Business Risk Assessments for Every Entrepreneur
A simple but efficient way to assess the types of business risk is the Impact vs Likehood matrix. Often we learn it at business school, but later in our careers and projects, we forget it. Big mistake! This is an exceptional tool for entrepreneurs and managers when assessing uncontrollable risks, so while you cannot suppress a crisis, you can prepare your business to survive (and thrive) on it.
You cannot predict the next crisis, but you can rehearse for it.
The first step to use this matrix is to draw a chart where the X-Axis is measuring impact—be it profit margin at risk or any other suitable measure, and the Y-Axis is measuring likelihood. The determination of the likelihood of catastrophic events must be done with extra care since humans tend to underestimate the chances of calamity (unless they just went through one). One common way to attribute likelihood is to observe how frequently the event happens. This may lead, however, to non-detection of rare-but-not-impossible situations–Black Swans, as Nassim Taleb calls them.
To detect possible Black Swans, the best way is to brainstorm every conceivable and adversity, accident, or disaster. Since you are an entrepreneur far away, bring the knowledge baggage from your land and sum the risks you know to the ones you imagine in your new place. Brainstorm together with other entrepreneurs or neighboring residents, if possible.
Once you have a relevant poll of unpleasant situations, divide them in the matrix below, according to both their likelihood and impact.
The 4 types of business risk
Fly in the soup: The name of the quadrant with low probability and low impact is self-explanatory. When you have a fly in your soup, you just take another bowl. You do not install expensive security systems or create detailed mitigation protocols for the problems of this quadrant because the investment would far exceed the avoided losses. But be sure that what you place in the fly in the soup quadrant are truly low-probability events, because even though their impact is low, if it happens frequently, it will pile up and turn into a money and time-consuming issue.
Casual accidents: The frequent bumps in your entrepreneurial road have their place in the high-likelihood, low-impact quadrant. Example? When I started my business in Poland, it was difficult to hire. A near-zero unemployment rate can be a risk for employers, even though probably this is better than high unemployment. Each expense from the recruiting effort was not significant when isolated, but summed all the costs of training, job ads, understaffing and uncertainty, it became considerable. Therefore, it was a management challenge, and a chance for improvement, something valid to most problems written in the Casual accidents quadrant.
The failure of Nokia is most likely due to casual accidents.
Disasters: The high-impact, high-probability risks are the ones we actively avoid. Just after university, I moved to Santiago, the Chilean capital. The region is one of the most earthquake-prone in the world, registering a third of all tremors above 8.5 of magnitude. Earthquakes have a high-likelihood in Chile, and their impact can be calamitous. Consequently, Chile is one of the leading countries in anti-seismic technology. When we talk about uncontrollable but frequent disasters, the effort is to mitigate their effects when they happen, because sooner than later they will.
In this quadrant are situations like global market crashes, pandemics, or Vulcan eruptions causing an airspace lockdown in half-continent (the Eyjafjallajökull did this in 2010).
I left the rare catastrophes quadrant at last because we often neglect it. This because flies in the soup do not have the impact necessary to demand attention, and both casual accidents and likely disasters are easily identifiable because of their frequency. However we, humans, have a problem understanding the likelihood of rare catastrophes.
There is even a name for this cognitive brain flaw: normalcy bias. According to the research from Esther Inglis-Arkell, near 70% of people display such bias. This is one of the two most common biases that we often see causing damage to business. The other is The Survivorship Bias, which I wrote about in this article.
Types of business risk – Conclusion
At the risk of sounding repetitive, I will tell you again: To thrive, first a business must survive. Online commerce behemoths like eBay or Amazon are companies that survived the 2000 e-commerce bubble burst.
Black swans like enormous Vulcan eruptions or virus mutations are impossible to predict. Therefore, the best counter-measure is to get rid of the fragilities and catalysts of negative impacts. In this article, we listed 4 types of business risk. We can classify nearly everything that threatens your business as one of them and handle it accordingly
A proper risk assessment will give you a better outlook on your project or company. It will help you to be ready for crises and obstacles. Learn how to write a good business plan with a proper risk analysis. It will make it easier to raise capital among investors or impress local authorities.
Build diversified income streams, create redundancies, and avoid risks that can wipe out your company. These are some ways to build an antifragile enterprise. If you want your business to survive one hundred years, events that happen once in a century should alarm you.
To learn more about types of business risk, this video is a good step.
Levi Borba is CEO of expatriateconsultancy.com and a best-selling author. You can check his books here. This article is based on a chapter of the book Starting Your Own Business Far From Home: What (Not) to Do When Opening a Company in Another State, Country, or Galaxy.