During our long winter hibernation, my husband and I have enjoyed watching pseudo-reality television shows, like Pawn Stars, American Pickers, Restaurant Impossible, and Bar Rescue. However, my favorite of these series has become Shark Tank. To my husband, the show’s premise is simply fun: multi-millionaire tycoons (Sharks) offer quirky-but-promising entrepreneurs opportunities for capital and professional advice, in exchange for either a percentage of the new company or royalty fees.
For me, the relevance of the show has moved beyond this basic view of its entertainment value, as I have come to realize it actually points to some interesting lessons on how accomplished business leaders manage strategic risk.
Strategic risk is the current and prospective impact on earnings or capital arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes, according to the Office of the Comptroller of the Currency’s 1998 Comptroller Handbook. In “shark” terms, investors are willing to assume a certain amount of risk that a business will fail to meet its financial and strategic business goals—for a price. Fledgling companies often don’t get off the ground, fail to meet sales targets, or mismanage operations. The higher the level of risk assumed by investors, the higher the expected reward or return payments.
While this risk/reward maxim is among some of the basic principles learned in Finance 101, the concept has received renewed attention by insurers as they implement enterprise risk management programs and prepare for their potential reporting obligations under the NAIC’s Risk Management and Own Risk and Solvency Model Act, or RMORSA. Managing strategic risk, and using ERM to achieve business goals, is a key pre-requisite to effective capital and solvency management.
What exactly are the company’s most pressing or severe strategic risks? What risks most impact, or are impacted by, multiple areas or departments of the company? How can the most dangerous strategic risks be best mitigated? More than ever, these questions need to be raised against all functional areas of the company, quantified as much as possible and prioritized. Further, appropriate controls or mitigating actions must have follow-though, and the entire process needs to be well documented so that interested parties (shareholders, rating analysts and regulators) have visibility into the process.
On the television show, the Sharks always seem to know the right questions to ask about a new venture’s business goals and operations, biting fiercely into its biggest vulnerabilities. To date, the Sharks have invested $20 million in more than 100 companies. Here are just a few examples of “sharkwisdom” that cut to the core of strategic risk.
Why are you in this business? What is your motivation?
One of the most basic questions the Sharks like to ask, is “Why are you in this business?” Entrepreneurs exploring a new line of business, or those with an unusual product that does not seem to fit with their career or personal history face particularly thorough scrutiny. Sharks want to know that the entrepreneur is highly motivated, energized, and prepared to take on bigger and bigger business challenges.
But, this is also a good question for all companies to ask themselves periodically, even those that have been around for decades. Why ARE we in this line of business?
There are many reasons why companies might maintain a marginally profitable business—to compliment current lines, to improve customer service or to diversify the company’s offerings. However, if this question cannot be answered for a current product succinctly or consistently by all board members and senior managers, it may be a sign that the line of business is ripe for a deeper review as well as an updated look at the current risks and opportunities inherent in the offering.
A dwindling or stagnant business, a line that the company leaders are no longer highly motivated to grow and support, is a drain on resources, and can lead the company to a slow—and sometimes not-so-slow—death. “We’ve always offered this product,” or “We’ve always done things this way,” are risky answers to strategy.
Do you truly have a business opportunity or is it merely a good idea? Do you have a track record yet?
A “good idea” alone does not guarantee sales. Often, investors come to the Sharks with an interesting product, but the inventors or sponsors have not actually sold many. Sometimes, if the idea is compelling enough, the Sharks bite. For example, investors quickly snapped up the LiddUp Cooler, an idea and prototype for a camping cooler with built-in LED lights inside that allow refreshments to be easily found at night.
However, the less track history a product has, the deeper the Sharks must delve into the product’s risks. For the cooler proposal, they discussed the risks of finding target customers; finding similar products that could be easily developed by established competitors, such as Coleman; and the potential for protective patents to be denied or copied. Indeed, many deals negotiated on the show actually fall apart off camera because of an extensive due diligence process, which includes reviewing the company’s books, patents, agreements and facilities.
