Environmental Factors that Cause Risks - Admission/Application Essay Example

 The macro-environment of a business may present various risks. For example, the political environment is a significant determinant of the risks that a business is exposed to. Government taxes and tariff barriers to trade also present significant risks. The standards set in the UK for food suppliers to maintain high quality of health in the foods they supply to consumers is an example of political factors that may pose a risk to an organization. If the suppliers do not comply, they might be denied their operating licenses. In the politically unstable states, the financial risks are high. On the other hand, the economic factors determine present various financial risks to an organization. These include factors such as inflation, exchange rates and economic growth as well as supply and demand in an economy (Thompson, 2002). The global economic crisis is one of the major risk factors that have made the operating environment in most countries unbearable for organizations such as GM, which has closed its foreign branches in various countries. The social factors that may pose risks to the business include the demographic characteristics of the population, health and safety awareness and culture, among the characteristics of the population in which a business operates, and the population that provides labor (Pearce & Robinson, 2005). For example, such as Agilent Agro Tech American Express and Caterpillar CB Richard Ellis Cisco among other U.S multinationals have established in India where there is cheap labor compared to the current wage rates in the U.S. Technological factors may also present financial risks to an organization especially in the highly innovative production environment. For example, organizations are usually faced with the risk of technology becoming obsolete before the end of its useful life. Decisions regarding outsourcing can also present financial risks especially when the outsourced services are not competitive. Jan (2002) observes that the environmental factors are also major causes of risks to organizations, with factors such as global warming, unfavorable weather and flooding affecting business decisions. Legal issues also present major risks to a business. For example, labor laws as well as workplace health and safety laws can largely affect the operations of a business. Introduction to Types of Decisions that Expose Companies to Risk The programmed decisions in a business usually expose it to risks especially due to the complexity involved. The decision makers have to make considerations of many inter-dependent aspects of the organization; hence there is a high chance of skipping some important factors that are significant in the process. On the other hand, the non-programmed decisions are usually characterized with uncertainty and therefore there is likelihood that they expose risks to the business. Under such decisions, there are usually many alternatives that can be undertaken, with each presenting differing levels of uncertainties and risks. Thompson (2002) notes that strategic decisions are the most risky for the business since they are focused on the accomplishment of long term objectives for an organization. Once a permanent decision has been made, it is usually difficult to implement. The uncertainty and the risks involved significantly affect the performance of an organization. When uncertainty exists for example in regard to the outcome of mergers and acquisitions, the business is faced with high risks especially when the smaller organization being acquired brings in incompetence in the larger organization. Pearce & Robinson (2005) argue that other risky decisions involve major activities such as expansion of the business in foreign markets where it is likely to meet competition and other drawbacks that may lower its competitiveness while increasing the costs of operation. Companies may be compelled to close business in a foreign market immediately after opening due to challenges faced as a result of uncertainty. It is important for financial managers to ensure that the identified risks are assessed and classified according to their severity as well as their likelihood of occurrence. Such classifications enable the financial managers in setting up priorities. The success of risk management depends on the accuracy of the prediction of risks leading to successful setting of priorities (Cooper, 2000). However, financial managers are faced with the shortage of information that can help them in maintaining accuracy in their predictions. On the other hand, it is also usually difficult to determine the harshness of the risks to the business. However, it is important for them to ensure that they have the most articulate predictions top ensure that they are able top manage the financial risks. This paper is a critical evaluation of the techniques available to financial managers so as to deal with risk in financial decision-making such as elimination, insuring which is a strategy of sharing, or budgeting for the risk, which is an indication of acceptance of the risks as part of the business operations. The essay presents these techniques with illustrations with practical examples from research. Techniques for Dealing with Risks Risk Avoidance and Reduction Financial managers can decide to