“BUSINESS IS ALL ABOUT RISK TAKING AND MANAGING UNCERTAINTIES AND TURBULENCE.”
BY GAUTAM ADANI, BUSINESS TYCOON
Late this September, the movie, Deepwater Horizon will appear in theaters. The high level of interest in this release can be recognized, with over five million movie trailer view from YouTube.
What could engage so many viewers in this movie? Across the Americas and the world, we witnessed in April 2010 one of the worst & most expensive man-made environmental disasters ever. The oil spill in the Gulf of Mexico resulted in the loss of eleven oil workers, thousands of square miles of ocean contamination, the countless loss of wildlife, over one thousand miles of coastline damaged across Gulf states and the highest ever corporate settlement with a government, amounting to $18.7 billion. The financial impact to British Petroleum PLC (BP) is estimated to be $62 billion and total costs will be larger than any fines levied on any individual banks during the subprime mortgage crisis in the US. The Deepwater Horizon disaster should teach all of us that risk management should be an intricate part of our budget, planning, and forecasting process.All businesses and especially start-ups by their very nature have financial risk exposures. While the risk valuations vary, the consequences can be just as devastating for its employees, customers, community, and its management.What is not always clearly understood by businesses large and small are the sources of risk and the early signs when a particular risk may soon become unmanageable. It would be hard to argue that any corporate finance or financial planning and analysis (FP&A) professional, would be more comfortable knowing:
- the existence of all known and potential major risks; and
- working together with senior management to contain those risks.
Corporate Finance’s historically traditional role as financial stewards working alongside accounting and focused only on the past has been shed long ago and now encompass all business operations. Given today’s faced paced, high-risk world, Corporate Finance needs to stretch its legs and comfortably walk across the business ‘ship’ from stem to stern, understanding what keeps the ‘ship’ afloat; what financial obstructions lie ahead along the course and what explosive financial mines could be below the waterline. Financial risk management is NOT an insurance function, it is NOT just a function found in financial institutions it should be a part of a routine budgeting and planning process for all companies. By including it your planning process you will help prevent corporate disasters, possibly like the Deepwater Horizon, but also make a better financial analyst, budgeter, and financial forecaster.
1 The View From The Bridge: Setting Course Heading & Conditions
How many saw the great recession of 2008? If you did, did you prepare for what it has become? The long, drawn out slow growth that is in stark contrast to the bounce back the US economy experienced after the 2000 crash?
At any time, a business could unexpectedly make contact with the symbolic ocean floor, rogue wave, or unexpected storm, that could lead to a gash below the waterline. These calamities could lead to a slow, or sinking marketing initiative, plant closure, layoff or worse. In addition, the business may operate in busy sea-lanes with many other competitors where it will occasionally collide with other market participants while pursuing customer deals or new opportunities.
How can an FP&A professional see the risks ahead? That’s where it’s important to go up to the bridge and talk with the marketing and sales team to see what they are thinking and what they see coming. The sales and marketing departments leads all companies everywhere. Period. Regardless of what you may have heard. technology may think they lead the company because they have to build the app or product or website or the CEO may think they lead because they set the direction or the strategy team because they lead because they decide what markets to enter, which is all true because everyone plays a part in moving the company forward, but in the end nothing happens until someone makes a sale and cash is exchanged.
In fact, offer to take someone from sales and marketing out to lunch and pay! They so often have to do it for clients and everyone else they will be shocked anyone else wants to do it for them, then just listen. Good questions to ask those in sales and marketing are:
- Are there new entrants in our markets? If so who are they? How do we fare against them and is there anything we are or will be doing to parry any future attacks?
- How long do you think it would take the business to change to address a new competitor or change in market condition? Knowing that smaller, more nimble competitors can make faster course corrections?
- Would any changes to assumptions, systems, staffing, or partners improve our ability to be more responsive?
- How well defined is our product roadmap, with overlapping new product releases and older product phase-outs?
- How does the business’s marketing cost per acquired client and sales cost per revenue dollar compare to its competition? If they don’t know it, then run an analysis and show them and find out.
- What is the health of our sales pipeline and how well defined and graceful is the handoff of a qualified lead from marketing to sales?
- What marketing and sales performance metrics are we using and what initiatives are budgeted to enhance our performance? Are there others that should be added?
Now, let’s now go below deck within a business.
2 The View From The Engine Room: New Product Development
Businesses are powered by a flow of new products and services to generate revenue. While designing new product innovations with more valued benefits and features is the goal, product release slippages are the bane of any Research and Development (R&D) department. What does an FP&A professional need to know to better appraise the likelihood of new product releases supporting the future business plan and forecasted revenue?
