Taking the leap of starting a new business can be exhilarating, but it also comes with a certain amount of risk.
According to the Bureau of Labor Statistics, only 79.4% of companies are still running at the one-year mark. By year seven, 53% of new businesses have closed their doors.
Still, over 1m new businesses were established from March 2021 to March 2022, a 51% increase from the year before. The question then becomes, “How can an aspiring founder turn the odds in their favor?”
Understanding industry risk is an excellent start. What the averages don’t tell you is that each industry comes with its own level of inherent risk.
By understanding the nature of different industries, budding entrepreneurs can make more informed decisions about which markets to enter and decrease some of the risk of launching a new venture.
What is industry risk?
Industry risk refers to factors that can positively or negatively impact a specific industry and, by association, the companies in it. Most significantly, your industry’s risk factors can affect your business’s growth, profitability, and volatility.
For instance, industries with historically volatile earnings (such as agriculture and fishing) or decreasing revenue outlooks (such as DVD rental stores and record stores) involve more risk. Other factors range from competition level to financing difficulties.
Generally, emerging industries are associated with higher risks than mature ones with steady outlooks.
Why you should understand industry risk
It’s tempting to look at a successful startup and attribute its growth to the competency of the founders or the brilliance of the business model.
But external factors also deserve a lot of credit. Companies don’t exist in a vacuum. Instead, they’re at the mercy of influences that business owners can’t control, such as competition, consumer behavior, and macroeconomic trends.
Some industries are more or less resilient to external factors. For example, hospitality companies were much more susceptible to travel restrictions and changes in income during the pandemic. Utility companies, on the other hand, tend to be less affected by economic downturns.
That’s why understanding the risk associated with your chosen industry is essential for any entrepreneur.
Industry risk can help you decide whether to quit your job and go all-in on a side hustle. It’s also something that potential lenders and investors may look at when determining funding.
Finally, analyzing industry risk will help you set more realistic expectations around essential milestones, such as when you expect to break even or turn a profit.
Sinoun Chea, CEO of internet marketing company ShiftWeb, says, “Industry risk analysis helped me plan for potential challenges and set up contingency plans. In my experience, being prepared for risk can make all the difference in a business’s success.”
Industry risk assessment
There are several risk factors to consider when analyzing an industry. They can be divided into three categories: structural, growth, and macroeconomic.
Structural risk refers to the factors inherent in an industry based on the nature of the product/services and the companies currently in it.
Barriers to entry: The obstacles that may prevent newcomers from entering the industry. Examples include startup costs, customer loyalty to brands, and industry regulations.
Competition level: The intensity of the rivalry between companies in the industry. Intensity is often higher in industries with slow growth (where competitors have to poach customers from one another) or where exit barriers are high and companies would rather compete than close.
Life cycle stage: The maturity of the industry. Emerging industries tend to be less predictable and are often associated with higher risk.
Volatility: Whether the industry has a history of rapid or unpredictable changes, often due to shifts in supply or demand, such as agricultural products whose yields can vary based on weather and climate conditions.
Bargaining power of suppliers: How much leverage vendors in the supply chain have. For instance, if there are fewer suppliers compared to buyers, they have more bargaining power.
Bargaining power of consumers: How much leverage consumers have over the prices of your product or service. Consumers tend to have more leverage on products that aren’t necessities or those that have low switching costs.
Risk of product substitution: How easy it is for consumers to find an alternative to your product or service.
Growth risk refers to the earnings outlook for an industry compared to the country’s economic growth. Mature industries with positive growth projections tend to be less risky because consumer demand is high and predictable.
Growth industries (or pioneer industries) are those in their early stages, such as artificial intelligence or virtual reality. Budding sectors can offer more growth opportunities, but they can be harder to predict as there is no historical data.
In contrast, industries forecasted to grow slower than the economy are said to be declining. Examples include newspapers, railroads, and bookstores. These types of industries present more risk because the opportunity for profit is slowing down.
