Can Business Risk Ever Be Eliminated?
For most people, risk taking is not only something we have to do to some extent (otherwise we may as well just stay home all day and do little or nothing – itself a risk in the longer term of course) but a natural part and parcel of business: no risk, no reward.
When it comes to business, it is important for all leaders at all levels to recognize the potential risks they face and prepare effective strategies to manage them. It is also necessary for such leaders to develop “contingency plans”, or alternative courses of action, when necessary or the when the risk has significant or serious consequences.
Of course there are many kinds of practical risks that any manager faces. Below are the major ones for most managers:
SPECULATIVE RISK is general uncertainty as to whether an activity will result in a net benefit or an overall gain (at least to some degree) or will result in some of loss (tangible or intangible). Examples here might be deciding to spend money on a new piece of machinery, a new building or more raw materials. Each of these decisions may expand a business, save it money, or lead to greater revenues and profits. However, it may also lead to losses, especially if the new machine does not do what is expected, the building rented or bought is too small or too much raw material is purchased and it cannot be sold quickly enough. Speculative risk is an inevitable part of doing business and can only be managed rather than eliminated.
ABSOLUTE OR PURE RISK relates only to potential losses (and never gains). Examples of this kind of risk are injuries to employees (or even death), severe weather affecting business or an outbreak of fire. It is called pure risk because the possibility of loss exists, but the consequences or severity of the risk is typically unknown.
OPERATIONAL RISK: Operational risks are about all the things that can and do go wrong in running an organization or commercial business. External to the business are market risks such price changes, competition from new products and services, and fluctuating economic conditions. Inside the business this may relate to errors and omissions, poor quality and even slowness to deliver products and services.
REPUTATIONAL RISK: This relates to the possibility that an enterprise may lose potential business because its character or trustworthiness has been called into question. The reputation of any organization is a function of its standing among its various stakeholders (investors, customers, suppliers, employees, regulators, politicians, non-governmental organizations, the communities in which the firm operates etc.) in specific categories (product quality, corporate governance, employee relations, customer service, intellectual capital, financial performance, handling of environmental and social issues). A strong positive reputation among stakeholders across multiple categories will result in a strong positive reputation.
PEOPLE RISKS: Because people operate all organizations, they represent perhaps the largest and most significant risk category of all. In addition, people side risks are often more volatile because most organizations expect every individual to use their judgment or what is often called “common sense”. The problem of course is that common sense deserts many individuals at times, especially when they do not see the danger to either themselves or the enterprise of which they are a part. A good example here is personal accidents. An organization may have an unsafe work environment with many hazards, thus increasing the chances of accidents, and/or it may have unsafe practices by individuals (poor judgments). Both of these risk situations therefore need careful management.
In order to manage any one of the above general risk categories, a manager first needs to be able to identify all the possible risks they face, then decide upon preventive measures to eliminate or reduce the impact of the risks.
Once analyzed, the best risk management strategy of all is avoidance or elimination. Hence, we should ideally invest the most attention and effort into investigating this option wherever possible. Avoidance or elimination strategies include not performing an activity that could carry risk or finding an alternative way of doing things that does not carry the same level of risk. It is important to remember however that elimination may appear to be the best solution or answer to all risks but avoiding risks sometimes means losing out on the potential gain that accepting (retaining) the risk (and then managing or controlling it) may have allowed.
Whatever strategy an organization selects, each course of action comes with its expected benefits/rewards and risks/losses. Good risk management does not then imply avoiding or eliminating all risks at all cost. Instead it means making informed and coherent choices regarding the risks the organization wants to take in pursuit of its objectives and regarding the measures to manage and mitigate those risks. A manager in any organization therefore needs to know how much risk he or she is willing to take, or determine his or her “risk appetite”. Risk appetite is the amount and type of risks an individual or a wider organization is willing to accept in pursuit of its goals. Of course there is no fixed or standard answer to this for any enterprise and even if it can be determined today, it must be constantly revisited so that risk appetite is adjusted and then managed, with a careful balance maintained between elimination and mitigation.