A Different Approach to Risk
Jeanette Nyden launches a new series on helping practitioners to look at "deal risk" in a different light. In this series she will:
- Talk about risk topics in a way that other people are not talking about
- Ask folks to think more broadly about risk
- Clarify concepts that people may not fully understand
- Provide a more complete picture of upstream and downstream dependencies
- Offer actionable steps to incorporate these ideas
- Improve overall performance
Have You Identified all Forms of Risk?
Perhaps no topic is more misunderstood by deal teams than risk. And that’s a shame because no other topic deserves a more comprehensive understanding. Misunderstanding risk means that risk is too narrowly defined and obvious risks that could be easily mitigated are largely overlooked.
Here’s an example: A financial institution outsourced all of its real estate facilities management to a service provider. One of the service provider’s duties was to renew the financial institution’s leases. When the financial institution switched service providers neither the exiting provider nor the financial institution had an accurate or complete list of pending lease renewals for the period of time the work was transitioning to the new provider. As a result, the financial institution missed a deadline to renew a lease.
That missed lease renewal is just one example of the ways in which deal teams overlook obvious risks.
Types of Risk
By risk I mean exposure to the chance of a hazard, injury or loss of any kind. Because all members of a deal team ought to use the same vocabulary to ensure that they are performing a robust risk analysis, I’ve bucketed risk into these three categories:
1. Transition Risk: Risks associated with transitioning the work to the service provider.
There are a myriad of risks in transitioning the work from a company to a supplier, or from a supplier to another supplier. One obvious risk is knowledge transfer– the kind of knowledge that sits inside a person’s head. Knowledge may be walking out the door in the form of the customer’s displaced employees or the former supplier’s employees. Loss of knowledge can be compounded by the complexity or breadth of services performed and/or interdependence between the parties to perform the service.
2. Execution or Dynamic Risk: These are risks that unfold as the deal executes.
There are several levels of execution or dynamic risk. One type of execution risk occurs when the service provider performs a particular task, process or service. For example, if a company contracts with a service provider to pay third party vendors, execution risks can occur at a number of stages in the process – from company approval of the purchase order, to service provider data entry, or issuing the payment.
3. Structural Risk: Risks that are inherent in the structure of the solution.
Structural risks include considerations such as inefficient tax structures, trans-border data flow, privacy risks and currency conversion risks. In many cases, these risks can be evaluated and handled before they affect the outcome of the deal.
Mitigate or Allocate Risks?
Once the risks have been identified, the parties must determine if it is wiser to mitigate the risk or allocate responsibility should the risk event happen.
Most deal teams focus on allocating risks between the parties. The better way to approach risk is to look at all types of risk and mitigate most if not all of the risks before the contract is ever signed. Only those risks that cannot be mitigated should be allocated between the parties.
Jeanette's "Risk" series continues next month