From an ERM perspective, companies with a strategy to develop new products must spend proportionately more time identifying and evaluating the full range of risks that can affect growth. More and more, it is important for companies with robust ERM programs to mature their processes to the point where they have dedicated, specific cross-functional committees or groups to evaluate both the strengths and weaknesses inherent in new products or services. This will help ensure that potential returns in the organization’s strategic direction will far outweigh its risks.
How will you actually execute your plan? What non-financial support do you need?
Lori Greiner, the owner of the QVC home shopping channel, invested in Reader Rest, which is a magnetic glasses holder. The product prototype did not cost a lot to develop, but the company’s primary challenges were reaching an appropriate market and how to best manufacture on a mass scale. With the QVC Queen’s expertise, however, the product earned three million in sales in less than a year to become one of Greiner’s most successful Shark Tank deals. Although the Reader Rest owners might have willingly struck a deal with any of the Sharks, they found that the right marketing and consulting expertise (offered uniquely by Grenier) benefitted their long-term strategy even more.
The lesson? Even if a product or business is well capitalized, other factors may be more important to consider when it comes to achieving the company’s goals. Poor marketing or failure to deliver on production/operations day-to-day can make or break a company. Management and focus must be balanced between multiple business functions and allocated holistically. Having a strong ERM program, where each functional area’s impact on business strategy is specifically and consistently considered or quantified, can help managers achieve a more balanced view of all risks affecting key strategies.
What is your bench strength? Do you have enough leaders or staff to support a new or growing product?
Solo entrepreneurs often come to Shark Tank when they have run out of other financing options. However, lone entrepreneurs create significant risks for the Sharks, who must consider all contingencies, such as what happens if he or she loses motivation, becomes disabled, or dies. For example, several Sharks appreciated the taste of Slawsa, a condiment cross between a coleslaw and salsa. They admired the owner’s gumption in getting the product on the shelves of several major grocery chains through her own initiative, and, although the company’s sales were trending upward, all sales, production and distribution work was being done by a single person, without a significant management team. In the end, the Sharks were scared off and no offer was made.
How often do insurers hire new underwriters to start or grow a new line of business, and create optimistic business plans around that person’s unique history, broker contacts, customer base, or specialized knowledge of the market? At the same time, are companies factoring in the downside risks of losing that person to injury, death, retirement, or pirating by other carriers? Are there staffing plans or other controls or diversification strategies in place to mitigate such loss?
When faced with “solo-prenuers,” the Sharks might suggest Key Person Insurance, pre-emptive hires of secondary managers with similar skills, or proactive outsourcing, as back-up plans. They know that the more significant a person or team is to the organization’s strategic direction, the more important it is to build support systems and redundancies into the organization to lessen the potential shock loss.
How can/will technological advances affect you? Will your product be easily pirated?
Technology is a major risk for all companies, but particularly for new products which have not yet been patented. Often, the best products are the quickest to pirate. And, today’s lightning speed technological shifts can lead to premature obsolescence, killing a company before it gets a toehold in the market.
OnShark Tank, the inventor of Rapid Ramen, a special bowl to microwave Ramen noodles in so they taste like the “were made on the stovetop” had to defend attacks that overseas companies already had the technology to make a similar product cheaply, quickly and with better materials. The maker of DoorBot, a doorbell with a camera application (app) for a smart phone, was also warned that the technology for the idea was not difficult to reverse engineer and would not be unique in the market for very long. The questions then became, “Could the Sharks make money on the crest of the initial wave of sales and for how long?”
In the insurance industry, the most rapid innovation in the past five years has been the distribution of personal lines via the Internet. E-commerce and mobile apps are rapidly becoming the norm, rather than a competitive advantage. The strategic risk questions? For those companies leading the pack in developing new ideas, ask “How soon will others be able to follow in our path?” That timeline has significantly shortened over the past few years. However, a company should never ask, “What are the costs and benefits of a company developing or adopting technology?” Rather, the problem now is determining what are the dangers if we DON’T adopt technology?
The Last Bite
For insurers today, the question is no longer whether or not they should adopt an enterprise risk program to help evaluate strategic risk. Companies now must ask, “What are the dangers if we DON’T use ERM to provide a comprehensive view of strategy?” Using enterprise-wide risk analysis to review strategic goals can help companies better evaluate a wide range of complex risks, and help keep threats at bay that are even more dangerous than “Sharks.”