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Practical tools for the identification of risk (and opportunity)
Date of Issue: Tuesday, 16 April, 2019
By Mark Woods, Statius Management Ltd
In this article we will seek to answer the following questions:
- Why identify risks and opportunities?
- How to identify risks and opportunity?
- What are the tools that enable us to identify external risks and exploit opportunities?
Why identify risks and opportunities?
Did you know that of the 100 companies that made up the FTSE 100 at its formation in 1984, only 28 were still breathing in 2017? Household names like Woolworths, MFI Furniture, Allied Lyons and Carillion are all now defunct. At the other end of the scale it’s equally bleak, almost 50% of SMEs fail to celebrate their 5th birthday.
Let’s face it, a common desire among all leaders is for the long-term viability of their organisation. However, the statistics above would indicate that risks are not being mitigated and opportunities are not being exploited.
How to identify risks and opporunities?
Firstly, the process starts with analysing the factors in the external environment in which the organisation operates. These factors cannot be controlled or changed, but they could have a negative impact if the company does not react to them. This is followed by examining the internal factors and challenges that the company can control and manage. In doing so, this produces information and data necessary to inform a robust strategy, objectives and plans that add real value.
The purpose of assessing the risks and opportunities regularly is to ensure you are being guided by your own key processes and strategic objectives to minimise the difference between where you want to be and where you get to. It makes decision making clearer; if an activity or opportunity presents itself and is not aligned with the strategy it can easily and quickly be rejected.
Risk management is about using tools, people and information to help drill down and focus on the things you need to do to reduce risks and exploit opportunities to achieve your objectives and remain successful.
BUT it cannot be stressed enough, that the principles equally apply to any organisation, however, there is not a one size fits all approach. It must be proportionate to the size and complexity of the organisation.
PESTEL is a common tool and is ideal to help analyse your external environment.
PESTEL is an anagram of Political, Economic, Socio-Cultural, Technological, Environmental and Legislative. These factors can have a significant impact on your organisation, and critically, you have absolutely no control over them, all you can do is be ready to react to changing events.
You should note there are some blurred lines between the components in the model, for instance; political & economic. Should changes in interest rates or unemployment come under the political or economic heading? The answer is, it does not matter. The tool is not about getting the right issue in the right box, but about using it as a tool to drive and challenge your thinking.
The associated diagram provides a few examples of the issues that might be considered under each component. However, below, we’ll explore a few examples in a bit more depth.
- Political – changes to the way in which the politicians, both nationally and internationally, are tackling what are increasingly seen by some as unscrupulous tax practices could impact companies like Google, Facebook, Starbucks and others.
- Political / economic – changes to the UK minimum wage. The minimum wage, introduced in the UK 20 years ago, was last month raised again pushing up costs for businesses, but raising living standards for recipients.
- Socio-Cultural – For some time the construction sector, particularly in London, has been staffed by committed and hardworking tradespeople from Eastern Europe (and beyond…I know of one lift company using Japanese workers!) but there are sometimes little English language skills. Consequently, the socio-cultural issue is that basic H&S training needs to be given in such a way to ensure understanding. (Obviously, that’s ignoring the Brexit risk which would come under the Political component of the model).
- Technological – Tesla is not only disrupting the automotive market generally, there are knock on effects both up and down the supply chain. Factories for battery production are being built on a massive scale and electronic charging points are now being seen in large hotel chains and local pub car parks.
- Environmental – The introduction of city congestion zones and low and ultra-low emission zones ripped thousands from the bottom line of numerous companies. That’s obviously before they recovered and, where they could pass these costs on to customers.
- Legislative – Utilities providers like British Gas and Npower are constrained by external and independent regulatory bodies like Ofgem who dictate a raft of issues including what the providers can charge for their services. At the smaller company end of the spectrum, a couple of years back we were working with several small steel fabrication companies that have found themselves in the “firing line” from the EU as the Construction Products Regulations were introduced for structural steels.
The Porter Model
Moving on from the macro high-level factors over which most of us have no control, to the issues that, over time, given enough resources, we can begin to control.
Over time all markets shift, at some stage they may get more concentrated and at others more fragmented. Michael Porter developed this model to highlight five forces that exert pressure on any industry.
- In the middle, is inter industry rivalry, this is about how hospitable or hostile a market is.
- At the top and bottom there is the threat of new entrants and of substitute products.
- On either side is the power of suppliers and customers.
All the forces effect the market, competition, and the risk or opportunity of making or losing money.
So, let’s take the example of the automotive market.
When I was young, Ford and GM were the dominant players in the automotive market, especially in the UK. Gradually, around the 80’s Honda, Toyota and others entered the international market. They were then the new entrants to the market, and they built and sold cars in larger volumes so they were able to expand the market and reduce their prices. The market stabilised and the Japanese became part of the established market. The Taiwanese were soon to follow, and Tesla is now the new entrant sending shockwaves through the market, not only introducing batteries and motors as new means of propulsion but also now selling online. They have acted as disrupter and as they have disrupted, others have had to follow.
The electrification of the automotive sector will undoubtedly have an impact on the supply chain. 100 years of established technology and established relationships will get written off probably over the next 20 years or so. The balance of power in supplier relationships will change considerably.
Substitute products and services for the automotive sector will include anything from simply walking to a variety of public and private transport provisions; buses, planes, trains, taxi’s etc. Additionally, and interestingly, Elon Musk is also potentially creating a substitute product for part of the sector with his pursuing of the hyperloop concept.
The beauty of the Porter Analysis is it provides you with a tool that enables you to identify things that you can change over the longer term. You can take over competitors, you can acquire key suppliers and you can create joint ventures. In short, you can shift the balance of risk and opportunity.
The outputs from the PESTEL and Porter Analysis identifies our external threats and opportunities and this information is directly inputted into the SWOT analysis, which I am confident most readers will be familiar with.
Strengths and weakness, on the other hand, are about understanding what the organisation is, and is not so good at in comparison to its competitors and in managing the threats and opportunities. Therefore, the SWOT is principally concerned with the internal workings of a company – how it develops and executes its strategy and operations.
Bringing it all together
Having undertaken the above analysis, you will now have significant information available and the next step is to prioritise the things you absolutely must do and change to continue to succeed. These can be called the Critical Success Factors (CSFs) – they may be a process, they may be something more nebulous, they may not be directly manageable, or they may even be statements of hope or fear. However, their purpose is to achieve buy-in (and critically) they should start with the words “we need” or “we must”.
Ideally, you want to identify 5-8 key things that you absolutely must do, only 8 if you are feeling ambitious and have the necessary resources, capacity and commitment, but perhaps only 3 or 4 if the objective is survival! The number is important, as repeated studies have shown that better performing companies will have their management team focused on fewer issues; the more issues there are, the less shared vision there usually is. Finally, the CSF list is likely to be a mix of both the strategic and tactical; below are four examples:
- We need best in class customer satisfaction levels
- We need more new business opportunities
- We need world class quality
- We need excellent new product development
Finally, you will want to assess your current processes or activities that affect the CSF’s. Some processes will affect multiple CSFs and some of them will be excellently managed while others less so. Work should then focus on those processes that affect most CSF’s and are poorly managed. This is where you get most value.
In order to ensure the long-term sustainability of any company, the leaders and managers must continually assess and proactively react to both the forces they can and cannot change.
PESTEL, Porter Analysis and SWOT are proven tools that enable you to evaluate and forecast the future to be better positioned to manage both risks and opportunities. Ultimately, allows a company to be more resilient and confident in its long-term success.