Steve Davies Online

Use the following Risk Analysis Profile to institute a review of all the areas where a downturn could impact your business, pinpoint issues and examine vulnerabilities that exist as a result of general economic factors or forces only affecting your industry.  

Financial 

Start by taking your P&L report and reformatting it to reflect the hierarchy of costs. This hierarchy has four levels of expenses as follows:  

• Variable expenses: Expenses which change depending on your level of revenues. These include such things as the direct cost of goods, freight, sub-contracted labor and sales commissions.
• Semi-fixed expenses: Expenses which are fixed but which can be eliminated in four months or less if necessary. For example, salaries can be cut but severance costs can mean that it takes time before the cost can be eliminated.   
• Fixed expenses: Expenses that take longer than five months to eliminate. Look at real estate and utility costs as getting out of a lease or finding a sub-tenant does not happen quickly.
• Debt servicing expenses: Expenses that relate to the service of debt  are the most difficult of all to change and the most dangerous because they are subject to variable outside forces. Any increase in borrowing costs comes directly off your bottom line, so if you have debt, calculate what the additional cost would be for each 1% rise in the prime rate. If the answer scares you, think about ways you can lower the amount you are borrowing – either by reducing current assets (receivables/inventory) increasing payables or cutting costs to increase profitability and liquidity.         

Having identified where each expense fits in the above hierarchy, recast the P&L report and calculate each category as a percentage of total revenues. Then take a step back and think about the implications of those results. Take a long, hard look at each expense and ask yourself “why is this here and how can I change it?” Take the easy ones first where competition is driving down prices (phones, freight, credit card etc) and reduce or cut whatever you can. Then set a goal to eliminate 10% of fixed and semi fixed expenses, by either cutting them or moving them up one category.   

For Example: The first place to make cuts is usually people. Having gone through that exercise you can also move costs from semi-fixed to variable by outsourcing specific functions such as bookkeeping, telemarketing, virtual administration. 

Customers and Suppliers  

A downturn will affect you if it affects your customers or suppliers. Think about their business from their points of view. What are the threats in to their industries? What are the economic and demographic factors that could adversely affect their revenue streams and their ability to continue to do business with you?     

• Is there a geographic concentration? Would a significant part of your customer or supplier base be affected by a regional recession or disaster such as Katrina? 
•  Is there an industry concentration in the same business groups? Are significant numbers of your customers or suppliers in the same industry and would they all be negatively affected by a problem in that industry? 
•  What are the risks to them of economic recession? Are their businesses subject to exchange rate fluctuations? Will the weakening dollar affect their business and their ability to buy your product or service?  

The way to reduce the potential risk from any of these concentration factors is to diversify. Look at your customers and suppliers from a different perspective and aggressively solicit new relationships that broaden your base. If that is not possible in your main line of business, look at another, ancillary business that could become a secondary revenue stream.  

For a company providing a product to financial service firms in the North East, factors to consider would include the threat of another terrorist attack in downtown Manhattan, the impact of the sub-prime crisis and the threat of recession. Some potential strategies to pursue would be geographic diversification away from the North East and broadening the kind of companies comprising the customer base 

Revenues, Products, and Services 

Anything that can reduce your top line is a threat. If it also reduces your bottom line it is a reality that must be proactively addressed. Specific questions to address are:  

• Is the market for your product/service growing or shrinking? If it is shrinking, what is the long-term trend and should you diversify? History is littered with examples of markets that went away, from buggy whips to vinyl records. The companies that failed to see these trends and diversify disappeared with them.    
•  What is the size of your potential market and what is your share? If you are in a market that is not growing and you also have a significant share of that market then it is unlikely that you will grow. How can you diversify into growing markets where you can capture business?    
• Are there products or services being developed that could be substituted for what you offer and be sold at a lower price? If there are, does this constitute a threat and how soon will it become a problem? What can you do to wrap more services around what you do to stop what you provide becoming a commodity? 
• Are margins under pressure? Can you raise prices or does competition limit you? 

Competition 

What would a downturn do to your competitors and how are you placed in relation to them? Would they be in more or less danger of going out of business than you?  

• If you were competing against your own company, what actions would you take and why?
• Is it easy for other competitors to enter your business? What are the barriers to entry? If there are few barriers to entry can you either create them by developing proprietary products or diversify into another ancillary line of business where it is harder for competitors to enter? 
• Is there a possibility of key suppliers beginning to compete directly or competitors entering your market and under-pricing you?  Is there a way to head off supplier entry or increased competitor activity in your marketplace through legal agreements with suppliers or strategic alliances with competitors?
• Are there trends that may negatively affect the nature of the competition you face (e.g. competition from Wal-Mart rather than local retailers)?
• How will the Internet affect your business? Is it a threat or an opportunity? 

Putting yourself in the shoes of your competitors is an important and rewarding exercise. If you feel that you are vulnerable to changes made by your competitors or to new competition it is important to consider strategies in finding new sources of supply, finding less costly delivery mechanisms of your product or service and adding value to your product/service  

The External Landscape  

• How will higher gas prices affect your company? How much would a $.50 increase in gas prices affect your expenses? Can you pass it on?
• Will a weakening of the dollar raise your cost of raw materials?
• Can international events result in a shortage of raw materials needed by your company?
• Are there developments in other industries that could indicate problems for you in the future? (e.g. lawsuits in the tobacco industry translating into similar issues in the liquor industry.)
• How could changes in the legislative landscape affect you? (e.g. universal healthcare, homeland security initiatives, immigration laws etc.)
• Are there any trends that could negatively affect either the economic or technical aspects of your business? 

This is the hardest part of the exercise as it really requires thinking outside the box. As you consider each question, ask yourself the following:   

• On a scale of one to ten, how important is this?
• “What can I do to change it ?
• What will it cost me to make the change?
• What will it cost me not to make it?