Risk Management (Part 2)
Did you know the Model 3 was one of Tesla's biggest risks? Our Risk Management (Part 2) deck shows the techniques that big tech companies use to minimize risks and identify new opportunities. We'll review the top Risk Management tools from the biggest consulting firms like McKinsey, Bain, and BCG who advise companies like Google, Amazon and Apple to avoid failure. You'll also read some real-world examples of how these companies conduct their own risk management to succeed where their competitors fail.
With this explainer, you'll read how many of the companies you know were actually on the brink of failure. We'll explain the tools and techniques they use to avoid catastrophe and manage their risks. Risk appetite, categorization, analysis and mitigation plans are just a few of the techniques you'll walk away with. You can download this framework to modify and swap out with your own data to customize for your needs, as these tools can be applied to your personal life, or decisions your business needs to make.
In 2015, the restaurant chain Chipotle experienced a string of E-Coli outbreaks that caused their profits to decline by 95% by the next year. In total, the company lost about $8 billion in shareholder value and had to pay $25 million in government fines. Why did this happen? Chipotle didn't do enough due diligence to manage the risk when they switched to a decentralized vendor management system. This left the restaurant chain open to E-Coli infections from individual locations that prepped their produce improperly.
To avoid issues like this, first separate potential threats into internal or external risks. For internal risks, divide them into strategic, operational, or financial.(Slide 3) From there, break them down further into separate buckets: product or design, manufacturing, systems and software, etc. Each risk category has to be managed independently.(Slide 5)
In the case of Chipotle, the company analyzed its supply chain, categorized its risks and created new risk prevention models to adapt. Managed by a dedicated food safety team, Chipotle partnered with suppliers to implement rigorous food safety standards before ingredients ever reach its restaurants. The company also incentivized food safety as a performance measure for quarterly bonuses and created a culture of risk management.
Knowing your risks is just the beginning. In order to plan your response, you'll need a strong risk response strategy. For example, Apple's largest external threat comes from emerging technologies that make it easier for new firms to enter the global market. In 2011, Apple sold 72M iPhones. Even still, its newest model at the time, the iPhone 4, was ranked fourth overall against the top-selling smartphone that year, Samsung's newly launched Galaxy S2. The probability of this threat has remained high as Huawei and Google have launched their own iPhone competitors. The impact of these lower-cost competitors is equally high, as iPhones bring in over half of Apple's total sales.
Document the risks you just identified on a risk register table along with their management processes. Risk registers typically include the type of risk, its likelihood of occurrence and its impact, as well as what the response should be and who will own that response.(Slide 9)
So how did Apple plan its response to its major threats? One risk response was to move its production plant to China to cut operational costs. While the iPhone was the fourth top sold smartphone in 2011, in 2021, the top four selling smartphones are all iPhone models. And while Apple is on track to sell around 250M iPhones this year, the company has diversified further into services as a way to reduce its reliance on and risk from products. While Apple services previously consisted of the App Store, iTunes and iCloud, today it offers Apple Pay, fitness trackers, TV streaming, and a full-suite services bundle called Apple One.
Risks are a natural part of business, but how do you know how much risk you can bear? Netflix had a big appetite for risk as it accumulated massive amounts of debt to build up its content library since 2013. It could afford this appetite as long as its subscriber base was still growing. In this case, the company's appetite for risk was synonymous with its potential for growth.
Risk appetite is the total risk a company can bear across an aggregate portfolio of risks. You can use a risk appetite table to calculate where potential risks land in your own appetite range. Simply multiply the impact score of the risk by the likelihood of it to occur, then confirm it doesn't land outside your risk appetite range.(Slide 11)
In Netflix's case, as the company's ability to gain new subscribers from original programming has slowed, it has taken on less debt and canceled its original series at a faster rate. However, since video game streaming represents a new growth area, it can take up some new risks and make new investments in the gaming sectors as a way to attract new subscribers.
