Since risk is a reality in business, and ‘certainty’ is an extremely expensive proposition, an enterprise’s appetite for risk has always been measured on a sliding scale. Companies with a low appetite for risk prefer steady predictability to meteoric growth. Companies with a high appetite for risk are willing to experiment and even accept the possibility for failure in pursuit of huge returns. The diversity of global companies and industries allows for both appetites; the question for each leadership team is what their current appetite is and how that affects short term decisions vs. long term planning.
There are many factors that go into determining a company’s risk appetite. Even the most straightforward decisions, such as the background of a job candidate or an alternate component design will be made based on the internal culture around risk.
When business conditions change worldwide, such as in response to a large natural disaster or the current pandemic, companies can easily be thrust out of their risk comfort zone in order to stay in operation. Regaining equilibrium in times such as these requires a conscious re-establishment of the appetite for risk, providing an adjusted set of guidelines so that individual decision makers can confidently take action.
The following questions can assess a company’s appetite for risk:
Liquidity / debt levels
- What is the company’s current cash position?
- Do they have access to additional funding if it is needed?
- How much risk has already been absorbed in the form of debt taken on to fund growth or capital investment?
- Are profit margins large or small? Are they consistent across the portfolio, or do some offerings ‘subsidize’ others?
- What raw materials are involved in the supply chain? Do cost inputs tend to have stable pricing or do they fluctuate wildly?
Human capital dependency
- To what extent is the company’s product offering tied to human knowledge and skill?
- Is high turnover a risk to the operation?
- Do staff need to be in a specific location, or can they work virtually – geographically independent from other parts of the company?
Level of competition / Barriers to entry
- How much pressure is there to maintain or increase market share?
- Is the industry startup-friendly? Can new competitors make peripheral or lateral moves in from related industries?
- To what extent do offerings or the product mix change seasonally or through new model releases?
Customer decision making process / Sales overhead
- Can customers subscribe or make a purchase independently or are new customers gained through a high-touch sales process?
- Once customers are won, are they largely independent or do accounts remain high maintenance?
- Is it easy for customers to switch to a competitor or are they likely to stay within the company’s platform or ecosystem?
Time to market / New product introduction
- How much time and treasure have to be invested to bring a new offering to market before resulting in revenue?
- Are there protections to ensure that intellectual property is protected from imitation for long enough to deliver an appropriate ROI?
Level of regulation
- Is there regulatory oversight that limits corporate decision making or inserts delays into business processes?
- Do regulations change by state and/or country or are they effectively consistent in the company’s target market?
It is true that each company has a unique risk appetite. This attitude is pervasive, and it stems from a combination of the executive leadership team’s mindset and the market conditions they compete in. Some will be specific to the company and others are systemic, affecting all companies in the space equally. It is critical to consider the contributing factors individually and directly to ensure that the risk appetite is appropriate under the circumstances, properly balancing the tradeoffs that must be made between risk and reward.
When a change takes place, such as the massive, worldwide implications of the coronavirus pandemic, decision makers should consider which (if any) of the above questions now have new answers. These exceptions will inform revised attitudes about risk and ensure that there is a healthy appetite in place for the future.
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