Topics:
- 91% of growing firms say their
operating risks are growing – but only 9% have integrated operational risk management. - What is operating risk?
- Bermuda triangle of growth.
- Growth is chunky and noisy.
- Regulators take notice.
- Delegation is forced rather than planned.
- Business processes become ‘black boxes.’
- Fire fighting in routine operations.
69% of the 700 business owners and senior managers reported in the Journal of Accountancy that their companies manage risk as individual threats and hazards rather than using an integrated approach to reduce overall business risks[1]. 67% described their firm’s risk management efforts as “very immature or minimally mature…and not based on a holistic approach.” Most of these companies focus on the risks of financial and hazard losses but ignore major operational risks from their routine operations that hurt profits and other performance.
But what is operating risk? How does it show up in growing companies? The theoretical definition of operational risk is “the risk of loss from inadequate or failed internal processes, people and systems or from external events.”[2] In the day-to-day operations of a growing company it shows up in failures of what should be routine business activities. Failures that hurt performance and market reputation, lose customers, drive up costs and drive down profits. The specific risks vary depending on the type of business but here are some examples:
- Mistakes in collecting or communicating about vital customer information for sales orders.
- Defects in delivered products.
- Schedules for delivering field services efficiently that don’t work well in practice.
- More “fire-fighting” in routine activities and operations just to keep promises to customers.
- Employee turnover rising – especially for experienced employees.
- Inventory shortages of some products and over supply of other items.
- Increasing expediting and special handling of orders to meet deadlines.
- Repeat orders or renewals from current customers decreasing.
Only 9% of the 700 reported that they actively follow an integrated risk management approach that includes operational risk[3]. These firms also recognized that their business risks are growing: 91% believed that both the volume and complexity of business risks that they face have increased significantly in the past five years. 69% reported that they had experienced either a “moderate or extensive
operational surprise” in the same time period.
But at least there is some good news: About 80% of operating risk exists within the routine operations and activities of the business. This means you have more control because most operating risk is baked in to your policies, procedures, performance measures and incentives. But even though it’s baked in, here’s the good news: we can change the recipe.
Bermuda triangle of growth.
Figure 1 shows the inter-connected demands of rapid growth can quickly force you into a business version of the Bermuda Triangle of Growth. If you think about it, doing any two of these things (like quality and speed) are reasonable if you can ignore the third component of profits (or raise prices to cover the extra costs). Likewise doing things with high speed and profits are no big deal if we don’t care about also delivering excellent quality. The problem is that you respond to all three or more demands at once.
Suppose a customer wants product delivered in two weeks instead of the usual two month lead time. If you take the order your primary options are to work faster and longer, hire more people, buy new equipment or outsource your production and services somehow – and to do it fast. The external demands of growing sales force internal reactions and inter actions in your business. And we don’t know if the solutions are even workable. We do know that each solution will have effects elsewhere in your operations.
Figure 1: The Bermuda Triangle of Growth
If expediting customer orders means working harder, faster and longer with new employees using the same old methods from start-up days then the quality of what you provide – both products and services – almost always suffers. New people mean inexperience and slower task completion while speed means rushing and longer hours that create stress and fatigue…and mistakes. Meanwhile we know that paying overtime, hiring and training people, buying equipment or expanding facilities drives up costs that burn cash and lower your profits – not to mention the costs of fixing mistakes. Outsourcing manufacturing and services may be a good solution but it takes significant time to find the right vendor (if such a vendor even exists).
But it gets worse. Customers often want products and services delivered their way rather than your way. They just call it being ‘responsive’ as a business. Customers want responsiveness but they want it delivered with the same speed, high quality and low cost of mass produced products and services. Business writers describe this demand for flexibility as the age of mass customization. For growing companies it’s a train wreck waiting to happen – unless you change your ways.
Sales growth and resources are chunky: Annual sales projections may show a smooth, upward curve implying steady growth but the reality is usually very different. Sales orders tend to come in large chunks – especially if your sales are concentrated in certain seasons or times of the year. And your capacity and resources to handle growing sales also come in chunks – you don’t get to buy half a machine or hire half a qualified employee as examples – especially for a few months at a time. Even if you can find qualified part-time people, you know that hiring part-time employees often means continuing turnover…and too many hours spent hiring and training replacements as the good ones leave for better jobs.
Unpredictable, chunky growth creates mismatches and risks. It’s tough to quickly adjust to the ups and downs of work flows if the timing and size of chunky sales growth is uncertain and unpredictable - especially when resources to handle growth come in expensive chunks. The problem of coping with chunky sales growth is especially hard on small companies. What seems like a small order for a large company can be a huge order for your small company with major impacts for you. And sales orders are placed and delivery expected at the customer’s convenience – not yours. The old adage, “when it rains it pours” is never truer than for growing companies.
Risky choices: One choice is to handle the deluge of success through lots of overtime and extra demands on employees, facilities and tooling. But when vital resources are stretched for more than a few weeks, mistakes and breakdowns grow too. People get tired and frustrated while processes like scheduling, quality assurance and post-sale support breakdown from overwork. Employee turnover rises and valuable employees with expertise and commitment are lost. It’s difficult to replace people quickly. Meanwhile the band-aid solutions that are used to get the order out the door just make things worse.
