Section 6f: The Operational / Contingency Plan anticipating problems A small business has a very simple management structure the owner is the manager. If you are the owner, you are responsible for establishing the goals and direction for the firm as well as for ensuring that everyone in your business not only knows the objectives but works to support them. Imagine for a moment that you are taking a road trip in your automobile. You have a brand new car and are want to drive from Prishtine to Berlin. You must be careful which route you travel. Some routes are more dangerous, some routes have few petrol stations with long lines, and some routes do not allow for rest. As the owner of the vehicle, you plan the route carefully and budget your money to allow for the trip. You have two partners, passengers, each a fully qualified driver, each capable of performing minor mechanical repairs in the event that something happens to the car. Enthusiastically, you depart. In time, you become tired, and one of your partners takes the wheel to continue the journey. You go to sleep. Your driver, not knowing everything you know, misses a turn and travels down the wrong road. The automobile is moving, it may even be in the general direction you intended, but it is not going on the planned route. Does this sound possible? Have you been in an auto when the driver took the wrong turn? It can happen more easily business than in an automobile, especially in a small business. You can concentrate on the road, steer the vehicle, and apply the brakes or the gas as needed to operate the automobile. But, unless you have planned your destination, mapped your route, and monitor your trip, you may not arrive on time, if at all. If you happen to fall asleep during your voyage, you may wake to find that you have traveled many miles in the wrong direction. Most entrepreneurs plan their intended route before they begin the business. The earlier portions of the business plan have laid out your intended plans. This plan is communicated to your partners and employees. Your method of organization has been discussed, and is likewise understood by all involved. The control system you intend to use to monitor your progress is important because you may need to alter your plans for unexpected occurrences. This operational section begins by discussing your control systems: the processes you will use to monitor and measure progress as well as to make necessary course corrections. In a manufacturing firm, control of the assembly line requires achieving production levels while maintaining quality within a financial budget. In a retail operation, the merchandise and displays must be maintained to ensure adequate choice for the customer while minimizing waste and unnecessary storage. In a service firm, labor must be managed to ensure productivity and customer satisfaction. Each business requires a unique control system. If everything operates as planned, there is no further planning to do. If it s not broke, don t fix it! Management isn t required when everything is going well. Management is called for when things don t go according to plan when we ve gotten off course. Entrepreneurship is risky. We ve referred to your personal ability to accept risk. When we introduced the concepts of four wheels and four tires we said that it was necessary to identify risks. Before we proceed, let s clarify the difference between uncertainty and risk. You don t know? That s uncertainty. Do you have something to lose? Then it becomes risk. The difference between uncertainty and risk is whether or not you can recognize possible outcomes, and by anticipating what might happen, insure against what you might lose. When you insure the possible loss you are managing the risk. Imagine for a moment that you are on the edge of a cliff at night. You cannot see the other side. That is uncertainty. Would you jump?
That would be foolish. Now, imagine it is daytime. This is risk. Why? Because you can see what might happen. Would you jump? Only if you thought you could make it to the other side. You might also build a bridge to carry you to the other side. This is a form of insuring the risk. All businesses face uncertainty. Some uncertainty can be recognized, or insured against, some cannot not. Risk management requires recognizing the hazards and potential losses facing your business and having a plan to minimize their likelihood. Risk management requires imagination, understanding, planning, and having accurate, complete and timely information. Entrepreneurs do not seek out risk. Contrary to what you may have heard or though, they do not like to take big risks. They do, however, assume risks by nature of their activities. As we have discussed, most risks can be reduced by a combination of awareness and decision making. You must be fully aware of current and future market and economic conditions. You should consider the consequences of various alternatives, and make appropriate decisions in response to changing conditions. You can rely on the truth of another Emeric-ian principle, everything will change when you lease expect it to. Some risks are easier to manage than others, and change always presents risks. There are four ways to respond to risk: Avoidance, reduction, transfer, and assumption. Risk avoidance eliminates the risk by avoiding or abandoning the activity that is risky. Risk reduction minimizes the risk by using various methods to either reduce the likelihood of a damaging event. Some risks cannot be avoided, but can be reduced by careful acts of prevention, such as using safety and protective measures when working with hazardous materials. Risk transfer is passing the effects of the risk to another person or organization outside of your business. Insurance, where another company pays you in the event of a loss, is the best known form of risk transfer. Finally, risk assumption involves accepting both the risk and the consequences of the event. Ideally, risk assumption is a planned and intended choice. Risk assumption is generally intended when either the risk of the possible loss is not financially significant to the business, or when the cost of insuring against the loss is too costly. In reality, however, any risk that you do not recognize and manage is assumed, meaning that you must bear the full burden of any possible loss. There are four categories of risk that should be explored: operational, property, employee and customer centered. Some of the risks can be identified, protected against, and insured to minimize your loss. Each category contains risks with loss potential that would devastate your business. Operational risks are those uncertainties which face the business during normal operations. Effective management requires you to be aware of your environment and the conditions under which your business operates, or those factors which could harm your firm if they changed. Operational risks range from macro-economic to micro-economic issues. This includes recession, legislative and market changes, product obsolescence, changes in competition, and the loss (or death) of key employees. Generally, these risks cannot be insured against. They can only be minimized by awareness and planning. This requires a constant monitoring of these areas and reacting quickly in the event of possibly harmful occurrences. Most of operational risk management is applied common sense. Proper diversification is one of the best protections against obsolescence, and also provides protection against recessions, market, and competitive changes. A company with several product or service offerings is less vulnerable to external changes than a company with only one offering. A business doesn t have to be large in order to diversify. A company that services automobiles can also service tractors and wagons. Minimizing the risk of losing a key employee is good management. You should
