Risk Management In Business - Research Paper Example

RISK MANAGEMENT IN BUSINESS Contents: Sr. # Topic Pg. # 1. Introduction 1 2. Benefits of Risk Management 5 3. Limitations 8 4. Cost of Accidents at Work 9 5. Insurance 10 6. Conclusion 11 References 12 Introduction “If you can't manage risk, you can't control it and if you can't control it you can't manage it. That means you're just gambling and hoping to get lucky” There has been a substantial increase in the pace with which the corporate environment has undergone a change, especially owing to large scale technological developments and the advent of market globalization. Although such environmental changes has brought about huge financial advantages for companies across the globe, they have also brought along with them, higher risks. Thus it is imperative for the companies irrespective of the industry to which they belong, to develop and implement active risk management policies and strategies in order to enable them to cope with such unforeseen risks. The importance of risk management has risen in recent times owing to the events such as rise in terrorist activities, the threats posed by them especially in the wake of the 9/11 attacks on the World Trade Centre, which has put companies in high risks of attracting unimaginable financial as well as personal losses. Moreover international high profile cases such as The Bhopal Gas Tragedy – India; The huge losses suffered by auto giant General Motors in the U.S. and the Lloyds Banking group in the UK on account of recession; etc bear testimony to the fact that risk management is all the more important to predict and safeguard the companies against losses, which are likely to disrupt the financial and operational activities of well established organizations. Furthermore in recent times, the risks from terrorist activities as well as environmental threats on account of global warming – which has lead to a sudden shift in temperatures, and an acute shortage of resources are likely to have a negative impact on various businesses. The companies thus, need to rely on effective risk management policies to safeguard themselves against such unforeseen events. This paper discusses the various issues related to risk management in business, including the various types of risks, the cost of accidents or unforeseen events to the organization, tools available at the disposal of the management to deal with risks – such as insurance, exposure to loss, benefits and limitations of risk management etc. Definition of Risk Management: According to Merna, Al-Thani, (2008): “Risk management is a formal process that enables the identification, assessment, planning and management of risks”. (Pp. 2) Blokdijk (2007) defines Risk Management as: ".. a process of identifying and analyzing risks and then taking appropriate plans and actions to avoid them if they have not yet happened, to minimize or eliminate them if they do happen, while still keeping attainable goals." (Pp. 17) Business Risks: There are various types of risks faced by an organization. These include strategic risks, operational risks, financial risks, risks related to the health and safety of the employees, as well as environmental risks (Sadgrove, 2005). Strategic Risks: Strategic risks are those risks which are encountered on account of the decisions made by the management related to the products or services offered by them, and include such risks as marketing, pricing, economic conditions which are likely to affect the pricings and costs of the products / services, change in technology, etc. The strategic risks have a major impact on the organization's costs, prices, and finances and may hamper the overall organizational development in the process. Hence it is important for the management to ensure that such risks are taken care of and appropriate preventive measures are implemented prior to taking strategic decisions. Operational Risks According to Gallati (2003): “Operational risk is the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and systems or from external events.” (Pp. 289) For instance the risk of losing revenues on account of workers strikes, breakdown of machinery or technological failure, fire or other natural disasters etc. Financial Risks Financial risks refer to the assumption, by the management, that on account of unforeseen situations / circumstances, the organization may have to deal with shortage of funds. A company may have to face loss of revenues on account of various reasons, and certain events may cause huge financial losses, for instance investing in a new business venture, launching of a new product, etc. which requires investment of huge amount of funds on the part of the management, and hence failure of such a task, may lead to huge financial losses. Health and Safety Risks Health and safety risks refer to those risks which an organization may have to face on account of accidents likely to occur in workplaces. Such risks are faced by all types of organizations across the industry, but are relatively higher in case of businesses which require its employees to work in extreme conditions or in places which have an inherent health and safety risk attached. For instance, workers involved in construction business, or mine fields, are exposed to such risks. Also, the lack of availability of proper safety services such as fire rescue, may also jeopardise