Shownotes
When we say higher valuation, many business owners focus more on profits than actually looking into the threats to earning those profits. Sean Hutchinson and Alistair Stewart of SVA Value Accelerators talk about the importance of risk reduction. Together, they lay down the five categories of risks out there for business owners to consider: strategic, compliance, operational, financial, and reputational risk. They present situations and solutions that could help you picture out how to overcome them. They also talk about whether owners are aware of these risks while discussing a de-risked company versus a risky company and the value gap between them.
—
Rapid Risk Reduction Methodology Detailed: Creating The Path To Higher Valuation with CEO/Partner Sean Hutchinson SVA Value Accelerators and Alistair Stewart
Creating The Path To Higher Valuation with CEO/Partner Sean Hutchinson
Risks are the consequences of an action, an event that is reasonably likely to undermine or threaten goals or objectives that have been determined. There are things you can do or stop doing to increase enterprise value that are counter-intuitive and will increase the value of your business.
We’re doing a deep dive continuation with Sean Hutchinson, CEO, and Partner with SVA Value Accelerators and Alistair Stewart. He’s the Manufacturing Practice Leader from SVA Value Accelerators. We’re going to dig deeper and we’re going to talk about rapid risk reduction. Alistair, let us know.
Risks are out there in a variety of categories and most business owners and people working in the business become a little desensitized to them. You can think of risks as being in a broad spectrum of categories. Strategic risk, compliance risk, operational risk, financial risk, and reputational risk. Those are five broad categories. We can also consider that risks exist within a business and risks exist outside of a business. If we look at how businesses are valued. If we look at the worth of a business, it’s pretty obvious to financial investors and pretty opaque to owners and employees that reducing risk represents a tremendous opportunity to increase the value of a business, particularly the transferable value of a business.
We can look at say strategic risk. Strategic risk is something that threatens the outcomes that a business has chosen to pursue. There’s a little bit of an eye-opener there. Are we choosing our outcomes? Do we understand the threats that compromise our ability to realize those outcomes? What might those risks, those threats be? We can go down the list of compliance if that matters to the industry that you’re in, operational, financial and reputational. A fairly straightforward discussion on those topics will reveal a tremendous amount of business value, of enterprise value, that’s threatened by inattention to these existential matters.
In these three categories of how to increase the value of the business, increasing earnings, reducing risk and increasing marketability, those broad categories, a lot of business owners and their teams are going to focus on increasing earnings as an instinctual way to increase the value of a business. That’s understandable. That’s where a lot of resources go. When we see that big category of things that you have to do to reduce risk or should do, could do or will do, less attention is typically paid to those things. They can have a dramatic effect immediately on the economic enterprise value, transferable enterprise value, and we can add value. What people need to realize, what owners might tune in on here, is that we can add value to our business pretty dramatically without adding $1 of revenue or $1 of profit. Those things in the beginning of the value acceleration process have less effect on value. In fact, they may counter-intuitively lessen the value of a business depending on how the dollars are earned. This is about the quality of the revenue and the quality of profit.
It’s not uncommon that an existential threat to a small business is undue or overreliance on owner or owners. It could mean, for example, that the owner of the business has critical customer relationships from which the majority of revenue or profits are derived. It could also mean that the owner of the business maintains the most critical supplier relationships. Both of these are areas for risk. Let’s look at customers. For example, you could have a key customer relationship is owned exclusively by the owner. It generates some profits. Perhaps not the best profits, perhaps by inattention acceptable profits and it’s all about the owner’s relationship with that customer. We think about transferable enterprise value, we think about risk in that relationship. If that owner transfers the relationship to the organization, transfers it from the individual to the organization, we now have a whole bunch of people who are capable of managing that customer relationship.
I have a real-world example. I’m working with a client now to de-risk. They had 40% of their business with one critical customer, who is price sensitive. There was a belief that the benefits of volume outweighed the sins of price concessions. The customer came back and said, “We like you so much. We’d like to give you more business.” The owner invested a non-trivial amount of time, personal energy and resources into winning price-conceded extra volume where we have 60% of the revenue and 52% of the profit coming from one customer. The entire relationship is exclusively owned by the business owner. That’s a tremendous risk to enterprise value.
There is often a tendency for relationships to forgive performance. We’d like to see performance measured in terms of delivery, quality, and cost. An objective team is going to look at that. Perhaps an owner who feels a personal connection to the supplier may not be focused on those kinds of metrics and will forgive performance sins. We move on not understanding that the inattention to those matters continues to increase the risks to enterprise value. Both of those factors from the supplier end and on the customer end are related to undue reliance on the owner. They have nothing to do with the organization’s focus on driving growth or if we’re going to market, putting together a book to tell the story about the company.
