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What Is Risk Management & Why Is It Important?
- 24 Oct 2023
Businesses can’t operate without risk. Economic, technological, environmental, and competitive factors introduce obstacles that companies must not only manage but overcome.
According to PwC’s Global Risk Survey , organizations that embrace strategic risk management are five times more likely to deliver stakeholder confidence and better business outcomes and two times more likely to expect faster revenue growth.
If you want to enhance your job performance and identify and mitigate risk more effectively, here’s a breakdown of what risk management is and why it’s important.
Access your free e-book today.
What Is Risk Management?
Risk management is the systematic process of identifying, assessing, and mitigating threats or uncertainties that can affect your organization. It involves analyzing risks’ likelihood and impact, developing strategies to minimize harm, and monitoring measures’ effectiveness.
“Competing successfully in any industry involves some level of risk,” says Harvard Business School Professor Robert Simons, who teaches the online course Strategy Execution . “But high-performing businesses with high-pressure cultures are especially vulnerable. As a manager, you need to know how and why these risks arise and how to avoid them.”
According to Strategy Execution , strategic risk has three main causes:
- Pressures due to growth: This is often caused by an accelerated rate of expansion that makes staffing or industry knowledge gaps more harmful to your business.
- Pressures due to culture: While entrepreneurial risk-taking can come with rewards, executive resistance and internal competition can cause problems.
- Pressures due to information management: Since information is key to effective leadership , gaps in performance measures can result in decentralized decision-making.
These pressures can lead to several types of risk that you must manage or mitigate to avoid reputational, financial, or strategic failures. However, risks aren’t always obvious.
“I think one of the challenges firms face is the ability to properly identify their risks,” says HBS Professor Eugene Soltes in Strategy Execution .
Therefore, it’s crucial to pinpoint unexpected events or conditions that could significantly impede your organization’s business strategy .
Related: Business Strategy vs. Strategy Execution: Which Course Is Right for Me?
According to Strategy Execution , strategic risk comprises:
- Operations risk: This occurs when internal operational errors interrupt your products or services’ flow. For example, shipping tainted products can negatively affect food distribution companies.
- Asset impairment risk: When your company’s assets lose a significant portion of their current value because of a decreased likelihood of receiving future cash flows . For instance, losing property assets, like a manufacturing plant, due to a natural disaster.
- Competitive risk: Changes in the competitive environment can interrupt your organization’s ability to create value and differentiate its offerings—eventually leading to a significant loss in revenue.
- Franchise risk: When your organization’s value erodes because stakeholders lose confidence in its objectives. This primarily results from failing to control any of the strategic risk sources listed above.
Understanding these risks is essential to ensuring your organization’s long-term success. Here’s a deeper dive into why risk management is important.
4 Reasons Why Risk Management Is Important
1. protects organization’s reputation.
In many cases, effective risk management proactively protects your organization from incidents that can affect its reputation.
“Franchise risk is a concern for all businesses,“ Simons says in Strategy Execution . “However, it's especially pressing for businesses whose reputations depend on the trust of key constituents.”
For example, airlines are particularly susceptible to franchise risk because of unforeseen events, such as flight delays and cancellations caused by weather or mechanical failure. While such incidents are considered operational risks, they can be incredibly damaging.
In 2016, Delta Airlines experienced a national computer outage, resulting in over 2,000 flight cancellations. Delta not only lost an estimated $150 million but took a hit to its reputation as a reliable airline that prided itself on “canceling cancellations.”
While Delta bounced back, the incident illustrates how mitigating operational errors can make or break your organization.
2. Minimizes Losses
Most businesses create risk management teams to avoid major financial losses. Yet, various risks can still impact their bottom lines.
A Vault Platform study found that dealing with workplace misconduct cost U.S. businesses over $20 billion in 2021. In addition, Soltes says in Strategy Execution that corporate fines for misconduct have risen 40-fold in the U.S. over the last 20 years.
One way to mitigate financial losses related to employee misconduct is by implementing internal controls. According to Strategy Execution , internal controls are the policies and procedures designed to ensure reliable accounting information and safeguard company assets.
“Managers use internal controls to limit the opportunities employees have to expose the business to risk,” Simons says in the course.
