Business Risk Assessments for Every Entrepreneur
A simple but efficient way to assess the types of business risk is the Impact vs Likehood matrix. Often we learn it at business school, but later in our careers and projects, we forget it. Big mistake! This is an exceptional tool for entrepreneurs and managers when assessing uncontrollable risks, so while you cannot suppress a crisis, you can prepare your business to survive (and thrive) on it. Here are some additional business survival strategies.
You cannot predict the next crisis, but you can rehearse for it.
The first step to use this matrix is to draw a chart where the X-Axis is measuring impact—be it profit margin at risk or any other suitable measure, and the Y-Axis is measuring likelihood. The determination of the likelihood of catastrophic events must be done with extra care since humans tend to underestimate the chances of calamity (unless they just went through one). One common way to attribute likelihood is to observe how frequently the event happens. This may lead, however, to non-detection of rare-but-not-impossible situations–Black Swans, as Nassim Taleb calls them.
To detect possible Black Swans, the best way is to brainstorm every conceivable and adversity, accident, or disaster. Since you are an entrepreneur far away, bring the knowledge baggage from your land and sum the risks you know to the ones you imagine in your new place. Brainstorm together with other entrepreneurs or neighboring residents, if possible.
Once you have a relevant poll of unpleasant situations, divide them in the matrix below, according to both their likelihood and impact.
The 4 types of business risk
Fly in the soup risks
The name of the quadrant with low probability and low impact is self-explanatory. When you have a fly in your soup, you just take another bowl. You do not install expensive security systems or create detailed mitigation protocols for the problems of this quadrant because the investment would far exceed the avoided losses. But be sure that what you place in the fly in the soup quadrant are truly low-probability events, because even though their impact is low, if it happens frequently, it will pile up and turn into a money and time-consuming issue.
Casual accidents risks
The frequent bumps in your entrepreneurial road have their place in the high-likelihood, low-impact quadrant. Example? When I started my business in Poland, it was difficult to hire. A near-zero unemployment rate can be a risk for employers, even though probably this is better than high unemployment. Each expense from the recruiting effort was not significant when isolated, but summed all the costs of training, job ads, understaffing, and uncertainty, it became considerable. Therefore, it was a management challenge, and a chance for improvement, something valid to most problems written in the Casual accidents quadrant.
The failure of Nokia is most likely due to casual accidents.
Disaster business risks
The high-impact, high-probability risks are the ones we actively avoid. Just after university, I moved to Santiago, the Chilean capital. The region is one of the most earthquake-prone in the world, registering a third of all tremors above 8.5 of magnitude. Earthquakes have a high likelihood in Chile, and their impact can be calamitous. Consequently, Chile is one of the leading countries in anti-seismic technology. When we talk about uncontrollable but frequent disasters, the effort is to mitigate their effects when they happen, because sooner than later they will.
Rare catastrophe business risks
In this quadrant are situations like global market crashes, pandemics, or Vulcan eruptions causing an airspace lockdown in half of the continent (the Eyjafjallajökull did this in 2010). And lockdowns are infamous for causing multiple problems, like inflation.
I left the rare catastrophes quadrant at last because we often neglect it. This is because flies in the soup do not have the impact necessary to demand attention, and both casual accidents and likely disasters are easily identifiable because of their frequency. However we, humans, have a problem understanding the likelihood of rare catastrophes.
There is even a name for this cognitive brain flaw: normalcy bias. According to the research from Esther Inglis-Arkell, near 70% of people display such bias. This is one of the two most common biases that we often see causing damage to a business. The other is something I already wrote about in a previous article: The Survivorship Bias.
Which type of business risk is uninsurable
There are several types of business risk, including strategic, compliance, operational and reputational risks. To measure or at least identify them is one of the essential things to ponder before starting a business.
Uninsurable business risk is any risk that is not covered by an insurer. These usually refer to the strategic and reputational risks that may befall a company.
The first type of uninsurable business risk is a strategic risk (which can be reduced by equally strategic business alliances). This type of risk is associated with growth and expansion efforts or changes within the corporate structure. For example, if a company buys another business and discovers that there are hidden liabilities, unforeseen costs, or other issues with the purchase, this may put the company at financial risk. Risk management firms cannot cover these types of losses because they can’t control them; they also cannot predict them as they happen in the future and are not associated with current risks that exist at the time of issuing insurance.
Another type of uninsurable business risk is reputation risk. Reputation risks concern damage to a company’s image or its relationships with customers, vendors, or stakeholders. For example, if a product has a recall or customer service issues arise, this can harm customer loyalty and damage sales. Though insurance may cover some losses related to this problem — such as potential lawsuits — it cannot cover public relations issues or lost sales
Trade secret risk
Trade secrets can be a product or process that is not known to others in your field. The trade secret could be a new chemical formula or the recipe for KFC chicken. It is the trade secret that makes a company profitable. If a trade secret is leaked, then the company is at risk of losing market share and profits as well as its competitive advantage over other companies.
Political risks refer to the risks that arise due to political decisions or instability of the country. For example, if a country changes its laws for foreign businesses, then it may become difficult for foreign businesses to operate in that country. Due to political changes in the government, there could be protests and strikes which can lead to loss of revenue and property damage. For example, if you are running a business in Libya and suddenly there is a change in the government due to which there are strikes and protests then you would not be able to run your business smoothly which would cause a loss of revenue and property damage.
Types of business risk – Conclusion
At the risk of sounding repetitive, I will tell you again: To thrive, first a business must survive. Online commerce behemoths like eBay or Amazon are companies that survived the 2000 e-commerce bubble burst.
Black swans like enormous Vulcan eruptions or virus mutations are impossible to predict. Therefore, the best counter-measure is to get rid of the fragilities and catalysts of negative impacts. In this article, we listed 4 types of business risk. We can classify nearly everything that threatens your business as one of them and handle it accordingly
A proper risk assessment will give you a better outlook on your project or company. It will help you to be ready for crises and obstacles. Learn how to write a good business plan with a proper risk analysis. It will make it easier to raise capital among investors or impress local authorities.
Build diversified income streams, create redundancies, and avoid risks that can wipe out your company. These are some ways to build an antifragile enterprise. If you want your business to survive one hundred years, events that happen once in a century should alarm you.
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Levi Borba is the founder of expatriateconsultancy.com, creator of the channel Small Business Hacks and The Expat, and a best-selling author. Subscribe to my articles (for free) and receive (also for free) the ebook “The Blueprint for First-Time Business Owners”.