Navigating Business Risks With Kevin McDonell

Thanks Crystal, thank you for having me on today, I really appreciate it. Well, I've been a CFO for many years now. As you said, I've been working with Aero Environment, which is a public aerospace and defense company. But before that, I've worked in many different industries with many different sizes of companies. So I've been kind of a student of seeing how organizations bring about change, how they adopt a strategy and try to grow, and how they make decisions in general. So that's what I'm really passionate about: how do organizations make decisions, how do they empower their managers and their leaders to make decisions, to change really, because organizations only survive if they're able to make changes along the way and adapt to their environment. If they're stagnant and don't make changes, then they're doomed to failure over the long term.

Well, somebody asked me the other day that since I'm a CFO, I don't like risk, but that's not really true. At the end of the day, you can only create value for any organization or even for yourself if you take risk. The key is to understand what the risks are and understand what the rewards are, and balance the risks with rewards so you can make good decisions. But you don't just make decisions based upon not taking risks, because that will get you nowhere. So for businesses to achieve long-term success, they need to understand that they have to take some risk, but at the end of the day, they need to understand what their goals are and how to allocate their resources to those goals and not get distracted by things. A lot of times organizations get distracted or, as I like to say, they fall into what's called the good idea trap, meaning people think that if it's a good idea, they should do it. But in reality, organizations need to focus on the things that are going to get to their long-term objectives and not try to do everything that's a good idea. It's not a trick to find good ideas; it's a trick to decide what are the top few good ideas that you should pursue as an organization, a startup, or even a more mature company. How do you sort through all those opportunities and make sure that you're doing the best ones and putting resources to that? That is really the trick to business in a nutshell.

Well, I've really thought a lot about how people make decisions and why they make certain decisions, and I've also kind of come to understand that risk and reward is foundational to our whole life, to everything that we do. And so few people really understand the dynamics of risk and reward. Even simple policy changes, like how people would license or have fees for housing, have affected our housing market because they've increased the fees thinking that the developers can just pay it, but at the end of the day, that decree increases the risk and the cost of doing something, so the risk-reward isn't there to build new housing. That's why we have a housing shortage. So it's the same thing for any organization: they need to understand the risk-reward dynamic. People fundamentally, in our nature, try to avoid risk, and we're educated probably to avoid risk, but they need to get over that. And leaders, at the end of the day, leadership is about the people that are able to take risks to move beyond the status quo, which is taking risk in and of itself, and do things that are going to change the organization for the better, or in ourselves the same thing. It's a personal thing also. We, as we do things like doing this podcast, I've never done a podcast before, it's taking a risk to do a podcast. So in order to move ourselves forward, to move organizations forward, we have to take risks. But again, we have to understand what the nature of those risks are and how to maybe mitigate them. And usually knowledge is one of the things: learning something about something first and really understanding it before you jump into it is a big risk mitigation factor.

Well, if you're in a company, one of your top risks is obviously your competitors and the environment that you're in. If you aren't responsive to that or understand that or have a systematic way to look at what your competitors are doing, they're going to surpass you, they're going to beat you in the marketplace, so whatever you're doing becomes obsolete. So the biggest risk, particularly for more mature companies, is their competition, the environment, how trends are changing, and things like that. Now if you're a startup, your biggest risk is running out of money, so you have to be very careful about how you spend the money, spending on things that are going to increase value. It doesn't make sense to me when a company says we're going to raise money and the first thing they're going to do is buy furniture and have a new office when that doesn't really increase the value of the firm. You have to do things that are going to increase the value so that you can take on more investors. So if it's a new product, you want to show that the product is working and there are customers that like it. Now it might need a lot of improvement, but at least you've proved that the product has value. So for a mature company, it's your environment and competitors; for a startup, it's really proving the business model, proving that the product works, and spending money wisely on that goal.

