These Things Could Shut You Down Fast

What could shut your business down fast?

Business owners face a myriad of risks. Prudence calls upon us to continually reduce our exposure to random events. When I was a banker - lending to businesses - I used to ask my clients, "What could shut your business down fast?" I'd make a list and discuss it with the owner. I wanted his or her opinion on the likelihood and potential impact of each threat, and what - if anything - had been done to mitigate risk. If the business remained exposed to real threats, I would ask the owner to address the issue before I'd agree to make the loan.

Risk Matrix. Marshall and Alexander use a tool for assessing risk in their Journal of Extension. Here is a summary:

Step 1: List and Rate the Threats to Your Business.

What risks does your business face? List them in Table 1 below. We added examples to get you started.

For each risk, estimate probability and consequence. Use a 1-to-10 scale for each (1 being the lowest). The consequence of the event can be thought of both in terms of severity and cost to the business. For example, in our sample event #1, the owner is in a car accident that prevents him from fulfilling his normal duties for a period of six weeks. We rate the probability a 3, with the consequence of the owner being unable to fulfill his duties for six weeks rated at 8.

Step 2: Plot Each Event on a Matrix.

Draw your own matrix on a piece of paper, identical to Figure 1 below. Then, plot each risk as you have rated it. We've plotted our sample events on this one.

Step 3: Devise a Response and Plot Movement

There are four basic risk management strategies.

Here's a summary:

• Avoid Risk - The business takes action to avoid anything that might give rise to the risk. Typically this means the business chooses not to undertake an activity. For example, a farmer may decide not to grow lavender because the growing conditions are unsuitable, probability of a crop failure is elevated and the consequence of a loss would be severe. This is represented in our example as event 6.
• As you'll see below, we have crossed out 6 because we decided to deal with the event by avoiding it.
• Reduce Risk - The business takes action to reduce either the probability or consequence of the risk. In table1, event 4, we have substantial exposure in losing Stacy Shirley, who is our #1 sales rep. She accounts for 75% of our business and we feel that the customer's loyalty is with her more than with us. This risk management matrix exercise has made us realize the level of this exposure, and we believe it is unacceptable. To deal with it, we will attempt to work on a long-term contract with her that will bind her to us, with penalties for breach. We also immediately will begin a program to: (a) build relationships directly with "her" customers and (b) boost the percentage of customers that we obtain through means other than Stacy Shirley. We have marked our strategy on the chart below by drawing an arrow from 4, down and to the left. This signifies that we are working to lower both the probability and consequence of her loss.
• Retain Risk - This is a do-nothing response, or at least a "suffer the consequences when they come" response. Unanticipated events will occur, and they all can't be eliminated no matter how thorough the planning.
• But something almost always can be done. For example, in event 5, we can train others to do the key tasks regularly performed by the owner. Or find others who could do some of the key tasks on an outsource basis. For "testing," we could have these persons actually perform the key tasks for a month. For example, the business owner could take an extended vacation. To designate our plan for reducing the consequence of our owner being "unable to work for a while," we have drawn a horizontal arrow pointing left.
• We have not reduced the probability, but if we do as planned, we will reduce the consequence. See Figure 3.
• Transfer Risk - This is moving the risk to someone else, such as an insurance company. Insurance is the most common method of dealing with the potential loss from random events. So example event 3 is readymade for life insurance. The insurance should be fairly cheap, assuming she is healthy. If the event occurs, the business might not be able to continue on, but the policy proceeds can mitigate the financial harm inflicted on the creditors and family of the owner. We've marked our strategy in Figure 3 with an arrow pointing down. We have not reduced the probability, but with insurance we've reduced the consequence.

You'll notice that example events 1 and 2 still need to be addressed.

To be sure, every business owner should periodically ask himself or herself and employees and advisors, "What could shut us down the fastest?" Then take action to mitigate risks. You've put a lot of work into this business, and a lot of people now depend on you for their livelihood. Your job is to protect them and  the business.

References

Marshall, M. I., & Alexander, C. (2006). Using a Contingency Plan to Combat Human Resource Risk." Journal of Extension (online), 44(2) Article 2IAW 1.

Table 1: What Risks Does Your Business Face?

On a scale of 1-10 (1=low), rate the probability and consequence (severity, cost) of each event

Event                                            Probability Consequence

1. Server crashes, database lost                      3           10

2. Owner, 80, passes away*                            8           8

3. Owner, 35, passes away*                            1           10

4. Stacy Shirley quits or becomes unable to work*     4           9

5. Owner becomes unable to work for a while*          3           6

6. Loss of our lavender crop*                         3           9

* hypothetical examples