Risk management is an essential business activity. Companies of all sizes and across all industries need to understand the risks they face, gauge the possible impact of specific risk events, and have a suitable plan in place to manage those risks. So what is the objective of risk management, which risks do companies need to consider, and what is the purpose of a risk management plan?
What is the purpose of risk management?
To understand the purpose of risk management, you first need to understand risk. In a nutshell, risk is the possibility that an unfavorable event will occur – and in the context of risk management, the possibility that this will result in financial, reputational or other damage to the business.
In practice, businesses can face a number of different types of risk. Some of the most significant include:
- Financial risk – the risk of losing money, or the risk that a company will be unable to fulfil its financial obligations. This can include a number of types of risk, such as liquidity risk, foreign exchange risk, commodity risk, interest rate risk and credit risk.
- Operational risk – the risk that the company will experience loss as a result of inadequate processes, systems and policies. This might include events such as the failure of essential systems, employee errors or the loss of key suppliers. Another notable threat is the risk that the company will fall victim to fraud or a cyberattack.
- Strategic risk – the risk that certain factors may prevent the company from executing its strategy and achieving its goals, or that the company’s strategic decisions do not result in the desired outcomes. For example, a company might engage in M&A activity which fails to deliver the expected benefits, or might be unable to adapt successfully to market changes.
- Compliance risk – the risk that the company may fail to comply with laws or regulatory requirements. This can lead to financial or other penalties, and/or reputational damage.
What is risk management?
Risk management is the systematic process by which companies seek to understand and manage the risks they face. The objective of risk management is therefore to manage risks effectively by having processes in place to identify and analyze the different types of risk that the company faces, and to take the necessary steps to mitigate, control and/or monitor those risks.
Why is risk management necessary?
In order to manage risk effectively, companies need to have a suitable risk management strategy. A risk management strategy is an important component of corporate governance, as it enables a corporation to:
- Maximize upside risk. Risk is not always negative – for example, the value of an investment could increase more than expected.
- Minimize downside risk. A key goal of risk management is to minimize the impact of any negative event that might occur.
- Evaluate the company’s risk appetite and risk tolerance levels. Different companies will be willing or able to accommodate different levels of risk.
Fundamental goals of risk management
So what is the goal of risk management? This can be broken down into a number of different steps. In particular, companies should aim to undertake effective risk management planning, identify the various risks faced by the business, assess the likelihood and potential impact of these risks, and determine how best to respond to those risks. Let’s look at these risk management objectives in more detail.
- Risk management planning
The risk management plan purpose is to understand the overall business strategy, and the potential sources of risk faced by the company. Planning is a vital part of risk management as it will determine how the company’s risk management process will be implemented and reported on. The more effective the company’s risk management planning, the more likely it is that the resulting risk management process will be effective.
- Risk identification
Identifying the risks faced by the company is also essential as this exercise will provide the inputs for the rest of the risk management process – in other words, risk assessment, response planning and risk monitoring/controlling. As such, companies should aim to spend enough time on this step to ensure that any significant risks are outlined and documented.
The risks that a company faces can change significantly over time as the company grows and as market conditions evolve. As such, risk identification should not be regarded as a one-off exercise – rather it should be approached as an iterative process which is reviewed and updated on a regular basis.
- Risk assessment
Once the risks faced by the company have been identified, the next step is to carry out a risk assessment. This should be a thorough process including the creation of a Risk Prioritization Matrix, in which the x axis shows the likelihood of a specific risk, and the y axis shows the possible impact. Likelihood should be evaluated on a numerical scale – for example, 1 might indicate an improbable event, while 5 indicates that an event is almost certain. Similarly, impact levels can be evaluated on a scale – for example, 1 might indicate minimal impact, with 5 indicating a large impact.
A contingency plan will need to be formulated for the risks that are identified as most likely, and/or of the highest impact. If one of the identified risk events subsequently occurs, the plan can then be executed to minimize the impact. Risk identification and assessment meetings should include the same stakeholders, as this will optimize the risk planning process.
- Risk response planning
After identifying risks, and assessing their likelihood and possible impact, the next step is to decide how the company will respond to those risks. There are a number of points to consider in this part of the process, but the main goal for each risk is to identify strategies that will allow you to minimize negative outcomes – and, indeed, to maximize positive outcomes.
When a risk event occurs, the company will be able to respond the chosen risk response strategy. For each risk, the possible responses include:
- Risk elimination. Also known as risk avoidance, this approach involves taking action to remove the possibility of a certain risk event.
- Risk mitigation. This involves reducing or limiting the impact of a certain risk event, for example through the use of a hedging program.
- Risk transference. Companies may be able to transfer risks to another party, such as through the use of insurance policies.
- Risk acceptance. In some cases, the potential impact and/or likelihood of a risk event may not be enough to justify the cost or effort of taking action.
Whatever the chosen approach, you’ll need to decide which team(s) should be responsible for executing the relevant risk response strategy. It’s also important to establish a clear understanding of the events that will trigger any given response.
- Risk monitoring/controlling
Finally, the company will need to monitor and control risks on an ongoing basis. In order to do so, it may be valuable to ask the following questions:
- Are the identified risks being actively tracked?
- Have we updated the risk prioritization matrix with emerging risk factors?
- Has a risk event occurred, and a response strategy been triggered?
- How effective are the existing contingency plans based on current business conditions?
Again, the process of monitoring and controlling risk is not a one-off exercise, but an iterative activity: the risk landscape is continually evolving, and companies need to make sure that the strategies they have in place continue to be appropriate.
What is the goal or objective of an IT risk management plan?
Companies will face different risks in different situations – and one scenario that’s important to consider is an IT transformation project, which can result in specific risks beyond those faced in the company’s day-to-day operations. When a company sets out to overhaul its IT infrastructure, a number of possible threats can arise, such as:
- Procurement delays. The purchase of hardware and software components may be delayed by inefficiencies in the procurement process.
- Availability and scheduling of resources. Configuration and testing will need to be carried out at certain points during the implementation process, but this can be hindered if the necessary resources are unavailable.
- Poor communication. The stakeholders involved in the transformation process will need to communicate effectively. Delays may ensue – or the outcome of the project may be adversely affected – if the relevant people are not well coordinated.
- Evolving business requirements. The needs of the business might change during the course of the transformation project – for example due to macroeconomic developments or M&A activity. The company will need to adapt to any such changes in order to keep the project on track.
- Test environments and test data. Difficulties can arise if there are issues with the availability of the relevant test environments, or if the quality of the test data is insufficient.
- Inadequate post-implementation support. Last but not least, the transformation project doesn’t end at go-live. Post-implementation support may be needed to iron out any wrinkles – so make sure your chosen vendor provides adequate support before, during and after the project.