Do you know the difference between “real-profit” and “risk-profit”? A real-profit is the reason you are in business, while the risk-profit is the profit that is related to a risk that is not in your core business and that you should spend (or invest) in a way to reduce your risk, and to protect the real-profits.
Business case 1
A client CEO of mine was telling me that his company board lacks focus about their succession planning and he was finding it difficult to emphasis its urgency and importance to many members.
We estimated a business insurance cover of about $40,000 p.a. for each of these key positions. With 5 directors on the board, this is about $200k p.a. of “risk-profit”. While it is very unlikely that all directors will get hit by a bus together, any risk on any of the key directors will put a dent in the company’s profitability and long term viability. This risk-profit must be invested in finding, training and keeping success talent in order to protect the longevity of the company.
I recommended to the CEO that the company purchases these insurances out of the risk-profit and takes them out of the Board Bonus Pool. Each board member will need to demonstrate to the board that he has a “Ready Now” talent available to take over from him. Only then will the relevant insurance be cancelled and the premium returned to the bonus pool.
Business case 2
A client of mine discovered that her supplier was not providing her with the quality material that he claimed to be providing. She suddenly found herself with tens of thousands of dollars of worthless products in her warehouse.
The reason she had one supplier is because of the increasing bargaining power she could have in negotiating her material costs, and thus her increased “profit”. However, what she did not realize is that most of this was risk-profit and was directly related to an increase in “supplier risk”, and not in her core business.
Now she understands that splitting her supply chain to, say, at least two suppliers may reduce her purchasing power but the marginal increase in cost is her “insurance” against supplier risk, and the long-term viability of her business.
Be bold, be visionary
Only a visionary leadership can insist on walking away from “risk-profit” to invest them instead to protect the real-profit and the long-term viability of the business.
Building a viable business is not a “nice-to-have”; it is your obligation as a responsible businessperson towards your clients, your employees and their families as much as yours. It is your duty to “understand” your profit margins, and how they come about. I also alluded to this in a previous post No Risk No Business.