> Not to nitpick but managing supply-chain risk is a lot more complicated than insurance.
I agree. I manage an ERP system at a pharma-manufacturer. I added a YMMV precisely because of the different situation - different impact reasons. My main point was:
Incumbent Sales Price SP1 = Cost of (Base + Risk + CYA-buffers) + Predetermined Margin
Incumbent Profits PR1 = SP1 - Total Actual Cost
Startups Sales Price SP2 = Cost of (Base + Risk) + Predetermined Margin
Startups Profits PR2 = SP2 - Total Actual Cost
If you assume Cost of (Base + Risk) to be relatively on-par then SP1 > SP2 because SP1 includes CYA-buffers. The problem is that when incumbents become lean and shave off overhead, they can continue to command high prices due to entrenched contracts and make a much larger profits. This reinforces their position in the industry, making it harder for startups to compete.
Sidenote: While in a perfectly competitive market, the sales price should be determined by the intersection of supply and demand curves, instead of being a predetermined markup based on cost, in most contract manufacturing environments, all the costs are known, markups are expected, and thoroughly negotiated.
I have seen two predominant forms of risks factored in by the larger incumbents waiting to be disrupted. One is, like the author puts it, the risk due to breakage. Be very mindful of this risk and insure against it if possible or change something to avoid/lower the risk (sorry, we don't wash Luxury cars).
The other risk factor is pure CYA. Nobody wants to prepare a costing worksheet for a customer quote where your cost is too low because you didn't factor in the various overheads. Only after the annual financial statements are made will you find out if you lost money on the product or not. Do you want to be the guy who buys at $10 and sells for $20 only to find out before bonus-time that overhead was $90 per unit? So you factor in the cost of capital, inventory hold charges, shipping delays, warehouse pallet transfer cost, foreign exchange currency buffer, and tons of other charges. This makes it appear that your cost is high and so it is only natural to charge more for the product. Boeing isn't going to sell an Arduino + LED light for $100. It will be $500 because of risk of breakage and be $5000 by the time all the CYA risks have been tacked on by six levels of middle-managers.
The wonderful thing about CYA risk factors is that they help justify your high prices and if you are able to be lean, they give you a terrific margin. THIS is what you want to disrupt. You can charge less than the incumbents because they are playing it way too safe as nobody wants to lose their neck for selling a product at a loss. But don't charge so low that risk of breakage ends your business. The good thing is that the risk of breakage is not as large as the CYA risks in most every costing sheet that I have seen. YMMV depending on the industry/product.
You should address that question to d0vs, as he is the one who made that point.
But now that I have a chance to think about it, I can see his point. Most companies don't really take that particular risk into account and just kick the problem down the road. If you tried raising it as an issue, you'd get responses ranging from 'sure, figure out a way to value the risk and we'll add it into the model', to 'who cares really?'.
Thanks for the feedback. I am attempting to understand my own failings in interpreting these responses. I am attempting to evaluate risk in a business context.
To add: Choosing which risks to tackle should definitely be weighted by difficulty, impact and available resources.
Also, this feels like it's forcing an external portfolio manager view on the internal operations of a startup. Nothing wrong with this - it's just odd to me.
1. At least on first reading, I don't disagree with anything in your analysis responding to my own; in particular, your mail-order catalog analogy seems quite apt.
2. You're correct that the risk-management precautions to which you refer have costs associated with them. Within limits worked out over decades in legislatures and courts, the law allows companies to use contracts to reduce such costs by shifting the associated risks to others.
When a company has sufficient bargaining power, its management typically attempts to do just that: Use standard-form contracts to shift risks to others, and thus reduce the company's costs.
(I spend some of my time helping to negotiate such contracts. As you might imagine, the standard-form contract of a powerful customer will usually be very different from that of a supplier.)