eliminate a particular risk in the system by skipping the actions that are likely to pose a risk to the organization. Pearce & Robinson (2005) argue that strategies for risk avoidance are developed by the managers when they realize that overlooking a particular step that is thought to be associated with a particular risk in the decision making process, is unlikely to cause harm to the final outcome. However, not all the risks are avoidable since there are certain actions that have to be carried out for an organization to accomplish its financial plans. The management needs to adopt flexible practices to be capable of making a change in the objectives of the business to avoid risks. This is done especially in the situations whereby there are no alternatives other than eliminating the objectives that may cause financial risks, or accepting the risks by allowing the objective to be accomplished. For example, businesses such as Coca-cola are highly dependent on their brand name, especially if the customers associate it with superior quality. For this reason, franchise may pose a great financial risk especially if the products of the organizations that are franchised do not meet the demands of consumers. In situations where another company needs to be franchised by Coca-cola, the risk associated with such an action needs to be evaluated and if it poses a risk to the brand name that is significant in the maintenance of competitiveness in the organization, it should be avoided (Burns, 2007). On the other hand, it may be discovered that an already franchised organization is posing a risk through the introduction of substandard commodities under the strong brand. This may lower the brand equity over a particular period of time, and risk reduction would be the most appropriate. This can be accomplished through revoking the franchise agreement or putting control measures to ensure that the franchised company offers quality products in the market. Other companies may effectively avoid financial risks by moving their foreign subsidiaries from politically unstable states, which may lead to losses in case the firm is attacked. Decisions to avoid risks are undertaken regardless of the profitability of a business venture overseas. In other words, as Alexander & Sheedy (2005) observe, risk avoidance is accompanied by the failure to utilize a business opportunity to save the current operations from the adverse effects of risks that may arise from undertaking a new business venture. Many financial managers may opt to adopt avoidance of risk, but it is important to understand the fact that opportunities are lost in the process. Hazard prevention is also a strategy for risk avoidance whereby strategies are developed to safeguard the organization from the vulnerabilities identified. For example, Kroszner et al. (2007) give an impression that the housing boom in the United States could have been identified as a potential hazard that could lead to the banking crisis. Lending would have been a lucrative venture for the banks if all the borrowers could have repaid their loans. However, the financial managers did not carry out effective assessment that could have made them capable of identifying the possibility of a mortgage crisis. Risk avoidance needs to be timely before the risk affects the business. The eventual strategy that the banks in the United States adopted was increased strictness in the appraisal process for lending, which was meant to avoid or reduce the risk of borrowers who were not creditworthy. However, the strategy was not adopted in the right time since the banks had already suffered huge losses and were getting in to a severe crisis. On the other hand, Alexander, & Sheedy (2005) argue that the reduction of risks is important in controlling the impact of risks. For example, strategies may be put in place to deal with the risk for which the impact is already being felt. In other words, the risk occurs but may be mitigated to have a lesser impact on the business. Mitigation may not be the right option since the business suffers from the risk. However, when it is discovered through evaluation that the risk is unavoidable, the business may opt to undergo an opportunity cost, especially if the business is likely to reap more benefits compared to the losses incurred as a result of the risks that the business is exposed to. Under certain circumstances such as lending by financial institutions, risk reduction plays a significant role in keeping the business in operation. This is because the risk is unavoidable since without lending, the business can not be functional. Risk reduction in lending may include putting measures in place to ensure that the credit appraisers use the most appropriate tools to evaluate the creditworthiness of a borrower (Borodzicz, 2005). It is significant in reducing the risks of failure to accomplish the obligation of repaying the loan. With such measures, the creditors can offer credit facilities with minimal risks. Risk Retention Companies some times are compelled to accept the failures after undertaking risks. This strategy applies to the purely unavoidable risks whereby the business has no alternative apart from either maintaining the status quo or closing down. The risks may not be insured after consideration of particular aspects such as when they lead to losses that might be