The Strategist: Hazards Ahead

Bad things can and do happen. But dealing with the smaller risks along the way will help your board prepare for the worst of the what-ifs.

With regime changes, rogue governments, cyclones, fires, recessions, stock market booms/busts, ups and downs in exchange and interest rates, and seesawing commodity prices, terrorism, cyber attacks or loss of sensitive data, power deficits and loss of consumer confidence, there is much volatility in the world.

Businesses will always face volatility and preparing for the worst will help you better deal with smaller risks along the way. It’s part of sensible risk management. But it’s the unknown or difficult-to-predict risks that require “what-if” brainstorming and the development of business contingency plans. The challenge is to narrow down the possible risks across external environments and within your own company.

Stress test

A business is in trouble when it cannot pay its bills because costs outstrip revenue or revenue falls below operating costs. Common causes of revenue decline could include natural disaster; a surge of cheap imports; terrorism; or a sudden change in government regulation. Australian Bureau of Statistics data reveals that one in eight businesses close down each year, with many more opening. However, only 1.4 per cent of companies become insolvent and 0.5 per cent of unincorporated businesses become bankrupt, so we don’t experience widespread financial failure in today’s economy.

Immediate industry environment

On average, six years in each 40 to 45-year cycle are dangerous to the players. This is due to either irrational competition or the advent of a sea change in the characteristics of the industry.

Operating environments

Risks to P&L, cash flow and balance sheet are direct and the most critical of the external what-ifs you need to think about. The marketplace is where the majority of businesses spend most of their effort getting it right, assessing opportunities and threats. This is closely followed by the labour environment, where costs, productivity, low staff turnover, morale and innovation are key issues.

The services environment is much more significant than it was due to explosive growth in the outsourcing of non-core functions and activities. We must be vigilant regarding risks in the quality, reliability and costs of the supplied services. Cyber breaches or loss of sensitive data are an important consideration here.

The finance environment has also become critical, necessitating sophisticated management of financial variables, insolvency risk, management accounting and profit optimisation.

The environment for capital goods, raw materials and other input goods now demands a level of procurement expertise. Bad decisions within this environment can harm goods-producing companies in particular.

Government is not only a cost environment setting taxes and fees, it also creates the business climate via rules and regulations.

External environment

In the world environment, secession trends emerged in some regions due to populist movements, notably in the UK, Spain and Iraq. Most of these become counterproductive because of risks in falling trade volumes and loss of economy-of-scale advantages. There will also be booming, recessive and collapsing economies.

Risks in the resources environment normally impact agricultural, mining and tourism industries, though companies in industries dependent on the aforementioned trio are also threatened, especially in inland cities and shires. Prime risks are weather, commodity prices, exchange rates and offshore demand.

Despite fickleness in spending, society is the least of the short-term what-if risks.

Our economy presents far fewer surprises these days. Yes, there are fast- and slow-growing industries, some going backwards, and our GDP growth has been anaemic for too long. The main concern with the Australian economy is in the longer term. Our lack of reform, sensible policies for the future and leadership at the national level for a decade is a worrying malaise in a region growing at a heady five to six per cent a year — nearly three times Australia’s rate.

Our own business

Arguably the most important what-ifs centre on our own organisations. It is widely accepted these days that risks are split two-thirds internal and one-third to the business’s external environment.

Need-to-know performances to factor in include: the CEO and key reports, strategy, business plans, budgets and cash-flow forecasts, business differentiation (IP) and organisational culture. Our overall ability to achieve world’s best practice profitability, these days set at some four times the long-term average bond rate, is a daunting hurdle for the majority of companies in the economy.