Managing start-ups in Unregulated Markets

Developed by Aksel Watson

Abstract

In these times where many new inventions and technologies are erupting, many start-ups will find themselves in a place where they are entering untouched, untested or unregulated markets. For these start-ups it can be hard to identify and manage the risks that are associated with their future business since there are many unknowns that must be considered. Through this article these risks will be assessed and analyzed in order to determine if traditional strategic management approaches and models are appropriate for start-ups in unregulated markets.

What are risks?

Risks are often connected to a specific decision that can end up with a company or individual losing something of value. This includes both monetary losses such as money or customers but also non-monetary losses such as social status or emotional well-being. Therefore, companies will often have numerous measures in place to reduce these potential losses. Risks are often associated with entering an area of many uncertainties and unknowns that must be considered before undertaking any endeavour. .

Uncertainties vs. Unknowns

An uncertainty within industry refers to a process/project conducted or decision made under intangible circumstance i.e. where all information is not known by the concerned person. Uncertainties are caused in situations where data is only partially observable or if the project lies within a field where many values are stochastic and volatile. Uncertainties can often be hard to quantify as there is missing information. Therefore, when dealing with this, one will often see companies relying on probabilities to assess the consequence of uncertainties. Practically this is done by reviewing all the possible outcomes of this project and then determining the probability of them happening based on historical data, previous similar events or executive experience within the field. Unlike from uncertainties, unknowns refer to conducting a process/project or making a decision in an environment, where values are impossible to predict. Unknowns come in every shape and form, and greatly impact companies across the globe, since the risks and consequence are also unknown to the concerned person too..

Uncertainties are for example found within the insurance field, since it can be hard to estimate the amount of injuries or illnesses that will occur to a person or company within one year and thus hard to determine the insurance cost. Here they highly rely on historical data to generate an estimate where they can ensure profitability. Unknowns are often seen in new, emerging and disruptive industries, since there is no historical data to predict e.g. the demand of a product. .

Risks associated with start-ups

When a new business is starting up it is very sensitive to both external and internal forces due to the sheer amount of uncertainties and unknowns when setting up a company. In many instances start-ups will not have the financial capabilities to ensure that all risks are taking care of before launching their business. Therefore, it is important to at least understand which risks can occur in this process. In this section we will review the main risks associated with start-ups.

Financial risks

Financial risks are one of the most important risks when considering starting up a business. Purely start-up costs can often be very high and without any revenue or future purchase orders, this investment will have no security. Furthermore, starting up a company often consists of giving up the primary income source, thus the financial stability. The aforementioned costs and consequences will often be known and therefore the start-up will have calculated the financial feasibility of these actions. However, other financial aspects can be unexpected, such as rising raw material prices or facility rents.

Market risks

In order for a start-up to make a profit, there must be enough sales to cover the operating costs. The products in a start-up will often have no historical data, and to make precise forecasts is almost impossible. This can cause a start-up to buy excessive raw materials for the number of customers there is; there might be none. Another major risk for start-ups competing in red-ocean markets is that a competitor will out-compete them on price, quality, functionality or geographic reach.

Legal and regulatory risks

All start-ups and all companies lie within some type of legislation, however when the core business is not law it can be difficult to identify which laws and regulations your product or service falls under. For example a Danish start-up that sells fruit must adhere to the food law, health and safety law, employment law, marketing law, import law and many more. These risks can be reduced by doing the right research or using an external lawyer to adhere to correct laws before launching the business. However, laws and regulations can change, which can make it impossible for a start-up to continue business as is. For established companies, it is possible to change their business model or start a different company, but for start-ups this can bankrupt their business.

Human risks

Another aspect that must be considered is the risk associated with hiring new employees. Firstly, the financial risks must be considered again, since it very costly to have employees in a business both in respect to salary but also benefits such as ‘holiday pay’ and pension. However, these costs are known before hiring a new employee and therefore the start-up will have calculated the financial feasibility of these actions.

A more intangible risk is that if he/she can be trusted with respect to handling their time while at work as well as not stealing company money or equipment. Long term risks include that the employee will find a job in an established company in order to increase their salary.

Risks associated with unregulated markets

Not many products or services lie outside the ‘normal’ legislations and regulations that are present in European countries. However, innovative products that lie within the financial field, will often find themselves selling products or services that are not regulated. This is due to the structure and standardization, which needs to be in place when handling other people's money and investments. All the risks mentioned in ‘risk associated with start-ups’ are naturally also applicable for businesses operating in unregulated markets. However, with respect to legality, there are more aspects that should be considered.

Legal and regulatory risks

If a company does not fall within any law or regulations, it in theory means that their product or service can be marketed and sold freely. However, this involves numerous risks, since regulation can be implemented at any time. This can cause serious consequences in different ways.

Freezing assets

The regulations might entail that the way the business is currently providing a service or selling products is not legal anymore. This means if operations continue the government will freeze your assets. This is a major risk, since the suppliers, employees and third-party services still must be paid, however the company does not have any income.

