John W. Myrna, Author, The Chemistry of Strategy: Strategic Planning for the Not-Yet-Fortune 500
Managing risk is a major element of the “chemistry of strategy.” You must understand strategic risks — what they are, how to identify them, and how to assess and manage them from a strategic perspective. Financial risk is embedded in all risks, since the impact of all risks is ultimately financial. There are five major sources of strategic risk. Two have the potential to wipe your company out overnight, and three, while unlikely to wipe out a company overnight, could smother it over the next three to five years.
Let’s look more closely at the two that can wipe you out overnight. While all the company stories are true, names have been changed to protect privacy.
Risk #1: Unhealthy concentrations
Unhealthy concentrations make a company vulnerable to the loss of a business keystone – a major customer, a uniquely skilled employee, a custom machine, or a single raw material supplier. Managing this risk requires you to balance competing demands on resources. Operational needs are immediate and can easily drive an unhealthy balance, with the most obvious risk to revenue coming from an unmanageable concentration (customers, suppliers, product, or market). When Acme Manufacturing learned that a major customer (Groot, which was 20 percent of Acme’s business) had just filed for bankruptcy, the Acme CEO told his senior executive team they’d need to cover the loss of Groot’s business, write off more than two months of receivables, and absorb the cost of a sizable inventory of custom parts and raw materials.
Five years prior to this, Groot had accounted for 80 percent of Acme’s business, but the executive team had recognized the risk of that concentration and forced themselves to diversify the customer base, just in case. At a strategic planning meeting seven years before Groot’s bankruptcy, Acme’s executive team had identified the loss of Groot’s business as its biggest potential threat. At the time, Acme’s CEO discounted the threat, citing Acme’s regular contact with Groot, excellent quality, and perfect on-time delivery. In my role as facilitator during that strategic planning meeting, I asked, “What if Groot gets acquired by a company with its own manufacturing supply chain? What if they go bankrupt? There are more ways to lose a customer than poor performance on Acme’s part.”
The Acme executive team established a risk component in its strategy to keep the largest concentration of business under 25 percent, since they felt that any sudden loss of revenue above that percentage would likely be unrecoverable. Acme became more watchful about maintaining accounts receivables, and more conservative about purchasing equipment and hiring full-time employees to meet growing demand from Groot. Acme also gradually shifted priorities and resources to building up a new revenue base in a new market with attractive potential. Acme made sure that everyone in the company understood the importance of fully supporting even small, trial orders from customers in the new market. Without constant reinforcement of why these small “unprofitable” orders were important, well-meaning employees could have sabotaged the new strategy with late deliveries and bad quality.
Risk #2: Unpredictable, high-impact events
These include natural disasters, facility fires, or an economic crash. Superior Tubing’s Arkansas plant was destroyed by a tornado. Employees got to safety before the tornado hit, and a year and a half later, the plant had not only returned to full production, the company’s two other plants set new production records.
The secret to recovery? Having identified the tornado risk years earlier, Superior incorporated a disaster recovery program into their strategy. They maintained sufficient financial reserves, standardized computer systems across all three plants, and put plants in multiple locations to reduce the risk of losing one. Because employees were already cross-trained to operate a variety of different presses, they were able to quickly redeploy staff to expand shifts at the other two undamaged plants. Superior Tubing’s planning team felt it was strategically important to integrate recovery into how the company ran, rather than create a plan to recover post-disaster. They didn’t wait for an actual disaster to verify that a disaster recovery plan worked. They made their company more robust through an integrated disaster recovery program.
Successful companies identify relevant risks and invest in changing the status quo to enable survival should that risk materialize. They strategically position the company to withstand the foreseeable but unpredictable. As Andrew S. Grove, former CEO of Intel said, “only the paranoid survive.”
I’ll discuss the next three strategic risks in a future post.