Imagine a financial analyst is able to predict a huge profit loss, and determines that a particular investment isn’t worth the substantial loss the business will incur. He then goes to his superior, and recommends against the investment. His superior agrees, and the investment never occurs. This is an example of good risk management.
All businesses need a risk management strategy, in order that they can be better prepared for profit losses. Because if you truly value your money, you don’t put it at risk if you don’t have to.
In the article, “Managing Risks: A New Framework,” published by the Harvard Business Review, the authors outline a very unique, and winning framework, for building a risk management strategy.
“The first step in creating an effective risk-management system is to understand the qualitative distinctions among the types of risks that organizations face.”
Basically, you want to determine where your risks fall. The article places risks into three categories, and it’s up to you to determine where your risks fit and if they’re necessary, and how unnecessary risks can be avoided. The following are made-up scenarios using each of the three categories, and how businesses can use their risk management strategy to avoid serious financial losses.
“These are internal risks, arising from within the organization, that are controllable and ought to be eliminated or avoided.”
The ABC Company creates pens, but there’s no internal product testing to determine if the pens leak. It’s not advisable to avoid internal product testing all-together, and ship the pens to customers. The ABC Company will lose a lot of money when the pens are returned, and the company is liable for shipping both ways.
Having recently implemented a risk management strategy, the ABC Bank invested in automated testing tools to ensure that their banking software functioned properly. It was determined that the software had a number of issues, many of which would had been overlooked without risk management. A risk management analyst determined that projected profits were worthy of the cost to have the software fixed. Changes were made, money was saved, and the software went on to garner the bank a number of new customers, which led to greater profits.
“A company voluntarily accepts some risk in order to generate superior returns from its strategy.”
An inventor nervously fidgets in a seat across from a bank representative. The XYZ Bank has an excellent risk management strategy, so even though the inventor has less than perfect credit, they under that his invention will yield considerable profits. The company’s risk management analyst has determined that the inventor’s product is the next big thing.
Despite the risk, the bank determines that the inventor is credit-worthy, and they slide a check across the table. Just before the inventor can scoop it up, the bank representative stopped him. In order to contain risks, the bank first asks the inventor to sign an agreement to repay the loan, as well as stipulations for his business, such as timeframes for product development.
Remember: Strategy risks require that you reduce the probability of losses any way you can.
“Some risks arise from events outside the company and are beyond its influence and control.”
Unfortunately, the ABC Company’s factory caught fire sometime in the night. Luckily, their risk management team had dreamed up such a scenario, and they were prepared when sprinklers doused the flames in water. Overall, minimum damage occurred.
Then, the risk management team entered the factory, and determine how and why the fire occurred. Because they’re forward-thinking, and determined to keep profit loss minimal, they implemented new strategies for dealing with natural disasters, political disasters, and major macroeconomic shifts.