the health and safety of the employees causing huge losses to the company in the event of fire breakout. Environmental Risks Environmental risks include risks which are likely to be faced by the management on account of changes in external environment such as change in legislative, administrative or regulatory policies concerning the business; change in climate; natural disasters etc. 1. Benefits of Risk Management: Adoption and implementation of appropriate risk management strategies helps organizations in preventing unnecessary costs, disruption of its day to day operational activities and incurring financial losses. Risk analysis facilitates the management to take appropriate decisions regarding classification of risks in accordance with their type i.e. the risks which are worth pursuing against those which can be ignored. Although the benefits of risk management are manifold they cannot be quantified in fixed terms. Usually organizations implement risk management strategies in response to the internal as well as external threats it faces in its day to day operations and hence it is an inevitable part of any business process. There are various benefits of risk management including strategic, financial, operational, as well as overall management benefits. These benefits are listed below: Strategic benefits of risk management include improvement in corporate decision making processes for individuals as well as at the organizational level; development, adoption and implementation of a progressive management policy which leads to the development of a positive organizational culture, which facilitates continuous improvement of the business as well as its employees; the improvement in reputation of the organization on account of developmental management styles, and positive approach of the stakeholders, partners as well as third parties such as suppliers and the general public; reduction in threats to costs, time as well as overall business performance which helps in faster accomplishment of the organizational objectives and goals etc. Financial benefits of risk management: It allows the organizations to avoid huge financial losses; enhance its value for money; improves the visibility as well as strict management of its contingency plans. The benefits of risk management to the business includes an improvement in the chances of the company to accomplish its goals and objectives; an improved understanding as well as identification of risks by the management and the devising of appropriate measures and mitigation plans which helps the organizations to sustain their competitive positioning in the market; facilitates better management of risks, costs and prices which are likely to be affected in the event of occurrence of an unforeseen calamity; development of an environment which allows for the wide scale implementation of developmental business wide policies on an informed basis; reduction of costs and the implementation of corporate governance procedures (Great Britain Office of Government, 2007). 2. Limitations of Risk Management The benefits offered by risk management processes are manifold and hence undeniable. However, although the process of risk management claims protection from unforeseen events, the process may not always be effective. The process of risk management applied by the organizations requires the management to identify risks at a conscious level, which in turn entails an analysis of various questions such as who would be held responsible for anticipating risks? How can such risks be handled? The various tool, strategies and policies available at the disposal of the management to handle the range of risks identified etc. Even though the management succeeds in identifying the various risks likely to be faced by them in the long run, certain risks are highly unpredictable. For instance, in case of the 9/11 incident, in normal circumstances, a range of risks can be identified, but the unimaginable levels of threats posed by terrorist actions, weaken the capacity of the management to analyse such risks. Also, the extent of financial losses cannot be calculated or estimated effectively, in the absence of adequate information regarding the magnitude of damage caused / likely to be caused. Since such estimation is humanly impossible, considering the nature of unforeseen events, risk management, cannot protect the organizations despite its various benefits (Frame, 2003). 3. Cost of Accidents at Work It is undeniable the workers / employees i.e. human resources are one of the vital strengths of any organizations. Hence safeguarding them against unforeseen accidents is of prime importance to organizations, since any harm / injury caused to the workers in the workplace on account of lack of adequate health and safety measures may cause significant losses to the organizations both - human as well as financial. The health and safety of employees is hence on the top agenda of the management, who take additional care to ensure that the workplaces are free of any danger and are capable of facing any potential threats / harm posed by the external environment. However, despite the apparent benefits of identifying such risks, estimating the health and safety risks faced by the employees is a highly complicated task not only in terms of accurate predictions of the tangible or direct costs such as physical injuries caused