What's the Risk?

Strategies for reducing risk and growing your business

By

"Risk can neither be avoided nor eliminated completely. Indeed, without taking risk, no business can grow,” says Peter Drucker, management consultant and author of 36 books on management. Drucker identified four types of business risks1:

1. Risk that is built into the very nature of the business and which cannot be avoided
2. Risk one can afford to take
3. Risk one cannot afford to take
4. Risk one cannot afford not to take

These risks are most definitely the concern of laboratory managers. Developing and commercializing a new product or process certainly involves risk. How can you reduce these risks?

Any new product or process must meet performance, cost, and quality criteria. There is always a risk that a newly developed product or process won’t meet these criteria. Laboratory managers should work with their staff members, their firm’s business development managers, and their salespeople to develop these criteria. Working as a team, these individuals need to determine:

• Users’ needs and requirements. This often requires working with customers.
• The size of the market. Is it sufficient to justify the expense of the R&D and developing manufacturing capabilities?
• Whether their laboratory has access to the skills needed to develop the product. Outsourcing or technology licensing may be required to gain access to these skills.
• Whether their firm has the capabilities and financial resources to manufacture the product.
• Whether development and commercialization costs are such that their firm can earn a reasonable profit margin.

A final question that determines overall risk is whether your firm can accomplish all the above in a reasonable time frame so competitors haven’t divided up the market by the time your firm commercializes its own product.

It is also important to address the risks associated with various strategies available for protecting your firm’s intellectual property.

Determine users’ needs and requirements

This often requires working with customers to determine product performance needs and delivery requirements. One can do this through meetings with individual customers. It may be necessary to carry out these discussions under a secrecy agreement. Attending industry conferences and reading trade magazines and research journals may provide you with the information you need.

The importance of determining customers’ needs may seem obvious, but many new product introductions fail because customer needs—in particular, new product performance and price requirements—are not accurately defined prior to beginning work on a product development project.

Determine the size of the market

The size of the market must be sufficient to justify the expense of the R&D and developing manufacturing capabilities. If the potential market for a new product is large, it may be beyond the capabilities of your firm to secure a substantial part of the market. To avoid becoming a marginal player, your firm may need to form a joint venture with another firm or obtain substantial finances to cover development costs and the construction of manufacturing capabilities.

Determine whether the laboratory has access to needed skills

Co-development, outsourcing, or technology licensing may be required to gain access to the skills required to develop and manufacture a new product. This access can reduce project risks. Outsourcing part of a project can reduce the workload placed on the project team.

However, outsourcing can increase project risks, because project managers often have less control over team members employed by other organizations than over those employed by their own firm. In addition, communication often suffers when members of more than one organization work on a project. The flow of information can be delayed, resulting in loss of time and perhaps the performance of unnecessary work. Another concern involves the flow of proprietary knowledge to another organization. This can eventually result in the outsourcing partner ultimately becoming a competitor.

Another approach to outsourcing is to shift project costs and work to suppliers or customers who will benefit substantially from project success and commercialization.

Determine if your firm has the needed capabilities and financial resources

It takes both technical capabilities and financial resources to develop and commercialize a major new product. This is particularly a concern for smaller firms with limited financial resources. One can either accept the risks and press ahead with a major project, or reduce the risks by taking on a joint venture partner. While this results in sharing the risks, it also reduces the profits associated with commercializing a new technology.

In the case of start-up companies, overly rapid consumption of funds may result in having to raise additional funds through a second round of financing. This “burn rate” is a negative cash flow that determines how fast a start-up company will use up its shareholder’s capital. An excessively rapid burn rate resulting in the need for additional financing will reduce the ownership level of the original investors in the start-up firm. What’s more, an excessive burn rate can force managers to terminate some of the laboratory’s projects and conduct a staff reduction to preserve cash for the company’s most promising R&D projects. However, abandoning some projects may adversely affect the longer-term growth prospects of the firm.

Determine an adequate profit margin

What determines a reasonable profit margin depends on the type of industry your company is in and the scale of manufacturing. Customarily, a very large scale of production generates a large cash flow. Companies in businesses with large production volumes, such as crude oil refining and commodity chemicals, can tolerate lower profit margins than companies in businesses with small production volumes, such as laboratory instruments, high-purity analytical reagents, and pharmaceuticals.

The estimated profit margin for a potential new product or process should be at least as high as that of the products with which your firm’s new product will compete. Otherwise, your firm’s competitors may have the flexibility to reduce their prices to maintain or grow their market shares while your company does not.

