Risky Business

Is your business ready to deal with the unexpected?
From the November 2008 issue of Entrepreneur

New York City-based Plum Organics was two weeks away from a production run of its organic kids' meals when the phone rang. On the other line was the company's organic cheese supplier.

"They said, 'We're out of organic parmesan cheese because there's a shortage of organic milk,'" recalls Plum Organics' founder, Gigi Lee Chang. The supplier said it expected a shipment of organic milk to arrive soon and that it could probably meet 3-year-old Plum Organics' production deadline. Chang was skeptical. She called another supplier, but because its organic parmesan wasn't fully aged, Chang, 41, feared it would change the taste of the product.

She weighed her options: She could either rely on her primary supplier to come through, or use the parmesan the secondary supplier had to offer? She decided to take a risk and go with the secondary supplier after testing some samples. Plum Organics met its production run, but "it was a very stressful two weeks," says Chang. "You try to ask questions to figure out what the risk is, and when you make your bet, hopefully it's going to turn out."

 

5 steps to successful risk management
  1. Anticipate. Ask all the "what ifs" and scan the news, including global weather reports, for things that could affect your business.
  2. React Quickly To Negative Trends. If you see more customers making late payments, for example, you might start requiring prepayment or offering discounts for prepayment.
  3. Find Flexibility With Customers. "Communicate to your customer some of the risks that you have so they don't penalize you," says Russell Walker, assistant director of the Zell Center for Risk Research.
  4. Involve Employees. They're on the front lines and see potential problems. Communicate with them constantly.
  5. Work Backward. Entrepreneur Gigi Lee Chang works backward to set a timeline after a delivery date is set. Says Chang, "Then we build in a little cushion for anything unexpected that might come up that would eat into that time frame."

You place bets every day on the risks facing your company--from strange weather patterns and supply chain interruptions to security risks and global economic trends. "If we've learned something from the subprime crisis, it's that what happens in Florida or California has an impact on a bank in Poland or Norway," says Russell Walker, assistant director of the Zell Center for Risk Research at Northwestern University's Kellogg School of Management. "The complexity of business is continuing to increase, and there's no sign it will go in the other direction."

 

But there are signs that companies aren't keeping up with the complexity. A McKinsey Quarterly survey of 273 global executives earlier this year revealed that a majority felt that their companies haven't fully addressed the global factors posing the most risk to their supply chains.

Larger companies are finding creative ways to mitigate risk. Walgreens and Navistar are just two companies that have moved their CFOs over to the emerging role of chief risk officer. Meanwhile, candy-maker Mars has hired meteorologists to stay on top of weather-related risks to sugar and other crops.

Other companies are turning to online risk-prediction markets to answer the unknowns facing the business world. One player in the space is Chicago-based Inkling, which offers a prediction market platform. Inkling co-founder and CEO Adam Siegel, 35, compares his company's product to the "Ask the Audience" lifeline on the game show Who Wants to Be a Millionaire: It takes advantage of a crowd's collective wisdom to answer questions. Prediction markets work under the same concept, only you're asking employees, customers and partners if a supplier can deliver or whether the company will meet projections. Participants use fantasy money to buy "stock" in their answers. "The stock price represents the probability of that answer being correct," says Siegel, adding that companies can gain insights from people they might not otherwise meet. Inkling's client roster includes Cisco, Lockheed Martin, Procter & Gamble and Wells Fargo, and it projects sales of more than $500,000 this year.

The approaches may vary, but the keys to managing risk remain the same: open communication and having as much relevant information at your fingertips as possible. "It's important to keep a very broad network of contacts that have access to information in different fields," says Russell. "If you simply go to the same pool looking for the same information, eventually you'll draw up the wrong answer."

Create redundancies in your supply chain where you can, and stay well-connected with your partners and suppliers. "Check in on [suppliers]--visit them [in person]," says Walker. "That sense of their operations and their sense of success are going to be indicative of the risks they're exposing you to."

Julie Allinson, founder of the 10-employee eyewear company Eyebobs, travels from the company's headquarters in Minneapolis to China, Italy and France at least three times a year to visit suppliers and manufacturers. She keeps first runs of a product small and tracks the company's just-in-time inventory levels. Still, economic trends are forcing the company, which expects sales of more than $1 million in 2008, to take new risks, like adding metal frames to its product line in response to the rising price of petroleum, a key ingredient in plastic frames. "The risks change," says Allinson, 50. "Every day you're learning something new."

Chang has learned never to take anything at face value. Now she cushions inventory levels to anticipate situations that could force Plum Organics' three employees to scramble. "I always go for the bird in hand," she says. Taking a bird's-eye view has been good for business: Plum Organics projects sales of $1 million this year.

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