THE BUSINESS RISK EQUATION SHOWS YOU HOW MUCH YOU WILL LOSE FROM ANY FAILURE EVENT
THE COMPLETE BUSINESS RISK EQUATION EXPLAINS WHAT INFLUENCES YOUR CHANCE OF SUCCESS IN BUSINESS
Risk = Consequence x Opportunity x Uncertainty of the Opportunity
One of the most important business equations of them all is the full form of the business risk equation shown above.
You start a business with great hope of success. But most new businesses will fail within a decade. Five years after start-up about a third of USA businesses are still in operation; under half of UK business start-ups survive that long, which is about the same for Australian businesses. Roughly ten percent of businesses are left ten years after start-up. People would make better start-up choices if they had a business risk equation that told them if they will be successful or not before going into business.
For society that is a good thing—only those businesses that satisfy a real need should trade. But for the business owner, their dreams of fortune and well-being often turn into financial disaster. A business risk equation that showed them where their business risks are would let them target their product design, marketing, and sales efforts to maximize success.
The effect of things that cause risk in a business can be calculated by using the following basic risk equation.
Risk ($/yr) = Consequence ($) x Likelihood (/yr)
Knowing what makes a difference to your business success lets you focus on doing the right things to maximize business survival rate.
The basic business risk equation says that your annual cost from a risk depends on what losses happen when the risk event occurs (the consequences) multiplied by the number of times a year that the loss event arises (the annualized frequency). A loss event that costs you $10,000 when it happens (say a car accident), which occurs twice a year (i.e. two accidents in twelve months) means you lose $20,000 from the risk of road accidents per year.
However, the basic risk equation is incomplete. There are really two parts to Likelihood: opportunities per year for the event to arise, and the degree of uncertainty that disaster will happen at an opportunity. The full business risk equation is:
Risk ($/yr) = Consequence ($) x [Opportunity to Fail (/yr) x Uncertainty at Each Opportunity]
If there are zero opportunities for an event to happen, then your risk is zero (e.g. if you never take a car on the road you cannot have a road accident). If the uncertainty is zero (e.g. you never have a car accident when you drive on the road), then the risk is also zero. Both business opportunity and business uncertainty are factors that you have a lot of control over in a business.
When you are in business the consequence for you is to either make money, or not make money, from trading with prospective customers.
Maximizing the number of opportunities to get paying customers is called Marketing Management.
Minimizing the uncertainty in losing a sale to an interested prospect (or maximizing the certainty of gaining the sale) is called Sales Management.
To reduce the risk of going out of business you need to be very good at Marketing to get paying customers, and very good at Sales to get those customers paying you.
This explanation of how to use the business risk equation to get business success brings with it a realization that the production and delivery of your products, goods and/or services is actually a Sales function. You will maximize your sales if your products and services satisfy prospective paying customers. The quality, performance, and cost of your product or service influences customer choice. And the sales uncertainty reduces when your customer gets high quality, a reliable product, and a price that they can afford.
Creating opportunity for paying customers to find you is in your control. You do that by getting better at marketing to find paying customers.
Improving the chance of sales success by removing uncertainty in a sales encounter is also in your control. It requires you to work on producing a product or service that is valuable to paying prospects.
Take half an hour now and on a blank sheet of paper list all the marketing opportunities that you can create, and all the sales uncertainties that you can remove. Once you have the list, put your options in order of likely success and start to remove the risk of failures from your business.