© 2011 Towers Watson. All rights reserved.

Enterprise Risk Management – Small Businesses2012 SOA Annual MeetingSession 21

Jay Vadiveloo, Towers WatsonDr. H.G. Parsa, University of Denver

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Outline

Motivation for Enterprise Risk Management for Small Businesses (ERM-SB) initiative

Why ERM-SB does not exist?

Similarities and differences between ERM for large corporations and small businesses

ERMSB initiative at the Goldenson Center, Univ. of Connecticut

Case study – ERM analysis of the Restaurant Industry

Where do we go from here?

Conclusion

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Motivation for ERM-SB Initiative

Small businesses are the largest, fastest growing and most important segment of the American economy

Small businesses experience one of the highest failure rates compared to large corporations

Lack of any institutional or formalized risk management for small businesses

Small businesses do not practice risk management in a formalized or organized manner.

Enterprise Risk Management is a comprehensive approach addressing risk in all functional areas

ERM is an effective proactive prevention tool for small businesses

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Why ERM is not popular with Small Businesses?

Small Businesses do not use ERM frequently for Lack of familiarity

Cost of implementation

Fear of change

May be financially unable to do so

Unaware of benefits of ERM

— ERM as a prevention tool

— ERM as an early ‘wake up’ call

— ERM as a comparative analysis tool

— ERM as a financial tool

As a consequence, ERM principles and literature are tailored primarily to large corporations

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ERM for Large Corporations Vs. Small Businesses

Fundamental Steps are Similar Identify and prioritize risks

Model and quantify the risks

Customize the model for the industry / firm

Create risk-mitigation strategies

ERM as an ‘exercise regime’ for healthy operation of a small business

ERM reduces insurance costs

ERM lowers workman compensation costs

ERM lowers potential risk in financial matters

ERM helps in identifying operational risks and the associated costs

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Differences with ERM for Large Corporations

Needs to incorporate business growth strategies as well

Need to focus on reasonably likely risks with serious consequences versus low likelihood events with serious consequences

Business owners are very knowledgeable about risks and business growth strategies

Easier to assess and manage risks of a small business, but consequences of a risk shock are far greater

Qualitative Risks Vs. Quantitative Risks

ERM analysis covers shorter time periods (one to three years) and should be revisited periodically to remain relevant

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Differences with ERM for Large Corporations: continued

A well defined ERM analysis, which incorporates business growth strategies, can materially improve the sustainability

and profitability of a small business

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ERM Initiative at the Goldenson Center, Univ. of Connecticut

Successfully operating for the past three years

Numerous success stories of helping small businesses with ERM

Students are funded by the Goldenson Center to undertake ERM-SB projects in the region

Service offered free-of-charge to small businesses

Students work in teams and provide a formal written ERM report and any software tools at the end of each project

It is a win-win situation

Small scale operations are in progress and on-going

Restaurant industry is the ideal choice for testing ERM-SB model,

© 2011 Towers Watson. All rights reserved.

Enterprise Risk Management – Restaurant Industry

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ERM IN SMALL Businesses

Service Economy

Restaurants as a Case Study One of the largest service industries in US

Over $640 Billion in annual sales

Nearly 13 million employed in this industry

Americans eat 1 in 3 meals at restaurants

A classic small business industry

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ERM IN SMALL Businesses

Failure Rate in Restaurants Over 30% of restaurants fail in the first year

Nearly 60% fail in 3 years

Survival rate dramatically increases after the 5th year

Independents have higher failure rate than chain restaurants

Failure rate depends on various factors

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ERM IN SMALL Businesses

Factors in Restaurant Failure:

Macro Factors Economy, Legislation, Tourism, Food Trends, Technology, Demographic

Shifts

Micro Factors Prime Costs, Management, Working Capital, Quality of Life, Entrepreneurial

Incompetence, Control Systems, Cash Flow Mgmt.

