Business is, like life, about taking, managing and coping with risk.

Economists categorise a risky activity as having two characteristics:

  1.  The likely outcome, for example the return on an investment; and
  2. The degree of variation in all possible outcomes.

So, a ‘fair gamble’ is one where, on average you will achieve zero monetary profit.  For example, for your investment you have a 50% chance of gaining £100 but you also have a 50% chance of losing £100. On average you do not gain.

An ‘unfair gamble’ means you will have only 30% chance of making that £100 but you have a 70% chance of losing that sum.  On average you will lose by accepting such a gamble.  This is how most casinos operate where the chance of winning always lies on the side of the house.

You also have ‘favourable gambles’.  This is where you have, say, a 70% chance of winning and a 30% chance of losing.  Such situations are referred to as profitable.  Success in business is about seeking out ‘favourable gambles’.

There are also different levels of risk.  So, for your initial stake you have the chance of winning £200, not £100, with the same percentage odds, your bet will be ‘riskier’.

Bear in mind, for most marketing campaigns, you should be looking for a return on investment many times that of your initial stake; your marketing budget.  It is not unusual to expect a return on marketing investment of between 500% and 1000%.  So you are looking at a ‘bet’, not of 100:30 but of between 1:5 or 1:10.

Businesses, like people, will have different risk profiles.  Economists classify such attitudes into these groups:

  • Risk averse
  • Risk neutral
  • Risk-loving

A risk neutral business will only invest when the outcome is likely to be profitable (on average.  They are only interested in fair gambles or better.

A risk averse business will refuse a fair gamble and will only invest when the odds are sufficiently favourable and the potential monetary profit will overcome their inherent dislike of risk.

A risk-loving business will take on an investment even if the strict mathematical calculation of the risk describes the investment as unfavourable.

Think of Richer Sounds, the hi-fi and electronics retailer.  The business has been in operation for over forty years and on average has opened one shop  every couple of years.  The slow careful growth of the firm could easily be described as, at best, risk neutral, and potentially risk averse.

Compare that position to the actions of Fred Goodwin at Royal Bank of Scotland.  One of the accusations made of Goodwin on the banks collapse was that he was pursuing rapid growth at all costs.  He was making investment and purchase decisions whilst ignoring the normal due diligence analyses carried out by the bank’s staff.  This resulted in the disastrous purchase of ABN Ambro, the Dutch bank.  In fact that purchase was not of all of ABN Ambro.  The profitable retail arm of the bank was purchased by Santander.  What Goodwin had purchased for RBS was ABN Ambros’ investment banking arm, which was stuffed full of American sub-prime mortgage debt.

Fred Goodwin was clearly a risk-lover.

Insurance is the opposite of risk.

Insurance is the payment of a small sum to cover unlikely events.  So you are willing to invest £300 a year to insure your car which is worth £15,000 (despite the fact that it is a legal requirement).

However in business, often the cost of insurance is ignored.  There was much anger that, after the disastrous fire, Glasgow School of Art was not insured.  But it is likely that the Charles Rennie MacIntosh designed building was uninsurable as the cost of a policy would exceed the cost of repair or rebuilding the school.  So, a business decision was made not to insure the building.

In such circumstances both a risk neutral manager and a risk loving manager would reject the cost of the insurance offer.

So if you cannot buy an insurance product to cover a business investment, how do you protect your investment?

In traditional gambling, a ‘punter’ will spread his bets.  He will make a small bet on a horse with long odds and a larger bet on the favourite.  If the favourite comes in, he takes his winnings, but if the outsider comes in, he covers his initial stake.

Some professional gamblers tactically ‘bet to lose’.  They make smaller bets against favourites.  Think how often horses listed as favourite fail to win races.

In the financial markets, investment brokers use hedge funds.  They hedge their bets.  So if they buy shares or derivatives with the intention of selling at a particular rise in price, they will cover the risk of that growth in value not occurring by laying a ‘hedge’ with a hedge fund to cover their investment.

For most small businesses, there is little opportunity to hedge or to insure investments in things like product development and market entry. So how do you protect your investment.

Well, that is where Philmus Consulting comes in.

Philmus Consulting can help your business develop robust due diligence systems with respect to food standards, metrology and trading standards.  We can help you with product safety risk assessment and product recall plans.  If you know the risk in a particular regulatory area, you can reduce the chance of the risk occurring and mitigate its effects.

In marketing, risk is reduced through market analysis and marketing research.  You reduce risk by using such information to set realistic business goals.  You reduce risk by creating strategic marketing plans and by defining alternative opportunities.  This can be achieved through the use of tools such as the GE matrix and the Shell Directional policy framework.  You reduce and insure against risk by researching your target market and developing products to meet the needs of that target market. This is by far a more preferable route to product development than that of creating a product and then trying to find a market for it.


Brexit and Regulation

Over recent months, this blog has focused on marketing strategy.  However, there is more to Philmus Consulting than strategic marketing planning.  This consultancy also offers guidance on regulatory due diligence in relation to food standards and consumer protection law.

So this week I want to address the thorny issue of Brexit and its effect on the regulatory environment within which UK businesses operate.

Of course, this subject isn’t wholly divorced from marketing planning.  Analysis of the political and legislative environment is a prominent part of the market analysis process.  Government and regulators are often key stakeholders in the policies and procedures of businesses.