Bring the product to market in a reasonable time frame

One must constantly monitor the project schedule to ensure that work is done on time and the project stays on schedule. However, falling behind schedule is another problem that often occurs during the course of a project. To get projects back on schedule, one can take advantage of “project float.” Project float is the amount of time a project task can be delayed without causing a delay to subsequent tasks or to overall project completion. Changing team members’ task assignments to take advantage of project float is one way to help get projects back on schedule.

Taking advantage of project float involves moving team members to critical path assignments and away from tasks not on the critical project path. The objective is to shorten the duration of the critical path. (The critical path is the longest sequence of activities in a project plan—it is those which must be completed on time for the entire project to be completed on time.) Should the project fall behind schedule despite the effort to take advantage of project float, it will be easier to get additional funding for noncritical path tasks after achieving major critical path milestones.

Intellectual property risks

Laboratory managers often participate in defining the company’s intellectual property associated with the development of a new product or process. Other participants in this process are members of the firm’s intellectual property department and business managers. One has to balance the costs of obtaining a patent against the risks of maintaining key features of a new product or process as a trade secret. However, even obtaining patents carries risks. The freedom to operate has come under increasing threat from the growing number of lawsuits between companies.

Patent strategies by other companies can result in their obtaining patents that prevent a competitor’s newly obtained patent from being used because the newer patent relies on technology covered by the older one. This older patent is referred to as a blocking patent. Conversely, the newer patent may include improvements to the technology covered in the older patent. The frequently used solution to this problem is that the two firms cross-license their patents so that both companies are legally free to practice the technology covered by the pair of patents. This strategy may go one step further and also involve more than one other company.

The alternative to cross-licensing is to file a lawsuit challenging the legality of an existing patent. Such lawsuits can be expensive to pursue. In addition, should Company A be found to be infringing the patent of Company B, the court may assess a financial penalty on Company A. Multimilliondollar judgments are common, and occasional judgments of a billion dollars are not unknown. Depending on the size of Company A’s financial resources, these financial judgments can impose a greater or lesser risk to the company.

Risks facing patent holders have shifted recently as a result of the increase of “patent trolls.” The “nonpracticing entities” do not commercialize technology—they instead obtain patents to limit technology improvements to previously existing patents. NPE companies acquire patents, identify possible infringers of these patents, and bring legal action to force a financial settlement. Companies with patents are forced to license these patents or engage in costly litigation, which they may not win. Because they do not commercialize products or processes, it is difficult to sue NPEs.

NPEs are largely a problem in the computer and communications technology industries. However, the practice could spread to other industries.

With the increasing job mobility of people who know an employer’s trade secrets, disclosure of these secrets to third parties is an increasing risk. The pages of Chemical & Engineering News increasingly contain notices of individuals who stole intellectual property from their employers or former employers.

Disruptive technologies

A disruptive technology is an innovation that reorganizes an existing market. Disruptive technologies improve a product or process in unexpected ways. Currently, computer and communications technologies are doing this in many ways in many industries including the chemical, biotechnology and nanotechnology industries.

Wrap-up

Peter Drucker notes, “All economic activity is by definition ‘high risk.’ And defending yesterday—that is, not innovating—is far more risky than making tomorrow.” This is what laboratory managers and firms conducting R&D do—make tomorrow. Thus risk is inherent in doing research.2

Harvard Business School professor Clayton Christensen suggests that by placing an excessive emphasis on satisfying customers’ current needs, companies can fail to develop or adapt new technology that will meet their future needs.3 Companies that do this will eventually fall behind. Instead, companies—often start-up firms—displace them in the marketplace by using disruptive new technologies.

References

1. Peter F. Drucker, “Managing for Results,” HarperBusiness; reissue edition (October 3, 2006).

2. Peter F. Drucker, “Innovations and Entrepreneurship,” HarperBusiness; reissue edition (2006).

3. Clayton M. Christensen, “The Innovator’s Dilemma,” HarperBusiness (2011). Dr.

Categories: Business Management

Published In

The Pathway to Management Magazine Issue Cover
The Pathway to Management

Published: January 24, 2013

Cover Story

The Pathway to Management

Step one, change your mindset.  There are five mental attitudes or mindsets that aspiring managers need to develop.  Uses this article as a walk-through.

Featured Articles

Growing Up

A laboratory that got its start in food twenty years ago continues to expand