Macroeconomic risk factors
An industry can also be analyzed based on its relative sensitivity to macroeconomic factors, such as changes in the gross domestic product (GDP). While the state of the economy affects all businesses, its level of influence varies between industries.
If macroeconomic factors have more influence on an industry’s performance and outlook, that implies more risk.
For example, industries with products that require financing, such as real estate and automotive sales, are susceptible to interest rates.
Along with GDP and interest rates, other macroeconomic variables include inflation, exchange rates, and government regulation.
Industry risk ratings
Market research companies, such as IBISWorld, Mintel, and Gartner, are helpful resources when it comes to analyzing an industry before entering it. They each have their own methodology to calculate the risk rating for a specific industry.
Examples of high-risk industries
Sawmills and wood production: Has declining revenue projections, due in part to high-interest rates, which reduced borrowing for construction products.
Cotton farming in the US: Relies heavily on revenue from exporting goods, making it sensitive to global shifts such as weather changes and international policy.
Telecommunications network manufacturing in the US: Due to an increase in competition from international providers who can sell at lower prices.
Examples of low-risk industries
Medical and recreational marijuana: Has high growth projections, increased consumer acceptance, and countrywide regulatory changes are in favor of the product.
US solar power: Has falling input costs and government encouragement of solar energy.
Online hotel booking: Due to increased interest in travel following the pandemic, as well as more people using the internet to book services.
Industry risk management: 5 tips
There’s no way to completely eliminate the risk of starting a new business, but use these tips to proactively manage and reduce your risks.
1. Limit your liability
As an entrepreneur, you want to limit your personal liability to the business, even if you’re a solopreneur. That way, you and your family are insulated in case of bankruptcy, lawsuits, and anything else that may happen.
Start by choosing a business structure that separates your personal assets from your business, such as an LLC or a corporation. Then, make it a habit to document all agreements, business activities, and transactions.
2. Buy insurance
Purchasing business and professional liability insurance protects you, your business, and your property from the financial risks of unforeseen lawsuits.
You can also get business property insurance to protect against building or equipment damage. Depending on your industry’s regulations, business or professional liability insurance may be a requirement.
Even if it’s not, consider it essential from the beginning. As an added benefit, insurance can help with fundraising as it lowers risk for your potential investors.
3. Monitor risk factors
Some risk factors most relevant to your business will surface during your industry assessment. Knowing them at the beginning is essential, but you don’t want to forget about them later.
“The most important risk management step for founders to take is to create a process and system for tracking, managing, and mitigating risks,” advises Josh Wood, founder of event app Bloc.
Wood notes that you need to identify potential risks, assess how likely and severe those risks would be, develop mitigation plans, and then track progress against those plans.
For instance, if you’re in an industry with compliance risk, such as pharmaceutical sales, you can schedule regular training sessions where employees learn how to implement new government regulations.
4. Implement quality assurance
Young companies don’t have the same resources as well-established corporations. That means issues that arise from poor-quality products or services can have a much more significant financial impact.
Implementing quality assurance (QA) procedures from the start helps reduce operational risk, which results from human error, inefficiencies, or failed processes.
QA refers to any system you put in place to verify that your products or services meet predefined standards and to fix any problems before your offering reaches consumers.
If you’re manufacturing products, that may mean inspecting items before they’re delivered. Software companies, on the other hand, often beta-test new features to identify and fix any bugs in the new code.
As an added benefit, focusing on QA early on enables you to build a culture of accountability.
5. Diversify income streams
Try to generate multiple streams of income so one loss won’t take down your whole ship. This could be as simple as ensuring you don’t rely on any single customer as your business grows. However, you can expand this idea to your product development too.
SaaS companies can opt for several product tiers, each aimed at a different type of customer.
For instance, you can offer a basic package that’s appropriate for small businesses and an enterprise tier for larger companies that want to customize their software. You can also offer adjacent products or cater to various industries or use cases.