Ruin the business model

As mentioned above, the new regulation might make a business ineligible to continue their business as is, which means that the giving company must rethink their business model. These changes can result in making the concept financially infeasible.

Global impact

Each country has its own legislation and regulations, and this means if the company is competing globally it can be affected differently in each country. Although this in some cases can be viewed positively, since only part of the company is affected, it can also result in high legal costs in each country.

Being suid

New regulation can cause the government or a third party company to sue the business. At the time of doing business the service or product was not illegal, however after new regulations, it has become so. In some instances, this will cause the government to sue the company for e.g. helping illegal gangs with money laundering.

Evaluating risks

The aforementioned risks are some of the most common endured in start-ups and companies in unregulated markets. Nevertheless, every company is different and the relevant risks associated with the business model must be assessed individually. A way to assess the risk involved in a business is using SWOT, PEST, PESTEL, BMC and PMC.

SWOT

SWOT stands for strengths, weaknesses, opportunities and threats and is a strategic planning tool for companies. It is used to identify internal and external factors that impact a business, a project or a product. The internal factors refer to strengths and weaknesses, since these emphasize which activities the company does well and which they could improve. The external factors are the opportunities and threats, since they represent factors, which the company itself cannot control.

SWOT analysis

Risk assessment

Using SWOT as a risk assessment tool, one must focus on weaknesses and threats, since theses constitute the risks involved in the product or service. A product’s weaknesses are often factors that can be improved and therefore a company can often follow a straight path to remove these risks. Threats are more difficult to act upon, since they are out of your control. However, when threats are identified, a company will have the opportunity to ensure that the consequences are minimized.

PEST

Pest stands for political, economic, social and technology and is a strategic planning tool for companies. Different from SWOT, PEST only considers external factors when evaluating a business, a project or a product. It is used to determine the environment that the business lie within with respect to the four aforementioned areas. Political refers to how the government impacts the businesses economy e.g. tariffs and taxes. Economic refers to how the economy in a given area is and includes factors such as economic growth, gross domestic product(GDP) and inflation. Social refers to demographics of the area and could be average age or sleeping habits. Lastly, technology refers to the rate the in which the technology is changing in the area and is often specific for each industry.

PESTEL

PEST is not comprehensive enough for many industries, thus for some projects, product or business PESTEL must be applied, which includes an environmental and legal aspect. These aspects allow a company to dig even deeper into the surrounding environment. Legal refers to the laws in the area such as marketing and competition laws. Environmental refers to the ecological aspects such as the weather or climate.

PESTEL analysis

Risk assessment

As PEST and PESTEL only investigates external factors, it is a very useful tool to identify which areas a company should focus its risk reduction measures. It can be very time consuming to make a comprehensive analysis for each factor. Therefore, companies can advantageously start by creating a SWOT, and then based on that decide which factors are relevant to dig deeper into. With the volatility of the current world and market PEST is becoming increasingly necessary when determining external risks.

BMC

The Business Model Canvas is a strategic tool often used by start-ups. It is used to visualize a company’s partners, activities, value proposition, resources, customer relationships, marketing channels, customer segment, cost structure and revenue streams. It allows the company to get an overview of all activities and procedures needed to sell their product to a customer. Unlike the previous models, the focus of BMC is internally in the company.

Project Canvas

The Project Canvas is very similar to BMC and describes the project's purpose, scope, success criteria, milestones, actions, teams, stakeholder, resources, constraints, risks and outcome. Unlike from BMC this model includes external factors such as constraints and risks. It is mainly designed to manage projects, but can be applicable to a company as a whole or a single product.

Risk assessment

BMC and project canvas are designed to be used when beginning a project or company. Their emphasis is therefore on the strengths of the company, instead of what weaknesses they have. Within risk assessment they both lack a comprehensive analysis of external forces that impact the business. It would therefore be beneficial to either combine BMC or project canvas with either a PEST or PESTEL to incorporate these risks.

Managing start-ups in unregulated markets

In conclusion it can be very demanding to set up a start-up, and there are many risks that must be considered before taking the step to become an entrepreneur. If in addition the start-up lies outside the country’s legislation and regulation it can be hard to move on without the right financial backing. Therefore, a start-up in this field, must be properly prepared for these indices and be able to withstand an ever-changing environment. Furthermore, all aforementioned risks must be considered in order to ensure, that the business does not end up going bankrupt.

A way for a start-up to be prepared in these types of situations is to combine external and internal strategic planning models in order to consider all aspects necessary. Thus, starting the analysis with a SWOT to determine the overall external and internal forces. Then making a thorough PEST/PESTEL based on the SWOT to identify the exact threat in respect to the surrounding environment. Then finally creating a BMC or project canvas, with a business model that facilitates the threats identified in the two previous analysis.

Managing start-ups is a time consuming task, that involves many unknowns and uncertainties, however using or combining the correct tools will facilitate the process.