It’s all about risk

Whilst studying for the Chartered Institute of Marketing qualifications, I was told a possibly apocryphal story about the beginnings of the Starbuck’s coffee shop chain.

I was told that when the first Starbucks café was opened it struggled to make a profit.  Faced with such mounting losses, the owners could easily have decided to close the café.  Instead they opened two more outlets.  The result was that the business took off.  Sales at all three of the businesses premises rocketed.

The result is history, a catering behemoth was born.

The owners of Starbucks took a huge risk.  If they had closed the original store, their finances would have taken a hit but they would have ‘lived to fight another day’: If the new outlets had failed, they would have been bankrupt.

Last week, I saw a newspaper article regarding Starbucks opening its first store in Italy.  Again the businesses owners are taking a big risk.  How coffee is drunk in Italy is virtually a religion.  For example, no one would be seen drinking a cappuccino in the morning and most Italians prefer a dark oily espresso which would knock most Starbuck’s customers for six.

Personally, Starbuck’s opening a store in Rome is great PR but I shall be extremely surprised if it lasts more than six months.  The reason the big American coffee chains have ignored Italy so far is that their business model clashes with Italian cultural norms.

Julian Richer, the proprietor of Richer Sounds, the specialist Hi-Fi retailer, has gradually built his business to fifty stores over forty years.  Unlike many retailers who plan to open several new stores a year, with the aim of having a presence on every high street, Richer prefers slow, steady growth over the long-term.

Other specialist retailers, such a Jessop’s and Maplin’s have tried the rapid expansion route and have failed.

So what is the definition of business risk?

Risk is an event or action that may adversely affect an organisation’s ability to survive and compete in its chosen market, as well as maintaining financial strength, a positive public image and the overall quality of its people and services.

A few weeks ago, I was discussing the collapse of Carillion with an entrepreneur who had worked for over 40 years in the construction industry.  He described it as a sector where many businesses “fly by the seat of their pants”.  They take massive risks and the continuation of the business is often reliant on the next contract tender or the next paycheck.  he was wholly unsurprised at Carillion’s collapse.

Of course, the definition of an entrepreneur is a manager or business owner of a business enterprise who through initiative and risk attempts to make a profit.  Disruptors are a specific form of entrepreneur who uses new technological advances to disrupt accepted business practices and models.

In most industries such laissez-faire risk-taking as that taken by Carillion is, in many sectors, no longer seen as acceptable management practice.  Managers are expected to mitigate and predict possible risks through forecasting and business planning.

Fred ‘The Shred’ Goodwin, the former CEO of Royal Bank of Scotland has been vilified for collapsing that bank.  His strategy, if you could call it a strategy, was to turn RBS into an international investment bank, rather than its traditional role of a retail bank, through high risk acquisitions and trading.  The criticism he has received can pretty much be described as his inability to assess risk and to plan for it.

Risk arises from a failure to exploit opportunities as well as from external threats.  There are four types of business risk:

  • Financial risk
  • Strategy risk
  • Operational risk
  • Hazard risk

Risk can be broken down into risks driven internally within an organisation which should be under management’s control; and risks driven by external events which are out with an organisation’s direct control.

Internally driven financial risk includes liquidity and cash flow. Strategic internal risks include research and development, intellectual capital and the integration of cultures after mergers and acquisitions.  Internal operational risks covers areas such as ICT systems, recruitment, supply chain and accounting controls.  Internal hazard risks include public access to the business’s premises, employees behaviour, maintenance of buildings and product and service safety.

Much of my career in consumer protection was taken up with this last hazard risk where I advised businesses on product safety risk assessment, legislative due diligence and product recall protocols.

Externally driven financial risks include interest rates, foreign exchange rates and the availability of credit.  External strategic risks include competitors’ actions, changes in customer dynamics, changes in industrial practices and variation of demand.  Operational external risks include regulators, changes in cultural expectations and board competition.  External hazard risks include contracts collapsing, natural disasters, failures by suppliers and environmental change.

Managing the above categories of business risk better can lead to clear and obvious benefits including:

  • Stronger and better business growth
  • Better business stability with less exposure to market and environmental change.
  • Better quality employees who understand their responsibilities
  • Stronger relationships with your suppliers
  • Better channels to market
  • Better customer acquisition and retention
  • Cheaper finance; and,
  • the driving down of costs

As a professional marketing strategist the process of developing strategic marketing plans plays an important role in risk reduction.

There are two main aspects to strategic marketing risk.

Primary demand risk is similar to financial risk in that it is beyond the control of marketers.  It relates to the general effective demand in the marketplace and customers ability to pay.  It is driven by economic life cycles, currency and exchange fluctuations, government regulators and technological change.

I am furiously opposed to Brexit precisely for its likely effects on primary demand risk.  This is already showing in the UK economy where productivity is in the toilet, retail sales are beginning to collapse, inflationary pressures are developing and interest rates are starting to rise.  Exporters have been able to rely on the fall in the pound whilst stocks of commodities bought with a its higher valuation lasted.  Those raw materials are starting to run out and factory gate inflation has been as high as 18%.

The second aspect of strategic marketing risk is market share risk.  This risk is relative to your competitors, not absolute as with primary demand risk.  This risk can be defined by asking yourself whether you are better at assessing the market than your competitors or whether they have a superior ability.

Organisations which are better at assessing the market tend to garner more market share and make better profits than those which are less able.

Factors which affect market share risk include:

  • Not acquiring your target customers
  • Not retaining your existing customers
  • Allocating too many or too few resources to:
    • Customer research and understanding
    • New product development and improving existing products
    • Price maintenance
    • brand distinctiveness
    • communications

The best ways of reducing marketing risks are:

  1. To carefully research your intended market
  2. To develop close relationships with your target customer groups
  3. To improve the quality of your marketing: and,
  4. to increase your share of marketing investment relative to your competition.