Figure 1. [Source: The Chemistry of Strategy: Strategic Planning for the Not-Yet Fortune 500, ©John W. Myrna, published in 2014 by Global Professional Publishing Ltd.]
Photo credit: ©John W. Myrna, published in 2014 by Global Professional Publishing Ltd.
Managing risk is a major element of the “chemistry of strategy”—and of successful supply chain management. You must understand strategic risks: what they are, how to identify them, and how to assess and manage them from a strategic perspective. Financial risk is embedded in all these risks since the impact of all risks is ultimately financial. In additional to managing risk within your company, you need to assess how well your customers and vendors are managing risk. A major supplier or customer who poorly manages risk puts your company at risk.
Let’s look more closely at each of these.
Managing risk requires you to balance competing demands on resources. Operational needs are immediate and can easily drive an unhealthy balance, with the most obvious risk to revenue coming from an unmanageable concentration (customers, suppliers, product or market). For example, Acme Manufacturing (company stories are true, but names were changed) learned that a major customer just filed for bankruptcy. The chief executive officer (CEO) told the senior executive team, “We have to cover the loss of Groot’s business, and write off more than two months of receivables.”
Acme’s director of operations added, “We also have a sizable inventory of custom parts and raw materials that we have to eat. Groot was 20 percent of our business!”
“But five years ago, it was more than 80 percent,” said the CEO. “Thankfully, we recognized the risk of that concentration and forced ourselves to diversify our customer base just in case.”
Acme’s early decision to accept the short-term risk and focus resources on building its business around Groot was rational, and the best way to achieve critical mass. However, Groot became such a part of the status quo that, for a long time, no one thought about the growing risk of depending so much on one customer.
At a strategic planning meeting seven years earlier, Acme’s executive team identified the loss of Groot’s business as the company’s biggest potential threat. At the time, Acme’s CEO discounted the threat, citing Acme’s regular contact with Groot, excellent quality and perfect on-time delivery.
In my role as a facilitator during that strategic planning meeting, I asked, “What if Groot gets acquired by a company with its own manufacturing supply chain? What if it goes bankrupt? There are more ways to lose a customer than poor performance on Acme’s part.”
The Acme executive team established a risk component in its strategy to keep the largest concentration of business under 25 percent since it felt that any sudden loss of revenue above that percentage would likely be unrecoverable.
Acme implemented that strategy several ways: It became more watchful about maintaining accounts receivables, and more conservative about purchasing equipment and hiring full-time employees to meet growing demand from Groot. Outsourcing work at peak periods reduced margins, but didn’t leave Acme with potentially unusable capacity should something happen to Groot. The company made sure it never took Groot’s business for granted and assigned dedicated staff members who were personally accountable for keeping Groot happy.
Acme gradually shifted priorities and resources to building up a new revenue base. Since Groot was the major player in its niche market, this required identifying an expansion market. Acme established an initial customer base in a new market with attractive potential.
Acme made sure that everyone in the company understood the importance of fully supporting even small, trial orders from customers in the new market. Without constant reinforcement of why these small “unprofitable” orders were important, well-meaning employees could have sabotaged the new strategy with late deliveries and bad quality.
Unpredictable, High-Impact Events
Superior Tubing’s Arkansas plant was destroyed by a tornado. Fortunately, the employees were able to get to safety before the tornado hit. A year and a half later, the Arkansas plant not only returned to full production, but the company’s two other plants also set new production records. The marketplace recognized how well Superior Tubing managed the catastrophe.
What was its secret to recovery? Having identified the tornado risk years earlier, the company incorporated a disaster recovery program as part of its strategy. Superior Tubing standardized computer systems across all three plants, making it easy to transfer the working files from the destroyed plant’s backup tapes. Furthermore, it put plants in multiple locations to reduce the risk of losing one. It maintained sufficient financial reserves to tide it over. Because its employees were already cross-trained to operate a variety of different presses, it was able to quickly redeploy staff, including temporarily relocating Arkansas workers, to expand shifts at the other two undamaged plants.
Superior Tubing’s planning team felt it was strategically important to integrate recovery into how the company ran rather than create a plan to recover post-disaster. It regularly manufactured Plant One parts in Plant Two to handle overflow demand. When doing maintenance on Plant Two’s computer system, the team ran Plant Two’s manufacturing resource planning (MRP) software remotely on Plant Three’s computers. It didn’t wait for an actual disaster to verify that a disaster recovery plan worked. It made its company more robust through an integrated disaster recovery program.
