What is risk management? What does it mean to manage risk? How should companies approach risk management?
Today's world has become much more complex. Businesses need to deal with multiple risks at any given time. Risk management is the process of identifying, analyzing, and controlling these risks. The failure to understand risks leads to poor decisions and a lack of preparedness for future events.
Let's start by talking a bit about what risk means.
Understanding Risk in Layman's Terms
In English, we use the word "risky" when something is likely to cause harm or damage. For example: "The weather was very risky today. It could have been dangerous for you."
In business, we use the term "risks" when there are things that can happen in our environment that will affect our businesses. These include:
- Weather - Stock Market - Political/Legal Issues - Changes in Technology - Competition - Changing Customer Demands - Product Defects
We also use the terms "adverse effects" and "negative consequences" when discussing the risk.
Examples of adverse effects might be a company losing money because of bad weather, people getting hurt on your factory floor, and your product not meeting customers' needs.
Negative consequences can occur when an event causes harm to people, property, reputation, finances, etc. Examples would be: - Someone being injured while working on your equipment - Someone suing you for damages - You have to pay compensation to someone else who has been harmed.
Formal Definition of Risk
ISO 9000:2015 defines risk as the "effect of uncertainty."
- An effect is a deviation from the expected — positive or negative.
- Risk is often expressed in terms of a combination of the consequences of an event and the associated likelihood of occurrence.
- The word "risk" is sometimes used when there is the possibility of only negative consequences.
Positive risks are called opportunities. You would like to take maximum advantage of these positive risks. We have discussed the difference between negative and positive risks in a separate post.
Why take risks?
- There is a balance between risk and rewards.
- Generally, more risks lead to more rewards. But that is not always true.
- You want more rewards with less risk.
Here is the definition of risk management as in Wikipedia:
"Risk management is the identification, assessment, and prioritization of risks (positive or negative) followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities."
Risk Management - 5 Steps
Risk management is the process of managing risks. It involves understanding the nature of the risks, their potential impacts, and how they may affect the organization. It includes planning to respond to those risks and monitoring them over time.
There are five steps involved in Risk Management.
Step 1 - Planning Risk Management
- Define risk-related terms
- Define roles and responsibilities
- Tools and template for risk management
- Planning includes how to:
- Identify risks
- Analyze risks
- Plan risk responses
- Monitor and control risks
Step 2 - Identifying Risks
- Risk identification is a systematic and methodic process.
- It is best done in a group environment.
- Many people participate in this process including management, employees, customer, other stakeholders.
Step 3 - Analyze Risks
- Risks are analyzed to set priority
- Sets focus on high priority risks
- There are two broad approaches for analyzing risks: Qualitative and Quantitative Risk Analysis.
Step 4 - Plan Risk Response
- How to decrease the possibility of negative risk affecting the objectives
- How to increase the possibility of positive risk helping the objective
There are four responses for negative and four responses for positive risks.
- Negative Risks: Avoid, Mitigate, Transfer and Accept
- Positive Risks: Exploit, Enhance, Share and Accept
Step 5 - Monitor and Control Risks
- Regularly review the identified risks and ensure that these are still relevant.
- Identify new risks
- Remove risks that are not relevant
- Risk audits may be conducted to ensure that the plan is implemented and effective.