What Are My Chances?
In 2014 Warren Buffett, the billionaire investor, challenged the betting world by announcing his own bracket contest for the Annual March Madness; The NCAA Men’s Basketball tournament. He offered $1 Billion to anyone who correctly picked the winner of each of the tournament’s 63 games. Each year hundreds of thousands of people make their picks in brackets offered a variety of different places—from the office pools to the March Madness junkies, through major newspapers and sports channels. Mr. Buffet’s bracket challenge had an extremely large payoff, but only for perfection. There are winners in the rest of the pools, usually based on a formula of most correct game picks and tournament champions. But how many actually have perfect picks?
Calculating the odds of picking all 63 winners of a seeded tournament is nearly impossible to determine, with estimates ranging anywhere from 1-in-5 billion to 1-in-128 billion. No one who created a bracket during the 2013 tournament on either Yahoo! or CBS, two of the most popular on-line brackets, picked more than 50 games correctly. So Mr. Buffet’s $1 Billion remained safely in his possession. Truthfully, trying to beat these odds in pursuit of perfection is utter nonsense, and a waste of time and resources.
March Madness continues for 2 ½ exciting and emotion filled weeks; loaded with upsets, drama, surprises and joy. In the end, a single championship game determines the colleges’ greatest basketball team. This is an all or nothing tournament—no best two out of three or second chances. You lose you go home. And the further a team progresses in the tournament, the greater the risk they are taking to get to the next level.
Business owners and managers also take risks when running their companies. But these risks should always include odds that are in their favor. Risking capital against overwhelming odds is both nonsensical and seriously irresponsible. But these mistakes, miscalculations and errors in judgment occur in all businesses. Even the most profitable and successful companies in the world will admit that they have made serious mistakes and bad decisions. It’s their ability to recognize their errors and quickly make positive adjustments, which sets them apart from less successful businesses. Knowing how to identify and assess their risks is the first step to managing their business successfully.
Business risk can generally be categorized into five distinct types: Strategic, Compliance, Operational, Financial, and Corporate Reputation Risk. Within each of these risk types, owners need to examine their business and identify specific things that could go awry. They should develop a formula to estimate the likelihood that they will occur and then quantify the impact they would have on their business.
Strategically, where is their business most vulnerable, and where are the hidden risks they may not see every day, such as:
- How dependent is their company on a particular technology that could be superseded?
- What if the cost of their primary raw materials doubled?
- What would happen if a powerful competitor entered the market and started a price war?
- Is there a chance that what they provide could simply become obsolete, and if so, do they have a plan to adapt?
- Can people survive without their product/service?
State, federal, local, and industry agencies all have rules, regulations and laws that must be observed. Business owners need to ask themselves:
- Are we venturing into any new markets that may expose us to new regulatory requirements?
- How sure are we that we’ve been complying with every single rule and regulation that applies to our business?
- What if there’s a rule we’ve unknowingly been breaking, and we have to pay a fine?
- If we hire more employees, does that expose us to any new employment regulations?
- What if the government decided to put new, burdensome restrictions on our core business activity?
- How reliable are our systems and technology? How often do they fail?
- What would happen if we lost power for more than 24 hours?
- Do we have sufficient controls on the flow of money in and out of the company? Are we liable to losses either from abuse/scams or from human error?
- What natural disasters are possible in our location?
- Would the loss of a key employee cause serious problems?
- What if our biggest client went bust and couldn’t pay its latest bill?
- Do we have a high debt load? How much of it is at variable rates?
- What if the interest rate on our loans increased dramatically? Could we still pay?
- Are we doing business internationally, or planning to? How vulnerable are we to changes in exchange rates?
- How much money do our clients owe us, and what would happen if many of them were late paying?
Corporate Reputation Risk
- What would happen if we got a negative review from a very influential magazine or website?
- What if one of our key employees became involved in a scandal?
- Is there a chance of a major lawsuit against us from customers or other businesses?
- Do we have any effective ways of gauging public sentiment? Do we have PR people or other staff who are capable of managing a crisis?
- How would our business be affected by a mass of bad reviews or negative comments on social media?
Once they’ve identified their potential risks, business owners must give each risk a value, in terms of the impact they would have on their business if any one of them actually occurred. Could they continue to thrive?
Each of these risks should then be measured against the probability or likelihood of them actually happening. Owners must make an actual valuation of all potential risks to their business, and identify the most likely to happen, with the highest impact risks on down to the least likely and lowest impact risks.
With accurate information and insight, corporate planning can be determined in a more sensible, honest manner. Then develop a plan for dealing with each risk. Which ones should they focus on? What strategies will they use to address them? Will they try to eliminate them, manage them, accept them, or pass them on to someone else (i.e. buying insurance)?
No one is going to make the right choice every time, but business owners can make a higher degree of correct decisions if they recognize, understand and plan for all of the risks that they are facing.