How can you better calculate your business risk and make smarter decisions?

A conversation with Nick Brown, Chief Risk Officer at OnDeck

How do you know if you’re making the right decisions for your business? Are you using the right tools and information to come to a decision? How are you evaluating your business risk through a short-term vs. the long-term lens?

These are only a few of the many questions small business owners have about evaluating their business risk and decision making.

Luckily, I had the pleasure of sitting down with OnDeck’s Chief Risk Officer, Nick Brown, and I was able to get the low down on how small business owners should consider risk within their businesses.

Nick Brown is the Chief Risk Officer at OnDeck. He oversees OnDeck’s credit and risk management strategy and execution, including credit and operational risk controls, portfolio monitoring, and the further development and optimization of OnDeck’s credit scoring models and credit policy. Nick joins OnDeck from Commonwealth Bank of Australia (CBA), one of the world’s largest banks, where he most recently served as the General Manager of the Group Decision Sciences team, and earlier as the General Manager of Group Portfolio Optimization. Prior to CBA, Brown ran the consumer lending business at Discover Financial Services (DFS), where he grew the Personal Loan book while simultaneously improving credit quality. Nick holds a PhD in Organizational Behavior and Statistics from Cornell University.

One of the most important thing for business owners to understand is the risk their businesses face, for both the short-term and long-term. In other words, make sure you’re evaluating long-term risk even when looking at short-term projects, not just short term—and vice versa. Projections for these categories are often of a different nature, and you will need to consider different factors to make the best decisions.

What is Risk?

Before we go further into talking about long term or short term risk, let’s define “risk”. Risk is a term that is often confused with projected losses, but in reality, risk is pretty straightforward. Simply put, Risk = Uncertainty. Unforeseen risk can sometimes result in losses, but risks and losses are not the same things. When you are asking yourself how much risk is involved in a decision, you are asking yourself what factors are you uncertain about and how much uncertainty can you live with when making a decision?

For example:

If you own a grocery store and past history and experience tells you that you will likely lose 10% of your inventory to spoilage every month – that’s not risk. You know that’s happening and can work it into your pricing. However, if you are considering an action with a potential to increase the amount of spoilage you have every month, but you don’t know by how much, that is a risk, and the degree of uncertainty determines how big it is.

You should be thinking about the things in your business that you have the greatest uncertainty about and which of those could have the most significant impact from this uncertainty. Once you evaluate your different options, the choice that offers the lowest level of uncertainty and the highest level of potential positive impact is likely where you should focus your efforts. You should avoid those initiatives with a high level of uncertainty and high potential for negative impact. Better yet, taking action to eliminate the uncertainty regarding those initiatives with a high level of uncertainty could make what appears to be a higher-risk project a profitable project.

To fully understand your business risk, every business needs to focus on three things, which will vary based on your business model and customer base:

1. Measure the risk

2. Monitor the risk so you can react to it

3. Wherever possible, take actions to mitigate the risk

All three of these areas are important because no one of them is sufficient to run your small business on – (1) you can’t mitigate risk away from measuring because without measurement you won’t be able to get a clear picture on an economic level. (2) You can’t get away with only monitoring because without the measurement framework it doesn’t prove the right signal to build the measurement on top of.

There are several resources available for business owners to help you evaluate and measure your business risk. There are also services to provide information on industry and customer sentiment. What’s more, there are advisors and tools at little or no cost through public agencies and universities to help you better understand and mitigate risk in your business.

Understanding Short-Term vs. Long-Term Risk Impacts: 

Short-term risk will cause disruption in profitability and growth in the short-term, manifestation windows are much different for the things you might consider long-term risks. It’s possible to see a seasonal variation, but not real changes in underlying demand, as a retailer for example, you likely wouldn’t see an increase in risk that would extend over a five-year, or longer, horizon.

If your business was a used bookstore, you may see month-to-month variations in your sales, but you would not have been able to see the drop in printed books over the last decade. Therefore, you could not make short term decisions based on the long-term risk, because you didn’t even know it was there.

To deal with long term risk your most effective approach is to hedge, or diversify to at least ensure your long term risks are uncorrelated. You can also reduce the impact to your business by increasing the diversity of your business model.

Cyclical Businesses:

Cyclical business should consider doing that in the down time, and make sure they know whether it is an inflection point of the usual cycle or a structural change. There are some cases when a business reaches an inflection point for a cycle that encompasses a shift in the market so large that you need to consider a structural change so that your business is set up for an exit into new opportunities. This is appropriate when your analysis reveals the market has changed and current business is likely not coming back again (think record shops).

Whatever your business’ long-term risks are—new tech, new products, etc. if you’ve properly evaluated the risks and set up your plans accordingly, you should be able to pivot and react in a timely fashion to any shift in the market.

Where Can Small Businesses Can Improve?

Long-term risk is what many small business fail to adequately anticipate. Because they are working so hard to stay relevant and profitable short-term—they don’t have the luxury, or take the time, to consider the long-term risks they face. So, when you consider the risks your business faces, make sure you consider the long-term risks to your business and your industry when you evaluate shorter-term risks. Don’t be afraid of the shifts in your industry—come at them with innovative ideas and gusto and your business will be set up as best as possible to overcome any challenges that come your way.

Thank you, Nick Brown, for taking the time to share your knowledge with us!