At the risk of belaboring the obvious, this is the same principle that's behind self-service gasoline pumps and self-service checkout lines in grocery stores: The more of a company's costs that the company can get its customers (or its suppliers) to take on, the higher the company's margins will be for the same amount of revenue. Not least, companies' managements are motivated to do this because eventually a company's aggregate costs will necessarily be reflected in the price, and thus the competitiveness, of the company's products and services.
(The costs of a company whose stock is publicly traded will also be reflected eventually in the price of the company's stock. That's generally high on the list of management concerns as well.)
3. The question you seem to pose is whether we should simply forbid contracting parties from contractually shifting risk as described in #2. Various state- and federal laws already do that to a certain extent; see, for example, consumer-protection laws, as well as article 2 of the Uniform Commercial Code (which in most states governs the sale of goods), not to mention employee-protection laws.
Whether a given jurisdiction should attempt go even further in that direction is a question that comes up every so often. One example is the recent controversy over the U.S. Supreme Court's 5-4 decision that companies can legally include mandatory arbitration provisions in their consumer contracts, thereby largely eliminating the possibility of class-action lawsuits and thus considerably reducing consumers' leverage [1].
Whenever the issue does come up, representatives of various affected interests converge from all directions --- including but not limited to so-called consumer lawyers eager to gain, or preserve, sources of contingent fees and/or statutory attorneys' fees awards.
Ultimately the issue boils down to a political question: What should or should not the law be? As with so many such questions these days, the deep ideological divisions among the American people often result in no change to the status quo.
One person's calculated risk is another persons sheer terror. If you have been employed by a midwestern insurance giant for 20 years, your idea of risk might be heavily influenced by gartner, and you think in terms of "best of breed" and look for approaches that are "mature". If you are familiar with the field, and familiar with what you can do, you dive into building the key part yourself--something that never existed before and therefore has infinite gartner risk. And you are going to build your business on this?
My point is that the article shows how a different point of view about the risk of something if you are running your venture.
Mitigating risk is covered in the cost reduction side.
Yes the C-Suite is thinking about and mitigating risk. They probably know the exact number for a given class of risk in terms of current mitigation costs. You have to beat that by a margin wide enough for them to take action.
Even if you know their numbers and know you beat it by enough to warrant the deployment you will still get bumped if someone sells them a path to increasing revenue.
The out I gave was to frame it as value added (more revenue) and that is where you risk devaluing your current product.
If you frame it as cost reduction you are capped in both price and interest by the current, necessarily acceptable, levels of risk and cost of mitigations.
Because as companies get bigger they worry more and more about the long tail of risk.
They do this for many reasons, but generally predicting the risk of very low probability events is very difficult, so they don’t understand the risk vs cost tradeoff as well as they think.
It's way too early to know whether you're really at a disadvantage. That's just your lizard brain freaking out.
Your biggest risk is failing to execute. Both you and your competitor have a thousand ways to screw up long before you have to worry about the impact of competition with each other.
It's like obsessing over the danger of shark attacks while failing to wear your seatbelt. Deal with the risks that are orders of magnitude more important.
You don't even know if they're going to pivot in response to some other real or imagined competitive threat or opportunity.
I don't know if you are running your own business, but it's just so hard to take into account all kinds of possible risks. It's just impossible to work like that. Most of the time you gamble which resources to put where. Else you end up in analysis paralysis.
I agree. I manage an ERP system at a pharma-manufacturer. I added a YMMV precisely because of the different situation - different impact reasons. My main point was:
If you assume Cost of (Base + Risk) to be relatively on-par then SP1 > SP2 because SP1 includes CYA-buffers. The problem is that when incumbents become lean and shave off overhead, they can continue to command high prices due to entrenched contracts and make a much larger profits. This reinforces their position in the industry, making it harder for startups to compete.Sidenote: While in a perfectly competitive market, the sales price should be determined by the intersection of supply and demand curves, instead of being a predetermined markup based on cost, in most contract manufacturing environments, all the costs are known, markups are expected, and thoroughly negotiated.
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