Risk management plan
How do you prevent future risk? Apple has an interesting strategy: Major investors like Carl Icahn have criticized Apple for having so much cash on hand. They have argued Apple should pay out more through stock buybacks and unlock greater shareholder value. But Apple's cash is actually part of its risk management plan.
A risk management plan is a more in-depth plan to prevent future risks. Risks are sorted by the outcome and existing risk treatment plans. These plans are given a rating based on their level of quality, and new risk treatment actions are proposed alongside the additional resources and target date of implementation.(Slide 20)
In Apple's case, with the threat of global minimum tax looming over its Ireland headquarters and geopolitical concerns about its factories in China, Apple's risk treatment options in 2020 are much better positioned because of its cash on hand. The company can now relocate its manufacturing, build new remote headquarters, engage in R&D or make quick acquisitions because of this risk mitigation strategy.
So all you have to do to mitigate risks is avoid them, right? Not necessarily...
Credit scores are a perfect example of "risk avoidance" in action. For years, banks used credit scores to rate potential customers as low, high, or medium risk, and it helped them avoid giving out what they believed were "high risk" loans. Brazil's banking industry is notoriously profitable for its traditional banks and notoriously unusable by its local population, where more people take out loans to pay their bills than to buy a house, with 120-270% interest rates tacked on. These traditional banks were great at avoiding risk.
Similarly, companies can resort to risk avoidance after they've identified a risk and decide they don't want to go down any roads that could lead to that risk. But risk avoidance also comes with its own downside: opportunity loss.(Slide 21)
The fintech company NuBank saw the "high risk" underbanked population of Brazil as a huge opportunity that Brazil's traditional banks had avoided. It was founded in 2013 by someone who didn't even speak Portuguese and knew very little about banking. By 2016, Nubank had acquired 1.3 million customers and five years later, it has over 40 million customers across all of Latin America and is now the largest digital-only bank in the world.
Now fintechs all over the world are taking advantage of massive opportunities with the underbanked to help these "high-risk" customers build credit scores with debit payments or buy now pay later services. In 2021, payment processor Square just bought the buy now pay later giant Afterpay for $29B - a massive acquisition cost and shows the opportunity of these digital financial services.
Traditional banks across the world who avoided these risks now risk losing out and stand a good chance of being completely disrupted if they don't acquire or adapt to this trend.
Risk mitigation plan
What's the best remedy to the perils of risk avoidance? If you can't beat them, join them...
From Tesla's inception in 2003, the company has been full of risks. However, it chose risk acceptance in order to build an entirely new market where there wasn't one. When Tesla took on the Model 3 project, it faced its most massive risk due to the sheer production quantity it faced. In response, Tesla embraced the risk, built a new assembly line, enhanced its body center, and imposed higher productivity requirements to increase production capacity. Now, every other carmaker has embraced the risk and has plans to transition to electric vehicles. So Tesla has a new problem… it has to compete in the market it essentially created.
A robust risk mitigation plan can help you confront new challenges as they pop up. A simple visualization helps communicate key risks to internal and external stakeholders with a concise overview of what your mitigation plan will be across each risk.(Slide 20)
For example, with all these new competitors, Tesla now has to prove to its stakeholders it has a strong mitigation plan. Part of Tesla's risk mitigation plan is to invest in the raw materials needed to mass-produce EVs. In 2020, Tesla signed a new deal with mining giant Glencore to secure its nickel and cobalt supplies over the next few years. But Tesla competitors Stellantis and Renault are now doing the same with lithium. So how does Tesla continue to mitigate risks? Lithium battery recycling. While Tesla used third party lithium recyclers for years, the company invested in its own plans to recycle about 92% of battery cell materials with its own unique process.
Regardless of what angle you take, remember that risk management is a continuous process. For extra tools like risk item tracking, simplified risk analysis, risk assessment tables and risk response matrices, download your framework. Enjoy!