The difference between risk tolerance and appetite (and a few other things)

Risk management is all about ensuring you both understand and optimize the amount of risk your organization is taking in pursuit of strategy. It’s not about getting rid of risk, it’s about taking the “right” amount. There are a number of terms that are sometimes used in differing ways in various organizations, here is one perspective on how they should be defined:

Risk capacity: This defines what your organization is able to bear in terms of amount and type of risk. Differs from appetite because not every organization is willing to gamble everything on every new strategy that comes along. Some are, depends on who is leading and what is at stake.

Risk appetite:This is what your organization is willing to accept in terms of risk, in pursuit of the strategy. How far is the board willing to go? Something every CEO needs to know.

Risk tolerance: Tolerance is the maximum amount of risk acceptable, specific to your major risks or areas of appetite. Not intended to replace the balanced scorecard, this is a broader, longer term perspective within which the executive builds business plans.

Risk target: The ideal level of risk you want to take in pursuit of your strategy. Your organization may find itself offside with certain risk levels (above or below) when you first define all this. Only way to find out is to build this framework.

Being clear on what is expected, and where you currently stand, is a very good thing.

Increasing your market relevance

How much of your corporate marketing and sales efforts are applied to customers and potential markets that you are truly and incredibly relevant to? (Segments / markets that you have a real competitive advantage in) Now think about how much of your time is invested into those customers that you have moderate or low levels of relevance (and perhaps loyalty) with. What are you gaining by applying resources to that segment? What is it costing you directly or in terms of alternate opportunity?

The issue is how your business model creates potential for relevance within your market.

Enter: The more focused strategy

First, the answer isn’t always to narrow your market focus. But you have to have one. (more on that later) Trying to reach everyone with your product ultimately results in loss of relevance to anyone. When you do narrow your market focus, you create the opportunity to understand your customers better. The business model can adapt. The customer experience can be aligned. Clarity and alignment are the hallmark of all great companies. So how can you strengthen yours?

Couple of dimensions for consideration:
1) Is there a larger group of this customer psychographic available elsewhere – geographically, etc…
2) Is there a larger percentage of wallet share available by narrowing your focus further
3) Are there greater levels of success available simply by creating a different customer experience
4) Which customers generate your revenue and retain the highest loyalty?
5) Can you create competitive advantage within a larger market by doing something purposefully different

No one can tell you which one is the right choice, however, be sure that you are consciously making these choices. So before you consider selling more of what you sell to everyone, consider the impact that working with customers you have greater potential to be relevant to might have on your business in the long-term.