So in our last discussion we outlined the different ways that you can respond to the risks you face in business. With that list as our ‘toolkit’, we can now target our discussion on the different categories of risks faced by business owners and identify the best ways to respond to each of them.
Today, we’ll focus on strategic risks. These are the risks that arise from operating in a specific market or industry. Common examples include changes in consumer preferences, changes (shocks) to supply and/or demand, foreign exchange fluctuations, and changes in geographical/political policies (i.e. tariffs).
Let’s bring this to life by looking at a real strategic risk faced by a real company. Note how we break down the analysis into a few simple steps.
Here’s the situation: The majority of Starbucks’ coffee beans are supplied from Colombia. While they do have suppliers in other countries, those beans often come at higher prices, lower/inconsistent quantities, and may produce inconsistent flavours than the usual beans.
Before we can respond to the risk, our analysis must begin with properly identifying it. In the above situation, the overriding strategic risk is of lost profits should a supply shortage or price increase occur on the Colombian coffee beans. These changes to price and/or supply can arise from many sources, including changes in trade policy/tariffs, weather (natural disasters, drought, etc.), and so on.
With that laid out, we can now look to our toolkit to consider and select the best way to respond to this risk - in other words, we want to choose the best tool for the job.
It should be pretty obvious that this option won’t work here, and based on our definition of strategic risks, it rarely will when we’re facing a risk from this category. In the scenario given above, Starbucks depends on beans from Colombia to maintain their cost structure, brewing details, and resultant flavour. This may be considerable as a long-term transition, but as far as a response to this specific risk, it’s out.
Again, this option doesn’t suit strategic risks well, this one included. Starbucks cannot effectively transfer this risk to an external party. Even if you used an intermediary to buy the beans and commit to providing a predetermined quantity at a predetermined price, if they can’t hold up their end of the deal, Starbucks still faces the end repercussions from the consumer. Let’s move on.
We’re getting warmer now. Starbucks can take some steps to mitigate this risk to some extent. These might include: purchasing local Colombian farms (mitigates the price risk), developing farms in other regions (may mitigate the geopolitical risk), and negotiating supply agreements (mitigates the quantity/supply risk; although in reality, this is very likely to have already been done). However, note that we cannot fully mitigate all elements of this risk despite the options we undertake, nor can we combine strategies to try to ‘cover all our bases’ in a financially feasible way. Let’s consider our last option.
In the real world, this one is the most correct. Starbucks cannot effectively mitigate this risk, so the optimal response falls into the category of accepting it - this means that Starbucks would (and does) carry on their normal course of business while being fully aware of the risks involved (including this one). They ensure that the returns generated from operations compensate them satisfactorily for bearing these risks. We see this all the time even at huge companies: when Chipotle is faced with a food quality outbreak, some menu options may be unavailable. When there’s a long drought in Florida, oranges at your supermarket may be very expensive or of poor quality. A battery shortage from Panasonic may delay the completion of electric cars. The point is that companies of any size ultimately need to accept and bear strategic risks sometimes.
Of course, Starbucks didn’t become such a successful brand by simply standing idle when faced with risks to their business (same goes for the other companies mentioned above). Instead, they put a slight twist on the ‘accept’ response by combining risk acceptance with feasible (meaning reasonable from a cost/benefit perspective) strategies we touched on when considering the ‘mitigate’ option. To take this further, here are some of the actual strategies they have actually implemented in this scenario:
Develop and maintain supplier relationships in other geo/political areas to eventually diversify the supply chain/better insulate against these risks, or at least give the company a head start on if a drastic transition needs to be made.
Monitor economic and geopolitical trends that influence the likelihood of those risk factors (supply shortage, higher prices, etc.) coming to fruition to identify them in advance to give the company time to re-source their purchases elsewhere.
Develop a policy and assign a team to review/refine the above on a regular basis.
Well, there you have it - our first ‘real life’ risk identification, response, and analysis. Stay tuned for future posts as we move into taking a closer look at other types of risk faced by leaders in today’s business world.