actively train people for multiple tasks, and should be continuously developing your employees for advancement. You can reduce your risk from the death of a key employee by insuring their life. The step that is most often forgotten in a small business is protecting against the loss of the owner yourself. True, you can purchase insurance for your life, or you may even believe that the business does not need to survive you. Yet, what if you were disabled for a period of time? Would there be someone else in the organization capable of running the business profitably? Would the business survive to see you return? The best way to handle operational risks is to anticipate what might happen, and to make a plan for how to handle it. This requires trying to visualize all reasonably possible occurrences, anticipating their effects upon the firm, and coming up with a plan in case they happen. This plan should be in writing and reviewed annually if not more often. Operational risks will constantly change and always be a challenge. Most people think of property risks when risk management is mentioned. This is the potential destruction or loss of some physical asset of the business. Property loss is probably the easiest to protect and insure against. Whether it is fire protection, a security system, cash protection strategy, or computer security system, you must try to identify the potential hazards and come up with a plan to reduce the risk exposure, including the risk of a total loss. For instance, a building can be insured against fire, but if your building burns down entirely, what else has been lost that will affect your operations? Are your records and computer systems protected? Your contingency plan should contain specific actions in the event this, or any other major setback, occurs. Employee risks can easily be considered operational risks. Earlier we talked about the possibility of losing key employees. Employees are also involved with property risks. While we may not want to think about employee theft or vandalism, it does occur and must be guarded against. To a certain extent, employee risks can be insured against, either through bonding or insurance. The most effective means of protecting against employee centered risks is the careful selection and supervision of employees. As a business grows, it is necessary to find and train additional people. It becomes increasingly important that they are both capable and honest. We spoke earlier of the importance of your controls systems to your operational plan. One aspect of the control system is the mechanism you use for internal controls and the way you supervise your employees. This is like walking a tightrope. On one hand, your employees expect your trust and confidence in their abilities. On the other hand, you must monitor and control their activities to protect yourself and your business. This also relates to this is your employee relations program. You quickly agree that you need good customer and public relations for your business to prosper. Many entrepreneurs, however, do not see or minimize the importance of good employee relations in their business success. Your employees are a key resource and should be treated as such. Maintaining good relations with them will reduce your employee risk exposure. Yet another form of employee risk is that of the employee being injured on the job. A business is responsible for providing a safe working environment for employees. While all states within the U.S. and most countries have some form of worker s compensation to provide insurance coverage, the company may have risk exposure beyond that paid for by this insurance. Customer centered risks also can occur in different forms. One clear risk which is generally covered by insurance is that of the customer being injured in your facility. For retail operations, customer theft is highly possible but is related to property risk. The greatest risk associated with customers is in the area of product or service liability. Services must be provided with reasonable competency. Products must be fit for the intended purpose. Reducing
the risk of product or service liability requires constantly monitoring the quality of your operations, effectively training your employees, and avoiding exaggerated claims in your advertising and promotion. The remaining customer risk is that the customer either quits purchasing from you, or doesn t pay for what was purchased. Customers are the life-blood of the business, but customers that don t pay are the worst they siphon resources from your firm that could be productively used to service other customers. The only way this risk can be reduced is to qualify your customers and monitor them closely. Unfortunately, many growing businesses focus on increasing sales by getting new customers without focusing on customers willingness and ability to pay. The potential loss of a customer is similar to the operational risk of product obsolescence. The best defense is diversification. The best means of protecting your business is to avoid being dependant on any one customer. Throughout this section, we referred to insurance without going into any specific detail. There are various types of insurance. We are all familiar with life insurance and fire insurance. In addition, there are a variety of casualty, credit, business interruption, liability, surety and fidelity insurance coverages available. Insurance is complex and expensive and can take one of three possible forms: self-insurance, co-insurance, or full insurance. It is important to note, that while the risks of under-insuring is readily identifiable, over-insuring can also cause financial hardships. Self-insuring is the assumption of risk by the business without the involvement of an insurance company. It is the same as having no insurance. While many large businesses have enough cash reserves or assets to enable this, many small businesses do not. In reality, a risk that is neither recognized nor anticipated is self-insured. A co-insurance approach requires you to bear a pre-determined portion of the risk, usually in the form of a deductible. This means that you are responsible for paying for the first portion of the loss. As an entrepreneur, you will be seeking expert assistance in several managerial areas: most notably accounting, legal, and also insurance. Because this is a separate area of expertise, we are touching upon, but not delving into the specifics of insurance. The operation plan should conclude by not only identifying significant foreseeable risks but also presenting your risk management strategy, insurance portfolio, and your contingency plan. The contingency plan should specify what steps will be taken to minimize risks on an regular, ongoing basis as well as identify what actions will be taken in the event of significant partial or total losses. The plan does not need to be long. It does not need to identify every risk, but should identify all major risks that could materially damage your business. It should be comprehensive, in writing, and regularly reviewed. The following contingency checklist distills the key areas of concern: Contingency Plan Issues 1) Risk and risk mitigation areas a) Operational risks i) Diversification options? ii) Cross training of employees? iii) Key employee insurance? iv) Protection of computer systems and records? b) Property risks i) Insurance options for natural disasters, theft and vandalism? ii) Security systems for theft and vandalism? iii) Obsolescence? c) Employee centered risks i) Careful selection, training and supervision of employees? ii) Safe working environment
iii) Internal control procedures? iv) Employee relations? d) Customer centered risks i) Customer injury? ii) Product / Service liability issues? iii) Customer credit and payment issues? iv) Customer dependence issues? 2) Breadth and depth of insurance coverage a) Cost effectiveness / value of insurance coverage? 3) Comprehensive contingency plan a) Ongoing risk mitigation strategies? b) Actions to be taken in the event of occurrence of loss (single or multiple events?) c) Actions to be taken in the event of a catastrophic (total) loss?