the company. Based on that kind of analysis, he can then proceed with the work knowing that his company is protected and his efforts can be concentrated on achieving the best possible results.