Fancy a game of risk?

Life is risk. Every day we take risks.  We take risks with the choice of what we buy. We take risks when we decide to cross the road. Every decision we take has some level of risk.

Building a business is all about weighing up and taking risks.

Business stakeholder value links the level of risk involved in an investment with the required level of return needed for the investor to take on the investment. This is referred to as the risk-return relationship.

Imagine a graph with two axis. One axis is the perceived risk; the other is the level or required return. Zero risk could be considered as investments in a stable economy in instruments such as government bonds. These offer low returns but those returns are all but guaranteed.

Investing in a company with a volatile history will be considered to have greater risk than a company with a calm history.  For the investment in the volatile firm to occur, a greater rate of return would be required.

For many investors the risk associated with an investment will be assessed through extrapolating past performance on the future value of shares.

This results in the capital asset pricing model where the cost of equity capital (the return demanded by investors) increases with the perceived risk of the investment.  Risk is measured in terms of the volatility of the investment over time.

The OED definition of an entrepreneur is, “the owner or manager of business enterprise who through risk-taking and initiative attempts to make a profit”.

However, such risk-taking has boundaries. Company directors have a responsibility to maximise returns for stakeholders BUT they also have a responsibility to ensure that the business survives over time.  That means they must ensure that stakeholders investment is secure.  Directors and investment managers need to carry out due diligence and take reasonable precautions.  They need to take time to consider and assess those things which could go wrong.

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

This is where the marketers definition of risk differs from the risk definition of financial managers.  Rather than a backward looking, money-based assessment of risk, marketers look forward to potential risks many of which have no financial basis.

There are four types of risk in a business enterprise:

  1.  Financial Risk
  2.  Strategic Risk
  3.  Operational Risk
  4.  Hazard Risk.

There are also two sources of risk:

  1. Internal Risk – Which should be within the control of the organisation; and,
  2. External Risk – Which is driven by events external to the organisation and where the organisation has little or no control.

Financial internal risks include liquidity and cash flow. Strategic internal risks would include R&D, intellectual capital, and the integration of mergers and acquisitions.  Internal operational risks include accounting controls, information systems, recruitment and securing your supply chain.  Internal hazard risks include public access to buildings and facilities, the safety of products and the effect on the environment.

Financial external risks include interest rates, foreign exchange values and the ability to get credit. Strategic external risk includes the actions of competitors, changing customer tastes, technological change and levels of demand. External operational risks include government regulations, changing cultures and brand competition. External hazard risks include natural disasters and the effect of the environment on a business; contractual demands and the stability of suppliers.

Assessing business risk should not simply be a backward-looking exercise based on previous financial performance. To fully assess risk you should be looking forward to the future and at the social, environmental, cultural and political effects to com.  These elements are at the core of marketing and market analysis.

You should be looking forward to:

  • Create stronger and better growth
  • Ensure a stable business less prone to change
  •  Develop better quality staff
  •  Create customer acquisition opportunities and to ensure customer retention
  •  Develop consistent operations
  •  To acquire lower costs of finance through lower perceived risk
  •  To drive lower costs
  •  To ensure robust supply and distribution chains.

Marketing risk has two main factors:

  1.  Primary Demand Risk:  This is similar to financial risk and is external to the organisation. It is a factor out with the control of marketers. It relates to economic life cycles; currency and exchange rate fluctuations and changes in technology.
  2.  Market share risk:  This is a relative, not an absolute risk. It is the risk of not acquiring a particular prospect or nto retaining a particular customer.

Market share risk is affected by how much time, money and effort a business puts into:

  •  Customer research and the understanding of customer attitudes
  •  Product Research and Development
  •  Price maintenance and preventing price entropy
  •  Brand identity and differentiation
  •  Communications activities

Much of the role of marketers is the assessment of non-financial risk and then putting systems and structures in place to minimise or prevent such risk.  What makes the marketing risk game interesting is that your competitors are doing the same and will no doubt find different solutions and focus on different areas of risk.

The best ways to reduce marketing risk are by getting closer to your target customers, improving the quality of your marketing activities and increasing investment in marketing to a level greater than that of your competitors.