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When is Risk an Asset for a Small Business? – Part 1
The rules of the game have changed: effective risk management, rather than the commodity-driven “insure and pray” method (you insure your business and pray nothing goes wrong), is the separating line between successful businesses and non-successful ones. Unfortunately, I meet business owners every day who feel that the size of their business is too small, or the scope of their control is too narrow to allow for effective risk management.
Risk management planning is not new. Fortune 500 companies have been employing loss control techniques and risk analysis for decades – work that has lead to many advances in safety legislation and technology. But for many years, “risk management” has been viewed as an expensive proposition for smaller companies. It’s one thing for a large corporation to employ a fully staffed division dedicated to controlling, managing, and analyzing risk, but it’s seen as too much for a smaller organization. Making matters more complicated, most small business owners see the activities of professional risk managers as an “it’ll cost me more” proposition. Granted, there will be a reduced chance of loss, but that becomes a tough argument when the small business hasn’t had any losses to speak of.
First off, risk management DOES NOT cost more. In fact, for most small to mid-sized businesses, risk management will ensure that every dollar spent on loss control – everything from insurance to fire extinguishers – is well spent, an activity that actually reduces the up-front costs. CAN risk management cost more up front though? Yes. Risk managers are trained to examine what is called tolerable uncertainty, that is, how much risk is the client comfortable with NOT addressing? It’s an important concept, and one that without risk management, is answered by default (often with costly repercussions).
The best way to describe tolerable uncertainty is with an insurance example. Say you own a camp or cottage; now, it’s a nice camp, not just a shack in the woods somewhere. It’s got heat, electricity, running water; you’ve maintained and slowly upgraded this camp for years. In fact, it isn’t even the same camp you originally insured over 10 years ago, as reflected by your insurance policy which values the camp at $30,000. Unfortunately, with all the changes you’ve made, not to mention the increases in costs from the construction industry, rebuilding that camp today would cost closer to $150,000.
Without knowing, you are insuring that $150,000 property for only $30,000. There is no law that says you HAVE to properly insure the property – you’d just be on the hook for $120,000. The position of a risk manager isn’t then to say “you should or should not” insure it for the full amount, but have an informed discussion on the COST to properly insure it (or some measure of it) compared to the risk of doing nothing. It is then an informed choice – you COULD be paying more to control the risk (if you increased the coverage on the camp), or you could not.
This is just one example – and unfortunately a common one – but risk management isn’t just about what you are insuring and what you are not. It looks at any known loss exposures to you and analyzes the costs associated with the various techniques (anything from safety training to fire extinguishers) and compares them to the possibility, frequency and scope of a future loss. In this way, a risk manager allows a business owner to make informed and effective decisions regarding the money they spend on controlling risk, by providing:
- A written plan that identifies the various areas that may lead to a loss, and a cost analysis on the ways to control, reduce or mitigate them; and
- A means of regularly measuring the effectiveness of the risk management plan (which could be annually).
Risk management isn’t just about being frugal with bottom line costs; it balances cost with the growing legal, social and environmental demands on a business. It is in this balance that risk management is more than a means of reducing costs, it is also a means of elevating the money paid to control risk from being an expense to being an asset.
Let me put it this way, a typical company’s profit can be expressed as:
(Income) – (Operating Costs) – (Cost of Risk) = Profit
Where:
- Income is the total amount of money taken in by a business
- Operating Costs are the costs associated with wholesale goods, services (staff wages, etc.), taxes, etc.
- Cost of Risk is the cost of everything paid by a business to cover things like insurance, security, safety and the like
Conventional business wisdom seeks to do two things: increase Income while decreasing Operating Costs and the Cost of Risk. In the most simple of terms, the business owner would increase income by increasing marketing efforts, and lower operating costs as much as possible by negotiating better terms when possible, while also reducing the cost of risk by shopping for the lowest insurance premiums and providing only the most basic and legally required security systems, safety systems, etc.
The problem with this, or rather, the problem of looking at these three areas as separate and distinct, is that they are not. Would you want to work for a company that paid the lowest wages, and did only the bare minimum of what was legally required for the safety and security of their employees and clientele? If you did, would you feel motivated to perform at your best? Would you want to deal with a company who did the bare minimum of what was required? In all three questions, the answer is inevitably “of course not.”
A company that has a more effective and efficient means of dealing with risk has an edge over a company who is just trying to lower their Operating Costs and Cost of Risk. They have a Plan that balances cost with tolerable uncertainty, and they build a working culture of safety, security and high performance. This plan lessens the chance and cost of losses to the company, while at the same time serves to motivate and empower the employees, while giving the consumer another reason to trust and patronize the business. A company with a risk management plan is able to change risk from an expense to an asset, which helps them to grow and sustain their business’ reputation, performance and profitability.
The question you must ask yourself, is can you afford NOT to employ effective risk management techniques? Not unless you want to hand the competitive edge to a competitor who is employing them. But once you have made that decision, how do you build it?
Stay tuned for part two on Monday – 7 Ways a Small to Mid-sized Business Can Implement True Risk Management Techniques.