One company that could have benefited from implementing internal controls is Volkswagen (VW). In 2015, VW whistle-blowers revealed that the company’s engineers deliberately manipulated diesel vehicles’ emissions data to make them appear more environmentally friendly.
This led to severe consequences, including regulatory penalties, expensive vehicle recalls, and legal settlements—all of which resulted in significant financial losses. By 2018, U.S. authorities had extracted $25 billion in fines, penalties, civil damages, and restitution from the company.
Had VW maintained more rigorous internal controls to ensure transparency, compliance, and proper oversight of its engineering practices, perhaps it could have detected—or even averted—the situation.
Related: What Are Business Ethics & Why Are They Important?
3. Encourages Innovation and Growth
Risk management isn’t just about avoiding negative outcomes. It can also be the catalyst that drives your organization’s innovation and growth.
“Risks may not be pleasant to think about, but they’re inevitable if you want to push your business to innovate and remain competitive,” Simons says in Strategy Execution .
According to PwC , 83 percent of companies’ business strategies focus on growth, despite risks and mixed economic signals. In Strategy Execution , Simons notes that competitive risk is a challenge you must constantly monitor and address.
“Any firm operating in a competitive market must focus its attention on changes in the external environment that could impair its ability to create value for its customers,” Simons says.
This requires incorporating boundary systems —explicit statements that define and communicate risks to avoid—to ensure internal controls don’t extinguish innovation.
“Boundary systems are essential levers in businesses to give people freedom,” Simons says. “In such circumstances, you don’t want to stifle innovation or entrepreneurial behavior by telling people how to do their jobs. And if you want to remain competitive, you’ll need to innovate and adapt.”
Netflix is an example of how risk management can inspire innovation. In the early 2000s, the company was primarily known for its DVD-by-mail rental service. With growing competition from video rental stores, Netflix went against the grain and introduced its streaming service. This changed the market, resulting in a booming industry nearly a decade later.
Netflix’s innovation didn’t stop there. Once the steaming services market became highly competitive, the company shifted once again to gain a competitive edge. It ventured into producing original content, which ultimately helped differentiate its platform and attract additional subscribers.
By offering more freedom within internal controls, you can encourage innovation and constant growth.
4. Enhances Decision-Making
Risk management also provides a structured framework for decision-making. This can be beneficial if your business is inclined toward risks that are difficult to manage.
By pulling data from existing control systems to develop hypothetical scenarios, you can discuss and debate strategies’ efficacy before executing them.
“Interactive control systems are the formal information systems managers use to personally involve themselves in the decision activities of subordinates,” Simons says in Strategy Execution . “Decision activities that relate to and impact strategic uncertainties.”
JPMorgan Chase, one of the most prominent financial institutions in the world, is particularly susceptible to cyber risks because it compiles vast amounts of sensitive customer data . According to PwC , cybersecurity is the number one business risk on managers’ minds, with 78 percent worried about more frequent or broader cyber attacks.
Using data science techniques like machine learning algorithms enables JPMorgan Chase’s leadership not only to detect and prevent cyber attacks but address and mitigate risk.
Start Managing Your Organization's Risk
Risk management is essential to business. While some risk is inevitable, your ability to identify and mitigate it can benefit your organization.
But you can’t plan for everything. According to the Harvard Business Review , some risks are so remote that no one could have imagined them. Some result from a perfect storm of incidents, while others materialize rapidly and on enormous scales.
By taking an online strategy course , you can build the knowledge and skills to identify strategic risks and ensure they don’t undermine your business. For example, through an interactive learning experience, Strategy Execution enables you to draw insights from real-world business examples and better understand how to approach risk management.
Do you want to mitigate your organization’s risks? Explore Strategy Execution —one of our online strategy courses —and download our free strategy e-book to gain the insights to build a successful strategy.
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Risk management, meaning, and importance for companies
Checked : Suzanne S. , Michael T.
Latest Update 19 Jan, 2024
Table of content
Risk management: what is it?
Importance of risk management in business, risk management helps in risk identification, analysis, control, and treatment of the risk, avoid scams, data security, prevention of crime, prevents theft, conclusions.
The history of economic systems and financial markets in recent years has been characterized by many cases of crisis and, in the most pathological situations, of failures that have certainly left their mark. However, there is a very recurrent element that characterizes these negative situations. It is the misalignment between performance profiles and risk profiles within the decision-making system and corporate governance. The strong emphasis given to the need to achieve performance targets, especially in the short term, has often left little room for evaluation, and to quantify risk where possible associated with certain types of choices. The result was that there was a misalignment between the maximization of results compared to the capacity of companies and banking and financial companies to create value.