Well, a lot of companies, particularly as they get larger, face the challenge that their systems, their accounting systems, all of their operational systems are getting too small for what they have. For instance, QuickBooks is a good solution for a startup business in terms of doing their accounting, but as the organization gets bigger and more complex, somebody has to put in a new system, maybe it's a NetSuite or a more sophisticated system to allow the company to go global. Anytime you put in a new system, that's taking risk. And the fact of the matter is, a lot of people don't even have the experience of putting in a new system or how to set up a new system, so it's very risky for them. So the person who goes out in front and says I'll put in the new system is taking a lot of risk. And I tell people when they're implementing new systems that the worst thing to happen is they start calling the system by your name. If they start saying it's Crystal's new system, you're in trouble, because really it needs to be the company's new system, the organization's new system, and we all need to do this for the growth of the company. So that's a good example of where organizations have to take risks. Another risk might be a new product or a new market. If we're just selling something in Los Angeles, and now we want to sell it in San Francisco, or if we're in the United States and we want to sell it in Europe, that's a big risk. A lot of people underestimate the cost of selling a new product in Europe, where they have different requirements about privacy laws or how the electrical systems work. So there are a lot of complexities when you go into new markets.

Well, definitely that's a way to grow. At the end of the day, you have to grow, so in order to grow, you need to take risk, and a lot of times that growth has to be going into markets. But you have to go to the new markets for the right reason. Often I see you decide to go to Brazil because somebody's brother-in-law knows somebody in Brazil that might be able to sell your product. But at the end of the day, if you listed the top 10 countries to expand, you wouldn't pick Brazil, but you just happen to have a contact down there. So companies need to be thoughtful, not reactionary, to where they expand. They need to go to what's the next best market, not where do I know somebody. So find somebody to go to the market that is going to be the best next market for you, and find somebody that can help you expand there, versus doing it the other way around, going with somebody who just happens to be a connection. At the end of the day, that might not be the best next market for you. So many companies make the mistake of making that decision based upon some contact versus what's best for their product or service.

Well, as I think I said earlier, really it's about knowledge. It's having the information flow about what's happening in your market, and not just being inside your own silo of information, but really reaching out, understanding the market, using outside consultants to tell you about the market or evaluate your own position in the market. So you're not always just looking from an internal point of view, you're also getting an external point of view. That is very healthy, to get somebody to say we've looked at your product, we've looked at the market, and you're not in a good position, or you have a good position but you have to worry about this competitor. So getting that external point of view can be very helpful as you evaluate your situation in a particular market.

Well, again, be clear on what you're trying to accomplish and carefully monitor the milestones. So if you want to enter a market, maybe the first thing would be we're going to open an office there, we're going to hire people there, but what is a good milestone to see if we're headed in the right direction or not? Companies spend a lot of money getting set up, and before they know it, they don't have enough money to fully execute. So try to establish a proof point as early as you can in the process of whether this is the right market for you or not, and be reflective on what is working, what's not working, why is this going to be successful, why is this maybe not going to be successful. So many companies waste maybe even years before they really evaluate if this is going to be a good success or not.

Well, maybe the best example would be my last company. It was their pricing scheme, how they priced their services. It was a services company in the legal services market. They had a certain model that they were pricing their services, and I took a look at it and said it was out of sync with the market, meaning there was opportunity to get more revenue based upon making the pricing more consistent with their competitors. But bringing about a complete overhaul of the pricing scheme of the different services makes people nervous. How are the customers going to react to it? In reality, it simplified the pricing for the customers, and the customers appreciated the new pricing even though it generated substantially more revenue for the company. The profitability of the company actually tripled through the new pricing, even though the customers were happy with it. But it was a big risk, and we took a lot of time educating our own staff on the change and why we're making the change, allowed them to have input into that, and that all really helped make it a much smoother process. So educating people on the change and what's happening is a critical part of reducing the risk.

Well, I think my biggest learning is to educate people on why you're making the change. Maybe it's being responsive to the market, maybe it's because you need to improve your profitability, maybe it's preparing for growth of the company and that's why you're going to put in a new system. But no matter what you do, people are kind of like a bell curve. There's always going to be five or ten percent that are going to resist it no matter what you say. There's going to be five or ten percent that are on board from the beginning, they're all for the change. But then it's the people in the middle that you really have to educate and try to turn to the positive in terms of the change. You'll never convince that five percent that just don't like change and they just don't want to change at all. So you really focus on that middle group, educating them so that they understand why you're making the change.

Well, my theory is as you get the other 95 or 90 on board, they pretty much have to change or they leave the organization. They're not comfortable with it, but once they see everybody kind of on board, it's hard for them to continue to resist.

