Risk is inherent in every business. It’s more like the cost of doing business incurred through each commercial enterprise aspect. When you view business contract collection, you get to understand the risk an enterprise faces on a day-to-day basis, be it in employment, human resources, sales, finance, procurement, acquisition, etc.
Risk management, or even enterprise risk management, is not necessarily about eliminating risk. With enterprise risk management, you take a holistic approach to identify, analyze, respond, treat, and monitor company-wide risks to increase efficiencies and maximize opportunities. Mainly, it involves management-level decision-makers examining the company’s exposures in finance, fraud, strategic, credit, and operational matters. On the other hand, traditional risk management involves mitigating business vulnerabilities at the business segment or unit level to leverage opportunities and increase efficiencies.
Before we discuss the four types of risk management, let’s first understand what each of the process steps involves:
- Identifying – As the term suggests, you identify the vulnerabilities passively or using various risk identification methods.
- Analyzing – Once you identify the risks, you assess each to understand their magnitude and impact on the company, consumer behavior, and other business aspects.
- Responding – With a clear understanding of the risks, you can then implement the necessary controls to address them in a timely manner.
- Monitoring – This is an ongoing process whereby you monitor the risks continually, allowing you to respond promptly to minimize their impact on your business processes.
Other than improving your operational efficiency, proactive risk management has several other benefits, including minimizing exposure to losses, increasing customer satisfaction, and boosting profitability.
Types of Risk Management
While each of the four types of risk management’s ultimate goal is to mitigate vulnerabilities, they’re unique and address multiple scenarios. As such, you need to determine which of the four approaches is appropriate based on the existing systems and processes context. But generally, all four techniques ensure comprehensive and effective coverage of all business risk scenarios.
Let’s look at each of them to understand what they entail and where they can be used.
Risk avoidance involves forgoing activities that carry risk to eliminate vulnerabilities. However, the downside of the approach is that you also miss out on the opportunities and benefits associated with the forgone activities.
For instance, in contract risk management, you may opt for any of these four measures:
- Refusal of the proposal – If you identify the risk before a contract begins, you can decline it.
- Renegotiation – If the risk manifests while the contract is underway, you can renegotiate the terms to avoid potential loss.
- Non-renewal – If you discover the risk during the contract’s life, you can decline to renew it.
- Cancellation – If the risk increases beyond acceptable levels during the contract, you can cancel it.
Avoidance should not always be the go-to risk management technique. Owing to the apparent trade-off, other approaches should be explored whenever appropriate.
Risk reduction involves reducing the risk to an acceptable level to minimize its probability of occurrence or impact. An effective strategy should aim to reduce the risk at early contract stages to reduce the severity of the loss throughout its life cycle.
Common risk reduction approaches include contract negotiation and standardization. Under contract negotiation, you renegotiate the terms at any stage of its life cycle, while standardization involves creating a library of standard terms, clauses, and conditions for a cohesive team approach, especially during contract authoring.
In reducing the risk, you accept some vulnerabilities with some level of avoidance, leading to significant loss minimization compared to avoiding the risk altogether. Good examples of risk reduction measures include implementing tighter internal controls or diversifying your operations.
Risk transfer involves sharing the risk with a willing third party, e.g., through outsourcing. The strategy is especially effective for manufacturing and service-oriented businesses with processes that can be outsourced.
Generally, risk transfer allows you to benefit from sharing the risk involved in processes you lack the capacity to handle or those, are not your core competencies. For instance, if you outsource your payroll to an external service provider, you effectively transfer the risk of, say, legal compliance to them.
Risk retention is a ‘do nothing’ approach whereby you accept the risk and incorporate it into your planning. Essentially, all contracts bear an aspect of risk retention. This requires you to incorporate it in your risk management planning, assessment, and review of your risk tolerance and appetite.
In most cases, the technique is ideal when you want to minimize the cost of either avoidance or reduction if the possibility of risk occurrence is not high. A good example is whereby you cover your employees against workplace accidents by paying low premiums in exchange for a higher deductible.
Overall, besides mitigating your vulnerabilities and maximizing your opportunities, incorporating the four risk management techniques into your day-to-day best practices gives your customers, suppliers, and other stakeholders confidence, as they consider your business safer to deal with.