It is no coincidence, therefore, that one of the most important legacies that history has left us in recent years is the growing attention to risk assessment and management issues, in a word that is commonly called risk management.
What is risk management? This is the question that many people ask themselves when approaching the world of financial markets. Whether you are an investor, an entrepreneur or an aspiring one, you have found yourself in the position of having to understand exactly what risk management is and what the right techniques are to avoid the loss of your capital.
Risk management is the continuous process of identifying, analyzing, evaluating, and managing exposures to losses and controlling risk and financial resources to minimize the negative effects of a loss.
The main function of the set of risk management techniques is to maximize profits, trying to reduce the risk of losses.
The losses that the individual seeks to minimize with risk management can come from:
- financial risks
- operational risks
- political and environmental risks
- strategic risks
More extensively, risk management addresses the downsizing of all those factors that prevent an individual or a company from achieving its objectives.
Although accidental losses are unpredictable and unplanned, there are methods included in risk management that can make risk events more predictable.
The more predictable an event, the lower the risk as it can be prevented or minimized. Furthermore, unexpected expenses can be estimated and budgeted.
This is risk management, the process to make the losses more predictable. This is the definition that can be given of the whole set of techniques that seek to secure, to the extent possible, the investor's capital.
The key to proper risk management is to control all the functions of your risk management plan and make sure that they are necessary and effective to reduce the overall cost of operational risk.
Risks are part of life as much as they are part of any organization or company planning. It’s quite natural to face risks in your business that needs to be handled in such a way that it does not result in a loss to the business or business services that are provided. Risk management is the forecasting or evaluation of possible risks and identifying the process to avoid or overcome it. It utilizes the right methods and tools to handle the threat. With a risk management plan, you can always be prepared in advance and let the business not be affected by it. Here are a few reasons why risk management is essential for business.
One of the major tasks of risk management is to identify a risk when it is about to rise or has risen. It can categorize various risks related to financing, operations, strategic, and even referred to like the environment and the public. This would either help you to avoid the chance at the early stages or come up with plans on facing the risks.
Once a risk is identified, it is important to analyze it to see how it will affect the business and come up with measures to control or overcome it. Risk has to be treated carefully so that it doesn’t change the entire industry. The probabilities of loss and gain have to be discussed before preparing to deal with it.
Risk management helps your business to avoid scams and analyses how it would affect the image of your business. Further, they help your business by investigating the source of fraud and helps in filtering the scam. They also help in building up the tarnished image if involved in a scam or fake scams.
It assures that all your essential data regarding the business are safeguarded and does not fall into the wrong hands. Data security is vital in business, and the risk management team can help you with the necessary protection. They can also come up with data recovery, backups, and insurances for your business data to not lose it and affect your business.
They make sure that the business decisions you make are legally approved and help in preventing crime in business. Furthermore, they see to the security of your employees too and assure that laws are not broken. This helps in not just creating an impression about your business to your employees but also to visitors and consumers.
One of the major risks for a business company is the theft of an idea or data. This can lead to the loss of a company. With the right risk management team, they will assure that your thoughts and business plans are safe and are not leaked. With simple measures and tracking employees, it can be assured that data leakage does not happen through unfaithful employees. They also help in keeping an eye on the inventory.
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Risk management as a stream helps in securing your business to the next level. It is always best to have prevention, and having an active risk management team does precisely. It may seem scary to the possible risks. But with the right directions and solutions, it’s always easy to overcome them or even face them. Having a risk management team adds extra security to your business. It helps you in a-z of all the disasters, security, and risks of the business. If you don’t have a risk management team yet, it is high time you get one.
The growing challenges that characterize industrial, banking, insurance, and financial companies require the constant presence within the decision-making and control system of these organizations of skills and dedicated activities that allow them never to lose sight of the risk profile. It is a central theme in the life of companies. It is important, however, that this presence has the nature of a substance and does not only serve to comply with regulatory requirements or to construct façade solutions that serve no purpose concerning the responsible management of the business and the sustainability of the life of these companies over time.