I have not seen a higher turnover rate. Any change is hard, particularly if it's a new system. Not everything works perfectly. Usually sometimes in a new system, you're taking a step back, so it's really easy for the people that are critical to point out the problems. But after a period of time, the new system becomes the system, and there aren't as many issues. So again, it's all about educating people on why you need to make change, why organizations need to move forward.

Well, they're taking risks. Like I said, as a small company, you're taking a significant risk that you're going to run out of money. So when you start out, you've got to be really clear on what segment of the market you're going after. If you try to be too broad, try to serve too many different masters or too many segments in the market, you're probably going to fail. You're better to prove your concept on a small segment and do it really well, and that takes less money. The broader you go, the more money it takes. But if you focus on something, then it will take less money and you can do it well, prove out your concept, and then take it to a broader audience. But the key is focus on a niche, don't get distracted by all the possibilities, which is really hard because you're not really sure if you're picking the right niche. As an entrepreneur, you're never a hundred percent sure that you made the right decision, so you have this temptation to hedge your bets into other areas, when in reality, if you just focus on something, you'll have a much higher degree of success. I like a good example, not a small company, but Apple Computer and Steve Jobs. Everybody says how brilliant he was and he was a master designer of products, but the thing that struck me in reading his biography was that he took his team aside once a year and they picked the two or three things that they were going to focus on. If you think about Apple, they could have done many different products, they had a good brand, but they took the smart tactic of focusing on two or three and doing them really well. That's what small businesses should do also: pick a niche, do it really well, and then expand from there.

What maybe you pick your thing and you partner with other people on the other things, so you can provide a complete solution. Because maybe they need the complete solution and that's important to them, but you don't necessarily have to do it all yourself. You could, it's like building a house: the contractor maybe he's a good carpenter and he'll do all the carpentry, but then he hires everybody else to do other pieces of the project.

I think it's just what I've been saying: pick a niche, focus on it, be clear on whatever funds you have, that you use those funds wisely to get to your goals, because then it'll be a lot easier to raise additional funds if you need to raise outside funds or start generating cash flow in the business. The broader you get and the less focused you are, the more chance that you're going to run out of money and you're not going to get cash flow positive, you won't be able to raise investors. So focusing, proving it out, be confident in what you choose, because I think you shouldn't be second-guessing yourself on whether you picked the right niche or wrong niche. Maybe you didn't pick the best niche at the end of the day, but if you focus on that and do it well, then you can expand into other areas. But don't be too broad, focus.

Well, if they have enough money themselves, that's the best, because then they can. But it just depends what your goals are. Obviously, when you raise funds, particularly from the outside, you're going to face dilution, you're going to face somebody who may have an influence on what you're able to do or not do. So as long as you can push that off, the better. But when you get to a point where you've at least proven something and you know what the next goal is, that would be the time to raise additional funds with somebody that can add value to the situation, an experienced investor that might have knowledge about your market or can help expand your customer base. So you would look to raise money not just from somebody who has money, but ideally from somebody who can bring expertise. And then be real clear on what the milestone is that you're trying to achieve with the money you get. In other words, if you raise a million dollars, what does that million dollars get me? It gets me a product that's in at least 100 customers' hands, or some specific goal. And if you accomplish that goal, then when you go back to the investors, you go, I raised a million dollars, my goal was to get 100 customers with the product, and I did it, or I got 120. Now you have credibility, and now it's a lot easier with less dilution, you've reduced the risk. Again, it's all about risk and reward. So the more that you can prove that you can take the money you get and establish the milestones and accomplish them, the less risk the investor is going to have for the next round, and the less dilution that you're going to receive when you raise additional funds.

Well, I've been doing this a long time, I've seen a lot of different organizations, and I've kind of been curious always about what makes organizations successful. What makes them successful is the ability to make good decisions. Well, who makes good decisions? It's the managers. And why do they make good or bad decisions? It's understanding this risk dynamic and having an environment where those managers feel comfortable taking risk. If you're in a culture where if you take a chance and it's not successful, you lose your job, then nobody's going to take risks. So how do you create an environment where managers, particularly managers, are willing to take risks? I call it empowering the managers. Everybody talks about empowering employees or customer service, meaning the customer service person goes above and beyond to solve the customer's problem. But the manager side of it is how do I get managers to take the necessary risk to move the organization forward and create an environment where they're comfortable taking those risks? So that's kind of the basis of my dissertation: how do you create that environment?

Exactly, you got it on the head there.