Risky business: Plan to avoid pitfalls

Doug May
Doug May

The business model that leads to sustainable profits should be simple and easy. But business also can be risky.  Here are nine things to consider that could result in failure.

The market’s too small. Especially if there are geographic constraints on delivering products or services, successful niche businesses in a major metropolitan area might not find enough customers in a less-populated market.

A key customer or vendor could be acquired and decide to obtain your products or services elsewhere.

Your reputation for providing personal service might be so highly valued clients won’t refer you to others to retain your full attention. Known as the babysitter phenomenon, it happens in the world of doctors, real estate agents and other professional service providers with limited capacity.

Bottlenecks demonstrate the paradoxical risk of being too successful. While your business might be cost effective in manufacturing at a certain level, ramping up production to meet growing demand could strain staff, cause material shortages or result in snafus. Ramping up production typically requires cash — perhaps more cash than the owner has on hand — and create a situation in which too much success could actually kill the organization.

Your business model could be fragile. Just ask Chipotle Mexican Grill. A series of food-borne illnesses prompted customers to re-think their dining choices. Revenue at Chipotle Grill plunged more than 20 percent and profits imploded. The company emphasized new policies to prevent food spoilage, but the damage was done as the number of articles about customers getting sick after eating at Chipotle increased.

Sometimes risk cascades from another business to yours. You might have thought some of those customers who wanted fast casual Mexican food dining would head to Qdoba. But that wasn’t the case. Moreover, Qdoba ran heavy promotions to pick up those customers, squeezing its own profit margins. One of most extreme cases of risk cascade occurred in 2008 when problems with large banks associated with investment banks underwriting subprime loans cascaded over from Bear Stearns, Citibank, Lehman Brothers and Merrill Lynch to community banks down the street. Suddenly, everyone saw their liquidity affected as federal regulators moved to reduce lending across the country. Cascading risk also can affect businesses only remotely linked to the original issue. General Motors declared bankruptcy in 2009. Alternatively, Ford’s chief executive officer won acclaim by foreseeing difficulty and reducing debt ahead of the crisis, before things got too precarious.

Cash can evaporate – usually into the pockets of employees. Demand head fakes result from many sources, including fads that show great promise initially, but then consumer interest declines, perhaps just after management incurs a great deal of expense to ramp up production.

The political environment can interfere with customer relations. David Wanetek’s book, “Business Model Valuation,” provides an excellent example of how to both develop a business model and evaluate the risk in your model, using Sodastream as an example Sodastream’s manufacturing operations in the occupied West Bank territory became a point of contention and boycott Israel proponents urged customers to stop buying Sodastream products. Eventually, the company was forced to relocate the factory and lay off its Palestinian workers.

While the risk of governmental interference extends to many businesses and seems to increase exponentially, the real question is whether or not it’s making things better. The banking industry — ground zero for the 2008 financial crisis — is one of the most heavily regulated industries on the planet. Yet, wrongdoing still occurred and the repercussions from the crisis affect a wide range of businesses even today. Rules that favor big businesses have hurt many small banks and mortgage companies — along with the customers of those entities — while banking behemoths received bailout loans and historically low-cost funding to the point where we now talk about the possibility of negative interest rates, which will likely make access to capital even more difficult for small business owners who typically spur hiring.

If you’re of a mind to worry, consider applying the sort of analysis performed in the case study at BusinessModelValidation.com. A little time spent worrying might help you recognize and address some risks to your business you didn’t see coming. Spend too much time worrying, though, and you’ll never go into business for yourself. In that case, both you and the overall economy will lose out.

Your business plan isn’t meant to dissuade you from taking risk. The idea of going through a planning exercise is to prevent you from assuming avoidable risks, leaving only the things over which you have no control. If you can’t control it, there’s no reason to waste time being anxious about it.