- Understand how new products are designed, defined, prototyped, tested and released for production, recognizing existing and emergent obstacles to meeting release dates (e.g. new technologies; test equipment and methodologies, staffing and unsubstantiated schedules);
- Become acquainted with the history of prior releases and the life cycle of their projected revenue contributions;
- Learn R&D’s success in migrating in whole or part to short quarterly sprints, to improve the predictability and success in product (generally software) releases;
- Attend and participate in regular product design review sessions and core team cross-functional development meetings, observant of emerging development issues and changes anticipated in product specification, development cost, milestone attainment, or release date; and
- Assist R&D team members in decisions weighing risk decisions needed to meet scheduled development milestones and product releases.
Note that the longer a product remains in development, the greater the pressure by marketing to modify product features, changing expectations, increasing complexities and further extending release dates (scope creep). Also be on the lookout for products having the characteristics of being dead on arrival (DOA). In such instances, it would be best to spearhead post-mortems and determine why the product wasn’t killed earlier.
3 The View From Security: An Information Systems Appraisal
As businesses accumulate more customer data, businesses’ information custodial role and obligation to safeguard customer information becomes more pronounced. FP&A Professionals should seek to partner with the businesses’ Information Technology team and ascertain overall risk exposure on periodic basis including:
- To what extent does the business systems deter hackers from acquiring customer credit card and bank accounts?
- Is the business structured, particularly during holidays, including Black Friday from denial of service attacks, to prevent a major loss of revenue?
- Is the business prepared to shift its website or e-commerce servers over to a new host server farm, in the event of any kind of emergency?
Just this year, we’ve seen in the US a series of riots across many metropolitan cities, as well as intermittent terrorist attacks. While these violent activities currently appear to be restricted, there is the possibility that violence or attacks could increase or be directed to large commercial firms which could affect multiple market participants affecting large volumes of commerce. Understanding the business IT infrastructure will help provide certainty to future financial forecasts.
Risk is not just reactive, but proactive. When an event happen, how well can your business assists its clients, or competitor’s clients when confronted with horrific damage from natural disasters or other events? This could be a determining factor if a client becomes an uncontested supplier for life.
4 The View From The Exercise Room: An HR Appraisal
Maintaining and growing a crew of employees takes constant diligence. Every day, a business runs the risk of not fulfilling its needs and discovering that its best and brightest have submitted their resignations. It needs to maintain an objective position when it comes to understanding why turnover at companies takes place and what strategies can be employed to reduce turnover.
Can a business readily identify staff hiring efforts that are failing, whose consequences can be measured in the hundreds of thousands of dollars, if not millions?
Some businesses have found that it’s easier to offload employee segments to outside contracting firms called Professional Employer Organizations, from lot attendants and kitchen staff up to physicians, officers and entire crews for ocean-going vessels. Businesses have reduced recruiting cost and shifted direct employee costs over to contract services while creating a new set of risks. Regardless of the technicalities of the employment situation at a business, an FP&A professional should seek to find answers from the HR team as to:
- Depending on status, do workers under the businesses control have more ready access to move to other positions and locations outside our firm’s control. Can we live with this? For example, if the business moves a majority of its workforce from fulltime to part-time, or employee to contractor.
- Do our clients differentiate “our” employees from “our contract employees” with the expectation that all will satisfy their servicing needs? Is our service seamless across contract/employee staff members? If not, why not?
- Our staff-sourcing partner may not be as responsive to our fluctuating needs, requiring more advanced planning with their management teams for seasonal staffing requirements. Can we deal with short-term staff supply/demand mismatches?
Returning to BP’s Deep Horizon disaster, while nearly all of the staff on site were employees of other firms, the US courts held BP responsible. Using contract labor does not necessarily mean that that a business is held harmless if contract labor employee actions result in damage or harm to life or property.
5 The View From On-Shore: A Legal Appraisal
While we’re busy designing, building, selling and accounting for the business, legal is protecting the business from a host of possible issues that are not always on our radar such as.
- Workers’ compensation for job-related injuries;
- Intellectual property protection;
- Insurance protection from lawsuits against company officers or employees;
- Property insurance from damage to equipment or facilities;
The knowledge of how far afield a company’s management team can be off in estimating the operational risks is exemplified with the Deepwater Horizon disaster. There have been earlier plant disasters, having more fatalities (Union Carbide’s 1984 gas leak at Bhopal, causing 2,259 deaths per official records), but never has the bill been as high as BP’s. This serves as an expensive lesson on the need to understand and better weigh the benefits of cost cutting vs. mitigating financial risk and the health, safety & welfare of employees, customers, and community.
Our charge in FP&A is to provide a timely, thorough, actionable assessment of our respective firm’s condition, assessing all areas of the business, inviting a dialog for management to best determine how to shape its future. This is quite a responsible job, filled with challenges every day. That’s why we’re here.
Many of the above are hard questions and may be faced with some resistance. That’s OK, in FP&A you need to have a thick skin and keep asking, politely. Also, for smaller companies, many of these areas blend or are non-existent.
How do you assess risk in your organization?