Another choice is to spend the cash to purchase the extra resources upfront (like people and tooling) to give you more capacity even though it’s not fully justified by your sales as yet. This
means driving up expenses, driving down profits and burning through limited cash. Meanwhile your long-term sales projections that justify those expenses remain uncertain. So many variables mean lots of moving parts -that all move in uncertain, risky directions.
More players and interactions create noise: Examples include new and many more employees. Some assume that if we just hire people carefully we can be sure of getting the right people and that the new hires will fit in well with other staff. Being careful in hiring is very important and will reduce the uncertainty. But it will not eliminate it. Anyone who has managed people knows that some potential stars flame out because they just don’t fit the organization – not because they are incompetent or difficult people. Similarly some perceived low-potential people will rise to the occasion in the right environment.
Many more customers create uncertainty because we can’t control what they will demand and when they’ll make decisions that affect your company. Often this happens because customers can’t fully control their own business situations any more than you can control your own situation.
On the radar: Regulators take notice. As you grow your company will likely come to the attention of some new visitors. Examples are 
regulators like insurance and OSHA inspectors who will show up – possibly unannounced – to make sure you are following a byzantine collection of safety regulations. Safety and compliance with all sorts of regulations like environmental waste handling and labor laws may also become potential risks. Retrofitting your business operations and facility to fit so many new regulations and requirements – at least new to you – can be a tremendous time sink and source of risk.
When all this happens at your company the challenge is that it becomes much more difficult to pick out the critical blips from among all the other radar blips – all the noise. The results? Operational risks develop from failing to recognize and respond to critical demands and business needs.
Delegation: Growth also requires the new management skill of turning over business activities to others. It means striking a balance between the ‘throw it over the wall’ approach (and hoping you don’t hear about it again) versus micro-managing. Striking a balance is always tougher than taking one extreme or another. Plus you often don’t know if you got it right until after it’s over for better or worse. Given everything else that’s going on there are two certainties about delegating: First it is absolutely necessary for growth. Second, it creates significant risks.
Business functions become ‘black boxes:’ Growing firms cannot help but develop more specialized internal business functions like customer service, purchasing or accounts receivables and payables. Specialization is necessary both for the sake of efficiency and from the need for more sophisticated techniques and technologies. These improvements create risk because increasing specialization and sophistication of internal functions create conflicting priorities and demands. For example tensions develop between customer service’s need for flexibility and immediate responses to handle customer demands for products while purchasing thrives on longer purchasing cycles, quality assurance procedures and detailed contracts.
The problem for the entrepreneur leader is that the more specialized and sophisticated internal business functions become, the less we know about the details of what goes on inside those ‘black boxes.’ It’s harder to make decisions that fit the black-box processes or to change those black-box processes when situations demand it. How any times have you been frustrated when your IT person or bookkeeper tells you what you can’t do – for reasons that cannot be easily understood?
“Us vs. them” attitudes develop: When people don’t work together as closely then it’s easy to lose the work relationships. People lose communication and understanding of the important details of operations in other functions. The less we understand about what each other does, what others need from us – and why, the easier it is to ignore legitimate needs of other functions. Less understanding means it’s much easier to point the blame when things don’t go well instead of working together to find solutions.
Fire fighting vs. success: Some entrepreneurs thrive on fire fighting. Whenever something goes wrong it’s the owner to the rescue. It’s exhilarating and there’s lots of glory with every ‘success.’ No one is as good at handling the crisis as the entrepreneur – at least inside their company. It’s great being a hero too. Plus with the need for constant fire fighting the entrepreneur will always be indispensible to the business. But putting out fires is not the same as building something special. And it drives up costs, mistakes and stress while driving others away – especially key staff and customers.
So sales are chunky, resources are stretched thin and old ways of doing business from start up no longer work. Meanwhile day-to-day demands and interactions for the business and the entrepreneur leader are uncertain and unpredictable. No wonder that so many entrepreneurs report that the success they hoped for became the most difficult and risky time for their growing companies[3]. No wonder so many leaders of rapid growing companies wonder why they wanted to grow rapidly in the first place. What were they thinking…..!
There is no list of say, five challenges that afflict all growing firms. If that were true the solutions would be much easier. Instead there is a much longer list of potential challenges that could challenge a growing company. While we don’t know which ones will threaten, we can guarantee that some will. It is this uncertainty that creates risk combined with the potential damage in growing entrepreneurial firms. In the following sections we’ll find reason for optimism about coping with the risks of rapid growth. We’ll start by understanding what risk really is. Then we’ll look at some solutions to the challenges.
[1] “ERM: Opportunities for Improvement, Take your risk management system to the next level.” (September 2009) Beasley, Mark S., Branson, Bruce C. and Hancock, Bonnie V., Journal of Accountancy
[2] Basel Commission on International Banking, 2004.
[3] “ERM: Opportunities for Improvement, Take your risk management system to the next level.” (September 2009) Beasley, Mark S., Branson, Bruce C. and Hancock, Bonnie V., Journal of Accountancy
[4] “Managing for Responsiveness: Process Management and Market Orientation in Small, Growing Firms.” Bret Golann. Journal of Small Business Management, Summer, 2006.