You may be aware that I wrote to Michael Gove shortly after his appointment as Secretary of State for the Environment, Food and Rural Affairs. My letter tried to get some information as to DEFRA’s preparedness for Brexit.  I chose to highlight two areas of food regulation, Organic Certification and Products of Designated Origin.

I chose these two topics as they brought the issue of regulatory diversion into sharp relief.  Also in my mind was Gove’s comments at the referendum that we’d “had enough of experts”.  I did wonder if Theresa May was getting some revenge in early ass DEFRA is a department filled with experts and where attention to regulatory detail is often required.

I did get a reply from Mr Gove’s office but it was less than satisfactory.  I got a holding letter which stated that no detail could be given until the conclusion of the exit negotiations and that only after the Article 50 process was concluded, could such planning take place.

Last week, the UK government released its first tranche of contingency plans in the event of ‘no deal’.  One of these documents concerned the certification of organic food.  That contingency paper confirmed my worst fears of the UK government’s lack of preparedness for Brexit and the regulatory chaos that will be thrust upon UK businesses as a result of Brexit.

The UK government is slowly drip feeding industry with these contingency documents and have taken 18 months to do so.  The EU produced their equivalent documents six months ago.

The organic products contingency paper was written for a no deal scenario.  However, my reading of the law is that the effect of the UK becoming a ‘third country’ will be the same on the organic sector whatever the result of the article 50 process.  The impact of EU exit and the UK government’s utter failure to plan, could destroy the UK organic food sector completely.

Currently, the UK, as an EU member, implements the EU Organic Products Directive.  What this means in practice is that the UK complies with the EU-wide definition of organic food.  A food producer wanting to describe their food as organic, must meet strict criteria as to the use of organic production processes.  There are strict limits on the use of inorganic fertilisers and pesticides.  If a producer wants to be classed as an organic producer, they must be certified as meeting organic standards and they must keep detailed records in relation to their organic status.

Getting organic status is expensive and can be extremely time-consuming.  Achieving organic certification can cost thousands.  I know one farm which spent nearly a decade working to ensure their land met organic standards.

There are nine organic certification bodies in the UK.  three of these bodies are based in the Republic of Ireland.  Each has been licensed by the EU to issue organic certificates to UK food producers.

Once a UK producer has achieved organic status, they can mark their food labels with the EU green leaf passport.  This symbol allows the food to travel throughout the single market with no further certification checks.

I wrote to Mr Gove as it was clear to me that leaving the EU would mean the collapse of this certification process.

The government’s contingency document confirms my fears but it also contains one crucial detail which may mean that organic production in the UK becomes financially unviable.

The document states that, “in the event of no deal”, all UK organic certificates will lapse.  UK organic certification bodies will no longer be authorised to issue organic status certificates to UK food producers.  The UK will have to set up a new system of organic certification.

Certification bodies will have to be licensed by the UK government.  This could be a lengthy process as the UK government will have to set up the certification system and carry out effective audits of the certification bodies to ensure that they comply with new UK-only organic standards.  Only after these bodies have been licensed by the UK government can new organic certificates be issued to food producers.  Existing organic food producers will have to reapply for organic status and pay certification fees.

The effect is immediate disruption to the supply of UK organic produce.

But it gets worse.  The contingency document states that the UK will continue to accept organic food produced under the EU system with no further checks.

So whilst UK production of organic food is disrupted, EU producers have full, unfettered access to the UK market.

So what if you want to export organic food to the rest of Europe.  Well, the contingency document is clear on that.  It must be noted that organic food is a value-added export product.

It is clear that once the UK becomes a third country UK organic food will not be able to use the green leaf passport. UK food described as organic will be subject to additional inspections at EU state borders and, if it uses the green leaf logo unofficially, will likely not be allowed access to the single market.

UK organic producers will have to be certified by an EU-based certification body which is licensed to operate within the UK.  Currently, no such body exists.

As the UK will be a ‘third country’, even if the producer is certified by an EU-licensed certification body, the food will need to be clearly marked as being of ‘non-EU origin’.

So UK exporters of organic foods will face expensive dual certification and this could be increasingly expensive if EU and UK organic standards diverge.  UK organic exports will likely face additional controls and barriers at EU borders.

Whilst UK producers flounder in the regulatory molasses of Brexit; with increased bureaucracy and additional costs; EU organic producers will have free unfettered access to the UK market; a distinct competitive advantage.

Such a competitive imbalance, and the likely reduction in margins due to the cost of additional UK bureaucracy, could easily make organic production in the UK unviable.

In this article, I have concentrated on one issue in one market sector; but this is just one example amongst thousands.  Similar issues occur across the UK economy, from toys, to pesticides, to motor vehicles, to financial services, cosmetics, metrology; to name but a few.

There is now six months until Brexit day.  Even if the UK government comes up with new systems of certification and regulation, it is highly unlikely that such systems will be in place for March next year.

Much of the media attention regarding Brexit has been focussed on custom’s tariffs.  But regulatory issues are a far more problematic concern.  Deal or no deal, the UK government’s failure to recognise the problems of regulatory divergence, and their appalling lack of preparation are going to be a costly and disruptive issue for UK business.

A prominent component in the arguments from Brexit was freeing the UK from EU bureaucracy.  Of what I have read of the UK government’s contingency plans, the solution to the loss of EU red tape is…..even more UK red tape.