Every line of business leader, no matter what industry you’re in or which product you sell, is also in the business of managing risks. Risk management strategies can help your business:
- Save money
- Avoid costly mistakes
- Steer clear of business threats
- Improve profitability, and
- Make better-informed business decisions based on analytics.
There are many types of business risks in your day-to-day operations, as well as less likely (but higher-impact) risks like natural disasters. Not all risks can be avoided, and some risks are even “good” risks to take, if they can deliver ROI for the business. Every business leader needs to make risk management trade-offs between “avoiding costly mistakes” that hit the company’s bottom line, and “taking calculated strategic risks” that can help the business grow.
The financial costs and negative business impacts of risk can be mitigated with smart risk management strategies. And better analytics can help business leaders make better-informed decisions to minimize business threats while maximizing their potential for ROI.
Let’s take a look at what risk management really means for business leaders, and how to pursue smart risk management strategies.
What is Risk for Business Leaders?
For business leaders, “risk” is the chance of an undesirable impact happening to the company. Different types of risk can pose business threats that can disrupt operations, incur costs, or cause other types of financial, physical, or reputational damage to the business.
Types of business risk include:
- Physical risks: Depending on the type of business you operate, your physical risks might involve fire, explosion, hazardous materials, or other threats to the physical property or facilities of the business.
- Location risks: These might include natural disasters (if your business facilities are located in an area vulnerable to earthquakes, hurricanes, or tornadoes, for example). Other location risks might include a business that is vulnerable to changes in foot traffic as a result of possible redevelopment or rerouting of nearby roads, or a business that is vulnerable because of inadequate public infrastructure.
- Human risks: These include a business’ possible vulnerability to employee fraud, theft, or embezzlement. Health problems in a company’s workforce can also cause lost productivity and costly impacts on the business.
- Technology risks: Managing these risks could involve physical operations, like backup systems for electricity, lighting, and manufacturing facilities. Or the risks could be in the digital space, like maintaining information security, backing up your company data, and ensuring speedy disaster recovery.
- Strategy risks: These risks are a necessary, desirable part of doing business. For example, banks take calculated risks when lending money to customers. Without strategic risk-taking, there is no ROI. Business leaders take strategic risks when deciding to launch a new product, enter a new market, or invest in developing a new solution.
As part of the balancing act of managing risks, business leaders need to understand the negative impacts of risk (“what can go wrong”) as well as calculate the possible upside of strategy risks (“what can go right”). If your organization ignores risks, you leave yourself vulnerable to catastrophic costs. But if your organization is too risk-averse, you might not take certain strategic chances that could deliver profitable results, leading you to miss out on long-term ROI.
What are Sources of Uncertainty for Decision Makers?
Good risk management strategies help business leaders navigate an environment of uncertainty. Understanding the types of uncertainty that affect your business can help you with managing risks.
Here are a few sources of uncertainty that affect business decision-makers:
- Lack of knowledge: If your team is trying to decide how to price a new product, you might want to know your competitor’s planned product price.
- Complexity of process: If you’re trying to calculate expected demand or total addressable market (TAM) for a new product, there are several complex factors that go into determining this number. Demand is affected by overall economic factors, changing consumer preferences, brand reputations, and larger trends in technology and consumer lifestyles. All of these factors make it hard to judge the exact number of potential customers and create additional uncertainty for the risk analysis.
- Limited ability to measure and fabricate materials: What if your company is developing a new product that involves a specific material thickness that is measured in nanometers, or that requires sourcing a supply of a certain material? These limits can also create uncertainty for business decision-makers.
- Inherent randomness: Not every business process happens like clockwork. There’s a certain amount of inherent randomness, such as the behavior of macromolecules or the failure rate of electronic components, that affects business decision-making.
- Reducible vs. irreducible uncertainty: Some types of uncertainty can be reduced, with better market research, calibration, or physical testing. But some uncertainty is just part of nature, and cannot be eliminated. Your risk analysis team can lower the model’s sensitivity to irreducible uncertainty, but it will never be eliminated entirely.
Understanding uncertainty can help your analytics team create sophisticated models to calculate your risks more accurately – and improve your risk management processes.
Top Risk Management Tools
Now let’s take a look at some tools for analytics, and how they can help your company get more strategic with risk management.
- Quantitative risk analysis: this involves the creation of a mathematical model that includes uncertain parameters (beyond your team’s control) and decision variables (that your business decision-makers can control). Building a quantitative risk model can help business leaders make better-informed decisions and predict the likelihood of different levels of profit and loss, environmental impacts, ROI, and other business outcomes.
- Modeling and simulations: Once you have a quantitative risk model, your analytics team can run multiple simulations on that model. This involves running numerous computer-based tests, in rapid succession, in a short amount of time, to calculate the statistical likelihood of certain results.
- Monte Carlo simulation: This is a powerful tool for simulations, named for the famous casino city, that conducts hundreds or thousands of random samplings, calculates the predicted outcomes, and creates charts and graphs of the results.
Choosing the right risk management tools can help you make better-informed business decisions.
How Risk Analysts and Line of Business Leaders Can Collaborate on Risk Management Strategies
Business leaders and risk analysts need to make sure that they’re on the same page and speaking the same language. Here are a few tips for how business leaders and risk analysts can improve their collaboration for better risk management processes:
- Hone in on business goals: Risk analysts tend to have a more granular understanding of quantitative risk models. Business leaders need to focus on a higher-level strategic view of risk. They need to convey the company’s risk tolerance, strategic goals, and business objectives and make sure the mathematical models are aligned with this direction.
- Deliver actionable insights: The risk analysis process can sometimes create a lot of “noise” as well as “signal.” Business leaders need to work with risk analysts to make sure everyone understands which insights are most relevant to the decision-making process.
- Beware of cognitive biases: According to research from Harvard Business Review, “people overestimate their ability to influence events that, in fact, are heavily determined by chance.” Sometimes business leaders get too confident in their forecasts and fail to anticipate the full range of possible outcomes. Even the best mathematical model is vulnerable to human error and biased thinking.
Managing risks is part science, part art. Business leaders need to look at the data-based evidence and balance competing priorities, while using their intuition to make sound decisions for the company. But smarter risk management processes can make your decision-making clearer and better informed.
With quantitative modeling and simulations, your business can get better visibility into the parameters affecting your business results. Risk can never be eliminated, but with a strategic risk management approach, you can improve your likelihood of success.