lower than insuring them. Gorrod (2004) argues that the risks that businesses opt to retain may be appalling and the financial managers may be uncertain regarding their possible impacts to the business. However, such risks usually do not hamper the accomplishment of organizational objectives and when they do; they are usually catastrophic to the extent that the business may loose, but not as much as it would incur in insuring the company against war. For example, there are many profitable companies such as Bechtel, General Dynamics and Nour USA Ltd that have retained the risk of the war in Iraq. It is risky to invest in the country but they continue recording profits, which would not be accomplished if the companies would be paying the high premiums of insurance against war. If in any case the companies their properties are destroyed by war, they may incur losses. However, they remain in business because of its profitability and the huge costs that may be incurred in form of premiums. On the other hand, companies may adopt this strategy when they realize that the chances of the occurrence of a disaster are minimal. According to Dorfman (2007), the business adopts self insurance in risk retention through setting aside a certain amount of money that can be used to cover any losses that might result from the various risks that the business is exposed to. In other words, it means that the financial managers are aware of the potential risks but they do nothing until the business is faced by the impact of the risk. Insuring the business would require it to pay an excess of more than half of the money that may be paid in form of compensation after the organization has been affected by the risk that it was insured against. This means that whether or not the organization has been affected by the risk, it looses a substantial amount of money to the insurers. Risk Sharing Many businesses thrive through risk sharing whereby when they are adversely affected by risks in the operating environment they are compensated for what they lost, which is a significant factor that can help businesses to get back to the track after incurring huge losses that may lead to its closure. Hubbard (2009) argues that risk sharing is a form of risk transfer whereby an insurance company undertakes the responsibility of solving the issues brought about by financial risks. Financial managers usually adopt risk sharing when they are convinced that there is a likelihood of the occurrence of the risk, and that the amount of premiums does not exceed the losses that the business may incur in the occurrence of the risk for which the business has been insured. Many organizations such as Starbucks in the contemporary market place have adopted this practice. The company insures its products as well as its employees. It has been able to maintain competitive even during the current economic crisis. They insure their property against various risks that occur often such as fire, theft and bankruptcy among other potential risks. Conclusion It is important for financial managers to understand the macro-environmental factors affecting that may present risks to the operations of a business. They include the political factors that are concerned with government issues, economic aspects, social factors that are mainly concerned with demographics of the population in which an organization operates as well as technological, environmental and legal issues. There are also different decisions in a business that present different risks. They include programmed, un-programmed and strategic among others, which have various reasons that make them present a risk, such as uncertainty and the complexity of decisions. Financial managers can adopt various techniques for dealing with the risks, which include; avoidance and/or reduction of risks, retention and sharing, which are significant in maintaining the competitive advantage of a business. The most important fact is to identify the most suitable technique for the business. References Alexander, C. & Sheedy, E. (2005). The Professional Risk Managers' Handbook: A Comprehensive Guide to Current Theory and Best Practices. PRMIA Publications. Borodzicz, E. (2005). Risk, Crisis and Security Management. New York: Wiley. Burns, T. (2007). “The Legal Implications of Reputation Risk Management for Franchisors”. Journal of International Commercial Law and Technology, Vol. 2, 4 pp 231-240 Cooper, L. (2000) “Strategic Marketing Planning for radically new products”, Journal of Marketing, Vol. 64 Issue 1, pp.1-15. Dorfman, M.S. (2007). Introduction to Risk Management and Insurance (9th Edition). Englewood Cliffs, N.J: Prentice Hall.  Gorrod, M. (2004). Risk Management Systems: Technology Trends (Finance and Capital Markets). Basingstoke: Palgrave Macmillan Hubbard, D. (2009). The Failure of Risk Management: Why It's Broken and How to Fix It, John Wiley & Sons Jan, Y. (2002) “A three-step matrix method for strategic marketing management”, Marketing Intelligence and Planning, Vol. 20 Issue 5, pp.269-272. Kroszner, R. S., l. Laeven, & D. Klingebiel (2007). “Banking crises, financial dependence, and growth,” Journal of Financial Economics, 84(1). 187-228. Pearce, J. & Robinson, R (2005). Strategic Management, 9th Edition, New York: McGraw-Hill. Thompson, J. (2002). Strategic Management, 4th Edition, London: Thomson. Read More