Alistair, do you think that the owners are aware of these risks?
They are unaware because it’s business as usual. I think of this as driving at 32 miles an hour in a 25-mile-an-hour speed zone. They’ve become accustomed to it and it’s habitual. Unless and until we have a conversation about transferable value do they become sensitized to the risky behaviors that they’ve habituated over probably decades. The one that is most interesting of the five risk categories is this idea of strategic risk. Strategy in business is a plan to capture, create and sustain value. Without that plan which many small business owners don’t have and the few that have a strategy often fail to execute the strategy. When you think of strategy in terms of their risks, which threaten those outcomes, we’re now starting to have a meaningful conversation. How will we understand that risk?
There are two elements to any risk that an owner needs to understand deeply. What is the potential impact to value and what is the likelihood of that impact to occur? When we start the conversation about the impact and the likelihood, we’re starting to think differently about enterprise value and what threatens enterprise value, particularly the transferability. It’s not unless and until we understand that enterprise value is significantly threatened that we have these meaningful conversations. If we’re not thinking about enterprise value, if we’re thinking about the business as just an ATM to the owner or an enabler of lifestyle or business as usual, then we’re probably not moving in the right direction. We move in the direction of our conversations. A conversation about risk is a very valuable conversation for business owners and their management teams to have and to continue to have.
There are four things that I would emphasize. One, there’s this concept of whale hunting in the sales and business development process. You talk about going out and getting the big customer that’s going to be the game changer. The instruction to that team is to find the customer that’s going to immediately double our revenues. There are a couple of things that are likely to happen in that process. One, the customer concentration problem. Maybe we’re already doing business with that customer and they wanted to expand it. They went from a comfortable 10% of revenues with one customer to 45% or 50% of revenues from one customer. The sales teams are excited because they did exactly what they were asked to do. They went out and they found a big customer. They expanded an important strategic relationship, but they created customer concentration. The chances are good that the transferable value of the company fell. In some cases, the company became non-transferable as a result of that.
Risk Reduction: If we’re thinking about the business as just an ATM to the owner, then we’re probably not moving in the right direction.
The owner reliance issue, the owner may own that relationship. They may have been involved in the whale hunting. They may have been a key and they will continue to be key. The customer is doing business with the business but also business with the owner. If that’s the case and the relationship is not distributed in the organization, again, the value has fallen. They get a double whammy there. The third thing that’s happening in that relationship is smaller businesses typically do not have what Michael Porter would call pricing power in the marketplace. They’re doing business with a bigger company. They’re not going to drive the price. In order to get that bigger deal, they may have to discount. Discounting is a very dangerous execution in terms of risk management.
The sales team goes out and says, “If we knocked 10% off that deal or 15% off that deal, we can get it.” The top line is going to increase. The gross margins are going to go down. The net margin is going to go down. We want the owner to flip and look at their business through the eyes of an investor. That deal became much less attractive. We might have a better top line, but we got the worse bottom line. We might have better topline, but we’ve got all these risks. Any investor is going to say, “I like the financial profile of the business or some things about it, but what’s going to get in the way of me realizing that potential?” The risks are what they’re going to pay attention to. The fourth thing that I would point to is not every risk is an important enough to focus on.Think about impact and likelihood. You can score both of them and get a sense of the total risk
We can evaluate the likelihood and the severity perhaps on a five-point scale then we do some math. When you multiply them together, it’sup to the owner, advisory team, their management team to decide what calculation represents something that merits management. There will always be risks that we can’t manage. When we do that math we can say, “These are the risks, the likelihood and the impact of which exceeded an acceptable threshold. We’re going to start to manage that risk.” That means identifying how we control that risk, how we monitor that risk.As an example, customer concentration. You can go into your CRM system and you could evaluate customers by profit dollars and look at who is the primary owner of the relationship with those accounts, with those clients, for example.