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Essay on Risk Management
Students are often asked to write an essay on Risk Management in their schools and colleges. And if you’re also looking for the same, we have created 100-word, 250-word, and 500-word essays on the topic.
Let’s take a look…
100 Words Essay on Risk Management
What is risk management.
Risk Management is the process of identifying, assessing, and controlling threats to an organization’s capital and earnings. These threats or risks could stem from a wide variety of sources, including financial uncertainty, legal liabilities, strategic management errors, accidents, and natural disasters.
Importance of Risk Management
Risk Management is important because it prepares an organization to face uncertainties. It helps to understand potential risks and to make plans to minimize their impact. Proper risk management can reduce not only the likelihood of an event occurring, but also the magnitude of its impact.
Steps in Risk Management
Risk Management involves several steps. The first step is identifying the risks. The next step is analyzing the risk to understand its potential impact. The third step is evaluating or ranking the risk. The final step is treating or controlling the risk.
Risk Management Techniques
There are several techniques for managing risk. One is risk avoidance, where the aim is to eliminate all risks. Another technique is risk reduction, where steps are taken to reduce the severity of the loss. Risk retention and risk transfer are other techniques used in risk management.
In conclusion, Risk Management is a vital part of any organization. It helps to safeguard an organization’s future through the identification and treatment of risks. With proper risk management, an organization can reduce the negative impact of threats they may face.
250 Words Essay on Risk Management
Risk Management is a process that helps identify, assess, and control threats that could harm an organization. These threats or risks could be anything from financial problems, accidents, natural disasters, or even legal issues. The main goal of Risk Management is to lessen the impact of these risks.
Risk Management follows four main steps. First, we identify the risks. This means we look at what could possibly go wrong. Next, we assess the risks. We try to figure out how likely it is that these risks will happen and how much damage they could cause. Then, we work on ways to control these risks. This could mean coming up with a plan to prevent the risk or lessen its impact. Finally, we monitor the risks. We keep an eye on them to see if they change or if new risks come up.
Risk Management is very important because it helps organizations prepare for the unexpected. It helps them make plans that can prevent or lessen damage from risks. It also helps them save money that they might lose if these risks were to happen.
In conclusion, Risk Management is a necessary practice for all organizations. It helps them identify, assess, control, and monitor risks. By doing this, organizations can prevent or lessen the impact of these risks, saving them from potential damage and loss.
500 Words Essay on Risk Management
Risk Management is a process that helps you identify and control possible problems that might happen in the future. It’s like a safety net that prepares you for any unexpected events.
Why is Risk Management Important?
Imagine you are planning a picnic. But, what if it rains? Your picnic would be ruined. So, you check the weather forecast before planning. This is a simple example of risk management. In the same way, businesses also use risk management. They want to know about any problems that might happen. This way, they can make plans to avoid them or reduce their impact.
Risk Management includes four main steps:
1. Identifying the Risks: The first step is to find out what could go wrong. This could be anything from a machine breaking down to a sudden change in market trends. 2. Analyzing the Risks: Next, you need to understand how big the problem could be. This helps to decide which risks need the most attention. 3. Planning the Response: Once you know the risks, you can make plans to handle them. This could mean avoiding the risk, reducing its impact, or accepting it and making a plan to recover from it. 4. Monitoring the Risks: Finally, you need to keep an eye on the risks and how well your plans are working. This means you can make changes if needed.
Benefits of Risk Management
Risk Management helps in many ways. It can save money by avoiding costly mistakes. It can also help a business to run smoothly, as they are prepared for any problems. Plus, it can help to build trust with customers and investors. They can see that the business is ready for any challenges.
Risk Management in Everyday Life
Risk Management is not just for businesses. We use it in our daily lives too. For example, wearing a helmet while riding a bike is a way of managing the risk of injury. Or, saving money for a rainy day helps to manage the risk of unexpected expenses.
So, Risk Management is a very helpful tool. It prepares us for the future and helps to avoid or reduce problems. It is used in businesses, but also in our everyday lives. By understanding and using Risk Management, we can make better decisions and be ready for whatever comes our way.
That’s it! I hope the essay helped you.
If you’re looking for more, here are essays on other interesting topics:
- Essay on Risk Assessment
- Essay on Robbery I Witnessed
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Apart from these, you can look at all the essays by clicking here .
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