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ERM IN SMALL Businesses

Factors in Restaurant Failure:

1. Size of a Restaurant: Small vs Large

2. Ownership: Franchised Vs Non-Franchised

3. Concept: Regional preferences

4. Location: Downtowns Vs Suburbs

5. Location: Zip Codes

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ERM IN SMALL Businesses

Factors in Restaurant Failure:

6. Demographics – Study from Boulder, CO

7. Working Capital Vs Investment Capital

8. Cost Structure – Prime Costs

9. Economy – Tourism in particular

10. Legislation – National, Regional and Local

11. Legislation – Calories – Study from Denver Univ.

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ERM IN SMALL Businesses

Restaurant Failure Studies – Columbus, Oh - Ohio State University Atlanta, GA Los Angeles, CA Boulder, CO

Case Studies – Cornell University Report

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ERM IN SMALL Businesses

Risk Metrics and ERM in Restaurants

Financial Metrics

Operational Metrics

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ERM IN SMALL Businesses

Financial Risk Metrics in Restaurants1.Sales per Unit

2.Sales Growth in Dollars per Unit

3.Sales Growth Rate over 1, 3, 5 years

4.Ratio of Food to Beverage Sales

5.Prime Cost (Food / Labor Cost)

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ERM IN SMALL Businesses

Financial Risk Metrics in Restaurants1.Gross Margin

2.IBITAD

3.Cash Flow Analysis

4.Debt to Income Ratio

5.Current Asset Ratios

6.Fixed Costs and Long term Commitments

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ERM IN SMALL Businesses

Operational Risk Metrics in Restaurants

1.Guest Check Averages

2.Number of Seats

3.QSC Scores

4.Level of Ambiance

5.Employee Turnover Ratios

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ERM IN SMALL Businesses

Operational Risk Metrics in Restaurants

1.Management Turnover Ratios

2.Number of Seat Hours

3.Number of Transactions (Covers)

4.Number of Transactions per Ops. Hour

5.Longevity of the Business

6.Terms of Lease

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Risk Metrics and ERM in Restaurants

Expected Outcomes Lower Failure Rates

Improved Success Rates within a System

Caution Notice for Potential Failures

Proactive Strategies when at Risk

Comparative Analysis

New Market Analysis for Risk

New Location Analysis for Risk

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Risk Metrics and ERM in Restaurants

Expected Outcomes Lowering of Financial Risks

Improved Investment Decisions

Improved Operations

Good Public Policy – helping small businesses Good Private Decisions – financial & operational

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Where Do We Go From Here? Need to expand the Goldenson Center’s ERM-SB initiative in order to

make an impact in the Restaurant Industry or other business sectors

Any large scale implementation should be supported by a large organization, corporation, private foundation and government agencies and not necessarily by a small business

Most cost-effective way to undertake these projects is to partner with academic institutions and engage students at universities all over the country

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Where do we go from here cont’dERM text for Small & Medium-Sized Enterprises (SME’s)

Approached by Actex publishers to write text

No such text currently exists in the ERM literature

The SOA has expressed an interest in funding this text from their 2013 research budget

Articles will be contributed by experts in the field, both practitioners and academicians

If properly designed, this book could become a required text for students following the SOA ERM track

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Where do we go from here cont’dPotential Topics for text on SME’s

Underlying principles governing ERM for SME’s

Overview of SME’s in the US

Differences/similarities between ERM principles for start-up SME’s, SME’s in business for a few years and established SME’s

In-depth ERM analysis of some key SME business sectors based on actual case studies

Regulatory environment for SME’s and impact on failure rates of SME’s

Steps involved to undertake an ERM analysis for a given SME sector, including measuring and tracking results

General ERM principles and methodologies for large corporations which can be adapted for SME’s

Best practices to create a vibrant and growing SME environment in the US and the value of establishing a risk management culture for SME’s

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Conclusion

The Goldenson Center has just scratched the surface in showing how an effective ERM culture can be created with small businesses

ERM-SB is a form of micro-risk management and can be replicated globally with funding from large corporations and other entities with university students doing the projects

To have an impact, ERM-SB should analyze and monitor an entire small business sector (e.g. restaurant industry, retail drug store industry, independent marketing organizations, etc) versus individual small businesses

Huge payoff since any reduction in the failure rate for small businesses would be a boost to the overall economy

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Contact Information

1. Jay Vadiveloo, Ph.D, FSA, MAAA, CFA

Professor-in-Residence & Director

Janet & Mark L. Goldenson Center for Actuarial Research,

University of Connecticut &

Senior Consultant, Towers Watson

jay.vadiveloo@towerswatson.com

2. H.G. Parsa, Ph.D., FMP

Barron Hilton Chair in Lodging & Professor of Hospitality Mgmt.

Associate Editor, Journal of Hospitality and Tourism Research (JHTR)

Fritz Knoebel School of Hospitality Mgmt.

Joy Burns Center

2044 E. Evans Ave

Daniels College of Business

University of Denver

Denver, CO 80208-2100

(303) 871-4791

hparsa@du.edu