Once we establish a monitoring method for the risk, then we get it into saying, “Who is going to monitor the risk?” We’ve got a monitoring method. It’s who in our CRM system is making all the updates on the relationship, conversations, interactions, contracts, proposals, business, and fulfillment. We can monitor that, but who is going to do that? Who on a monthly basis is going to provide a client relationship report of interactions by a person within the organization, within the management team? We can establish a limit. We could say, “We don’t want any more than 30% of our A customers managed by the owner.” Right now we’re at 87%. That is a 57% opportunity to reduce undue reliance of the owner of key customer revenue and profit contribution. We can set a limit. In that case, I set a number of discussions with the advisory team, the management team and then what do we do? What actions do we put in place when we have an out of control condition? That could be in the next 60 days no “A customer” interaction will occur without the introduction of one or two others from the company’s team. It could be the straight sales leader on the supply side.
It could be the purchasing manager. It could be the person responsible for a value stream if the company sufficiently matured on its operational excellence journey to understand value streams. We also need to identify what actions are needed and what timeframe we’ll have to put those actions in place. It is a fairly straightforward process of understanding the impact, the probability, and the acceptable or unacceptable risk levels. What existing controls we have in place. How e will we monitor existential threats to enterprise value that the math of impact and probability represent? Who is going to be responsible at a monitoring level, because now we’re monitoring metrics? What’s our limit? What’s our action plan for out of control risks that exceed the limit? This is not intellectually challenging. It requires a constant conversation about risks to value and a focus on de-risking the organization.
Sean, you’ve got anything to add?
The accountability for managing risk, the dynamic nature of risk, is not static. It can be not risky one quarter and then upon reassessment in quarter number two, it could be a completely different story. Sometimes, external risks are out of your control, but you still need to be aware of them. Internal, more in your control, but still need to be aware and vigilant. That vigilance and that bias for action around risk management are important. It’s not about creating a scorecard, that’s a fantastic part of the process. Let’s identify and track it. Not all risks matter as much. Manage the metrics that matter the most. That’s what we refer to sometimes as big rocks versus little rocks.
You want to be putting your resources as a company towards big, impactful, likely risks which we would call the big rocks or existential risk. The things that if they were to emerge or remain present in the organization over a longer period of time could put it out of business. That’s the existential piece of this. Those are big rocks. The management team and the strategy and the execution of the company have to be aware of that and attack it with the right resources at the right time. If you spend all of your time pummeling away with your hammer at the tiny rocks, you can bash these things into fine gravel all day long.
Risks are the consequences of an action or an event that is reasonably likely to undermine or threaten goals that have been determined.
But if the big rocks are still there then your value drivers, the things that are driving value in your company, are facing such headwinds that you can’t get the boulder up the mountain. If you do get the boulder up the mountain like Sisyphus, it might roll back down. Now you’re in that spiral we were managing, but we didn’t act effectively enough to get the big impact risks out of the organization and keep them out of the organization. That’s the first part of the value maturity cycle.. You identify value drivers, and then you defend value by de-risking. Once you have minimized those things, you’ve got to set up a boundary that keeps them out. That’s what’s difficult. That vigilance is that boundary. It’s a way of monitoring and keeping that risk out of the organization.
I wanted to make sure that I didn’t forget to say for the folks that are going like, “That sounds like my company. I need to talk to these guys.” What are the ways to reach out to you guys via social media?
LinkedIn is a great way to get to us. We’re active on LinkedIn. I have a page, Sean P Hutchinson is my LinkedIn identity. Alistair Stewart has a LinkedIn page as well. The company page is SVA Value Accelerators. You can reach out to us in any of that channel. Certainly, our website BuildValueToday.com is a good way to reach us.
I’m the business owner reading and going like, “That sounds like me. I want to go down the road of starting this process.” What should I expect when you guys walk through the door or engage? What are the first things that occur?
Risk Reduction: Not all risks matter as much. Manage the metrics that matter the most.
What we call discovery. We’re going to sit down with all of our clients in the beginning and try to get a baseline on the company. We’re going to get a baseline on probably eight to ten different dimensions in the company that range from their ability to develop good strategy, execute good strategy, and identify and enhance operational value drivers and mitigate and defend against value killers. We’re going to rank those things. The most valuable part of the conversation with owners and management teams is the conversation itself. We can capture data and we can put red, yellow and green on it all day long. In the conversations, we capture what we call enriched data. Enriched data is where the real story is. Being able to interview clients’ face-to-face, interview other stakeholders in the organization gives us a good picture of what’s going on. We’re going to talk about what do we do in order to address all those things that are underperforming in an organization, things that are not creating transferable enterprise value. Right up front, we’ll start addressing risk. Rapid risk reduction is one of our early value acceleration sprints. What we’re going to do in discovery is to identify value in the organization, identify things that are killing and driving value opportunities. We’re going to look at it holistically. Think of defense as an immune system in the company so it can
