Haran landed the job of his dreams—an offer from a leading animation studio in Mumbai. He was both excited and nervous because he was moving away from home for the first time. Despite the fact that he wouldn’t know anyone there, Haran was determined to start the next chapter of his life on a positive note. He was willing to risk it.
We make risky decisions every day. It’s the only way to create new possibilities. Even businesses take risks because they want to continuously improve themselves. But, taking risks isn’t enough, you need to prepare yourself for the situations that follow. Read on to understand the meaning of risk management and how it can be an effective business tool.
What Is Risk Management?
Before we look into the definition of risk management, let’s understand what ‘risk’ is. Risk is the possibility of an unexpected or negative outcome. It involves uncertainty that’s caused by internal and external vulnerabilities. We take risks every day, however safe or challenging our situations may be.
Risks are inevitable in businesses and it’s crucial for organizations to stay prepared and avoid negative outcomes. Risk management is a framework that helps in the identification, analysis and response to risk factors. There are different risk factors—management errors, financial uncertainty, legal liabilities, security threats and data-related risks. Effective risk management helps you control future outcomes by acting proactively, not reactively.
Types Of Risks
Risk identification is a key part of strategic business planning. Here are the most common types of risks that’ll help you identify potential threats.
Usually taken by business ventures to maximize shareholder value and profits
They aren’t under a firm’s control and are influenced by political, social and economic imbalances
Internal Business Risks
They arise because of inefficient management in businesses
External Business Risks
They arise because of external environments and factors
Risks associated with any kind of financial transactions (company loans)
Risks that arise because of instability and losses in the financial markets caused by stock prices, interest rates, currencies and more
They arise because of operational failures including management failure, systems failure and human errors
These risks are related to technology failures, that are otherwise critical for the smooth functioning of businesses
Risk Management Strategies
A good risk management process doesn’t have to be resource or cost-intensive. A little structuring and a strong understanding of the organization can prepare you better. Here is a four-step method for efficient risk analysis.
Identify Potential Risks
There are several types of risks involved in businesses at any given moment. Labelling makes it easier to tackle or avoid them. Risk identification in organizations involves brainstorming to review various sources of risks and arranging them in order of priority. Start asking questions like, ‘what can possibly go wrong?’ to gauge potential threats.
Analyze the Risks Identified
Once the risks are identified, they need to be assessed. It’s important to map different risks to its underlying factors. Start asking questions like “what caused such a risk and how will it impact the business?”. Many organizations use risk maps or visual representations of risk factors that detail which risks are severe and/or frequent. This will further help you utilize your resources effectively.
Choose An Appropriate Response
After locating and ranking your risks, try finding solutions that are both affordable and effective. Organizations often determine their action plan to navigate threats by sharing, transferring, avoiding/accepting risks. For example, an organization transfers the risk by purchasing fire insurance for its office space. The same organization accepts risks when it hires an external consultancy for its projects. You should be able to determine what response works best.
Monitor And Review
Risk management isn’t an end in itself but a process of continuous improvement. Risks are constantly changing and new ones keep emerging. Therefore, your risk management process should be consistent and standardized. By doing this, organizations develop a risk culture, becoming more resilient and adaptable in the face of change. There’s better clarity on the operating environment and everyone’s prepared for future challenges.
Types Of Risk Response
A basic step in the risk management process—‘risk response’ is the process of controlling identified risks. In short, we make different plans to deal with different types of risks. Let’s look at the different types of risk response.
You eliminate a particular risk by getting rid of its source; anti-discrimination policies make it mandatory to protect employees and other stakeholders
You decide to take the risk; for example, you decide to invest in a startup business
You take actions to reduce the risk; for example, purchasing superior quality tools to reduce workplace safety risks
You transfer the risk to a third party; for example, you get car insurance in case of unforeseen accidents or damages
You distribute the risks among multiple members, teams or projects; for example, if your startup business faces risks, you and your co-founder will jointly face the consequences
You plan ahead to handle anticipated risks; you create back-up plans in case a new strategy doesn’t work out
You decide to retain or keep a risk because you think it’s advantageous to your current situation
Importance Of Risk Management
A well-prepared business is one that successfully minimizes the impact on its earnings, time, productivity and stakeholder relationships. An effective risk management plan can help you stay prepared. Here are a few benefits of implementing a powerful risk management plan:
Builds A Risk Culture
The purpose of risk management isn’t eliminating risks altogether. In reality, it’s impossible to eliminate every risk because they’re unpredictable. The system actually helps you develop a risk culture that minimizes potential negative consequences. You make smart decisions to better manage the consequences for a favorable outcome.
Prepares For Unexpected Events
Surprises aren’t good for businesses. Good risk management practices enable you to identify trouble spots and communicate it with relevant people. When you map out all potential threats, you prevent them or manage them. Either way, you’re controlling the likelihood and severity of unpleasant future scenarios.
Decision-making is a challenging process because your choices impact future events. Risk management helps make smaller strategic decisions that benefit larger objectives. You can determine the strengths and weaknesses of a decision and determine what risks you should pursue or avoid. The more choices you make, the stronger your decision-making powers get.
A strong risk management culture is beneficial for everybody in an organization. It creates a ‘prevention is better than cure’ mindset, allowing everyone to address a problem before it escalates. When dealing with multiple projects, you can easily identify which project isn’t going according to plan and take corrective measures. You gain confidence in your abilities and your motivation enhances your productivity.
Increases Customer Satisfaction
Risk management increases operational efficiency, therefore improving customer satisfaction. Happy customers will promote your product or service with their networks. This in turn drives business growth because employees are motivated to do better. This further helps improve the quality of products and services.
Limitations Of Risk Management
While risk management is extremely beneficial for organizations, its limitations should also be considered. Some of the disadvantages of risk management are:
False Sense Of Stability
It may look like risk management is all about focusing on the future, there’s actually a lot of emphasis on the past. You’re less likely to make any changes when you see things running smoothly. A false sense of stability prevents you from seeing the bigger picture.
Illusion Of Control
Many organizations become overly dependent on risk management systems because they believe that it quantifies and regulates every potential risk. Organizations are likely to neglect the possibility of new or unexpected risks because of their illusion of control.
Risk analysis techniques such as creating a model or simulation can be quite expensive. The process relies on extensive data collection and the information isn’t always reliable. It requires a lot of time and effort and there aren't any guaranteed positive outcomes.
It’s important to understand how your organization functions before you implement risk management practices. Harappa Education’s Navigating Workplaces course is designed to help you understand and manage your workplace culture and people. The Power Structures framework will help you identify the types of powers people hold at work. The Stakeholder Map method will help you identify decision-makers. Involve different stakeholders in your strategic risk identification process and build an effective system that benefits your organization. Take the risk or lose your chance—the choice is yours!
Explore our Harappa Diaries section to know more about topics related to the Collaborate habit such as Teamwork, Delegation of Authority, Difference Between Leadership and Management, Strategic Management, Functions of Management & Stakeholder Management and manage risks effectively.
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