Introduction

Risk in business is a reality. When these risks are successfully managed, the rewards can be substantial. Otherwise, a business can have serious problems and even collapse. It is unnecessary (and stupid) to ignore the risks.

For more than a decade we have advised and assisted companies in the growth and management of their businesses. Over time, we’ve seen many companies get into trouble because they ignored specific risks. This case study focuses on some companies that ignored an important aspect of risk management and then paid the price. The discussion is carried out under the following headings:

• Insufficient planning;
• bad relationships;
• without signal;
• Lack of discipline.

insufficient planning

Risk is drastically reduced with proper preparation and detailed planning. Planning includes feasibility studies, business planning, cash flow projections, and financial planning.

Recently, Hypothesis Toys approached us to help with additional financing. At that time they were already in dire straits and had invested a small fortune. The company was established to manufacture a specific type of toy. Management made the following assumptions:

• That customers would pay a premium (double the price) for your products compared to other existing products due to the fact that your products look different and are branded with the logos of professional sports bodies.
• That all the big supermarkets will sell their products.
• That the total market consists of every young child in the (developing) country in which they operate.
• That they would get 10% of this market in the first year and 50% in the third year.

This company didn’t stand a chance from the start. The random way they came up with their assumptions was mind blowing. The market penetration numbers were absolutely unrealistic. No research was done to get the real facts (except for the number of young children in the country). The scary part of this story is that it is not an isolated incident. Many entrepreneurs, and even established companies, put themselves at the unrelenting risk of failing to do adequate market research when embarking on a new venture.

bad relationships

Human relationships can never be ignored. It is potentially one of the most fatal risk factors in a business. Relationships should be fostered with all stakeholders in a business, including investors, financiers, suppliers, employees, and customers.

Some time ago, one of our clients asked us to handle a possible merger and acquisition on their behalf. They were approached by Fuzzy Manufacturers to buy their entire operations for a few years (they do a lot of business with this company).

The owners of Fuzzy Manufacturers handled some of their relationships during negotiations as follows:

• They never fulfilled the commitments they made with us or with our clients.
• They were not transparent with relevant stakeholders, including funders.
• They did not involve their senior management in any aspect related to the proposed deal.

The negotiations were eventually called off as the financiers withdrew. Everyone has lost respect for the owners of Fuzzy Manufacturers and some companies feel very uncomfortable doing business with them. Eventually some of their senior employees left and joined the competition. His business became a shadow of what it used to be.

without signal

Financial risks (such as currency risk and commodity price risk) can often be hedged with sophisticated products. Operational hedging is also possible (to a large extent) by spreading risk across a variety of vendors, products, distribution channels, customers, support facilities, etc.

Focused Systems specialized in IT networks. They were exceptionally successful, especially after landing in a major national concern. Thereafter, they made some serious mistakes by not hedging their operational risks, including the following:

• They focused on this customer and viewed all other customers as less important.
• This customer contribution grew to more than 35% of their billing and they were responsible for most of their profits.
• They stopped doing more international work.

The great national concern became the objective of an internationally listed entity. This group had their own IT specialists and Focused Systems lost count. The company almost went under. Fortunately the owners learned from their mistakes and with a concerted effort expanded their product and service offerings, their customer base, and their geographic representation. Today the company is really big. No client can stay with them due to the fact that none of them is responsible for more than 5% of the company’s turnover.

Lack of discipline

There is probably no better way to reduce risks in a business than to be properly prepared and disciplined. This is true for planning, relationships, and hedging, as well as being disciplined about things like controlling spending, growing within sustainable levels, staying out of the debt trap, and managing cash flow with an iron fist.

About a decade ago, Expansion Chemicals was well known and respected in the industry in which it operated. His vision was to be the market leader. Unfortunately they were not very disciplined and made the following serious mistakes:

• They sold products at any price just to get the sale. Their actual gross profit margins were much lower than their projected margins and their net profitability was very low.
• They grew at an alarming rate that was not sustainable with either internal financing or debt.
• Expenses for the owners (who also ran the company) skyrocketed and included luxuries like private jets and sports cars.

Unfortunately, this once profitable business failed. The owners are now employed by other businesses.

Summary

The companies discussed above basically ignored a specific type of risk. It can only take an unexpected claim against a business, a major customer being lost or not enough cash to pay a large supplier, to bring a business to a standstill. When a business plans diligently, works on all of its relationships, hedges its financial transactions and operations to the extent possible, and works in a disciplined manner, it greatly reduces risks in a business.

Copyright © 2008 – Wim Venter