Superior Competitive Solutions
Best Systems knew it would just be a matter of time before its market evaporated. It manufactured and supplied products based on a computer interface first introduced in military systems more than 50 years ago. Its business grew based on products that enable military users of legacy systems to build replacement applications that communicate with ships and planes still using this ancient interface. In the short term, Best Systems’ customers are happy to see it continue to develop new and improved versions of its products. However, the military was executing a strategy to phase out this interface, albeit over decades.
Best Systems follows a dual product/market strategy. For its legacy market, the basis of its business today, the company:
- Didn’t waste resources trying to sell products that would require its customer to adopt an old technology.
- Focused product development investments on opportunities with an 18-month return on investment (ROI) and/or features that enable legacy customers to defer their transition to new technology.
- Made every effort to identify and sell 100 percent of legacy technology users.
- Made every effort to motivate competitors to drop out of the market.
Best Systems’ five-year strategy spotlighted the need to identify, develop and grow a new business to more than 20 percent of total revenue. Given the product lifecycle, new market or product sales don’t reach their potential overnight because it takes time to build a customer base and volume. It may take a product more than four years to reach 25 percent of its annual potential. If managing risk depends on sales from a new market/product to replace an expected decline, you must start building that new business years ahead of time (See Figure 1).
For Best Systems, the smart strategy was to identify and enter the growth stage of the new business before its core business entered its decline stage. It maintained an open mind about how to obtain that new business, whether by growing it organically or through acquiring a business.
Insufficient Development Investments
Fun Foods’ business was built on supplying a single product to movie theaters. It sold replacements when its product wore out and made sales to newly built theaters. Revenue plummeted when hard times hit since no new theaters were being built and existing theaters deferred replacing old products. Over the years, the company discussed developing additional products for its theater customers, as well as searching for new markets for its product. Yet, when sales plummeted, the company didn’t have any new products or markets to fall back on. In retrospect, it is easy to see that Fun Foods never really invested sufficiently in developing them.
Fun Foods was saved by its aggressive acquisition strategy. After a protracted, painful period of downsizing, it acquired a new business that enabled it to survive the decline of its core market. A company’s strategy is a mix of exploration and exploitation. Once exploration identifies major opportunities, successful strategies shift to the exploitation stage. At least once a year, review your company strategy and verify the balance between exploration and exploitation.
Insufficient Volume and Focus
SWT Services provided three services: staffing, web design and technical writing. None of its customers purchased more than one service. In effect, SWT Services was three tiny companies under one corporate name. SWT was once the only firm specializing in placing technical writers. Formerly a leader in that niche, SWT now consistently lost opportunities to a local firm that only provided staffing services. By now, its competitor had more assignments in a month than SWT had in a year. Given its low volume, SWT Services started losing money on the staffing service. A small company can’t afford to split its focus. It’s challenging enough to generate a competitive volume within a single niche, never mind three.
Every year, your company, your competition and your industry can get smarter through an additional 12 months of experience. So, your company strategy must include a roadmap of how to become more competitive. Each time you move along the experience curve, expect to figure out how to spend less to sell and deliver your product. The first time you do anything is the most expensive (in terms of time, effort, money or revision). The more times you do something, the fewer resources it requires, allowing you to produce more results for the same amount of resource. This forms a virtuous cycle—the more widgets you produce, the cheaper it is to produce the next widget. The cheaper the next widget, the more competitive you become, assuming that your company follows a strategy of continuous improvement.
Leaders partner with quality suppliers and service quality customers they judge can support them in the future. The acumen to effectively manage risk is a key element in selecting the best suppliers and customers on which to bet their company’s future. In return, the best suppliers and customers only bet their future on you if they believe you are effectively managing your risks.
John W. Myrna is the author of The Chemistry of Strategy: Strategic Planning for the Not-Yet-Fortune 500 (Global Professional Publishers, 2014), available at Amazon.com. He is a management consultant and cofounder of Myrna Associates Inc., a company that helps organizations thrive by designing new strategic plans, formulating actionable tactics and evaluating workforce performance against those plans. His team helps clients turn their vision into reality by using proprietary methodologies as part of intense, two-day off-site sessions. Contact Myrna via email at firstname.lastname@example.org or visit www.myrna.com.