to the employees / workers in the workplace but also the unambiguous, indirect, intangible costs such as illness caused by unhealthy working conditions. According to Burton et al (1999): "The loss of worker productivity resulting from health problems is an indirect health cost to corporations that is largely unmeasured... Direct costs are much easier to quantify than indirect costs." (Pp. 863). The cost of accidents can be measured in terms of tangible losses and intangible losses. The intangible losses or the non-financial losses include loss of human workforce due to accidents, illnesses etc; lawsuits filed against the company leading to defamation of the brand image of the organizations bringing disrepute; loss of employee morale; fall in productivity; stagnation of work owing to fear among employees regarding their health and safety at the workplace etc. Accidents at work place may pose various risks to the organizations such as the risk of being sued by family of the victims leading to huge financial losses; lawsuits being filed by victims leading to loss of time, energy and money and hence increase in costs; loss of employee morale leading to a steep decline in productivity and ultimately loss of revenues; increased absenteeism on account of loss of employee confidence in the management; huge compensations being paid by the company to the workers; etc. The tangible losses on the other hand include such losses as loss of revenues on account of large scale physical damage to the company buildings on account of accidents such as fire; increase in operational expenditure to repair the damages; loss of goods, data and other important documents and physical damage to the personnel among others (Purpura, 2007). 4. Insurance Insurance is one of the most effective and beneficial forms of risk management in present times. It is a method / tool by which the companies can transfer their risks to the firms providing insurance in exchange for premiums. It is one of the best effective means of reducing losses. For instance if the price of oil rises substantially on account of various internal and external environmental changes, the disruptions that is likely to be caused to the company in terms of supply and distribution may hamper the organization’s goals causing huge financial losses. Insurance thus serves as a protective agent which safeguards the companies from such unforeseen risks and allows the organizations to accomplish their financial and economical goals. The risk management policy of the British oil giant, British Petroleum which is engaged in the exploration, extraction, refinement and distribution of oil and gas, serves as an appropriate example of the manner in which risks are identified, managed and insured in the oil industry. The company insures small unsubstantial losses while retaining larger losses and the smaller losses are usually insured only if there is a potentially significant financial gain in doing so. The decision related to insuring losses is however directly related to various factors such as insurance premiums, returns likely to be received by the company in case of accidents / financial loss, the number of competitors in the market etc. The strategy of BP as analysed by Doherty indicated that the company’s profits (1987 – 91) accounted for approximately $ 2 billion annually, and its assets accounted for over 50 billion USD. The local managers were authorized to purchase insurance for losses up to 10 million USD. Such minimal losses (as against the assets of the company) are usually not insured, but in case of BP, the key reasons behind insuring such minimal losses include the payment of premiums amounting to 1.5 million USD which returned about 250 million USD in claim payments; and the impact of losses upto the amount insured was relatively insignificant and the insurers gained no advantage in offering services to the company. (Harrington, 2004). 5. Conclusion The fact that certain risks are unforeseen and unmanageable at times is undeniable. Hence it is important for the management to consider risk management as a separate function which exclusively deals with estimating such risks and works on developing policies and strategies which help the organizations to cope with such risks and successfully survive the damages caused. Company -wide policies aimed at monitoring and controlling risks is an effective way of managing the unpredictable damages that the company may face in the long run. Furthermore, it is also important to understand, explore and assess the overriding goals and objectives of the organization which are focused on reducing the extent and scope of damages caused by such unknown risks faced by businesses across industries, through development of robust risk management policies. Such policies not only help the businesses in safeguarding their organizations against financial losses but also ensure health and safety of its employees, and retaining their competitive positioning in the industry, which is crucial especially in times of cut throat competition. References: Blokdijk, G., (2007). Risk Management: 100 Success Secrets, Lulu Publication Burton, W. N., Daniel, J., Chen, C., Schultz, A, edington, D. W., (1999). The Role of Health Risk Factors and Disease on Worker Productivity, Journal of Occupational and Environmental Medicine, Vol. 41 No.10, Pp. 863 - 877 Frame, D. J., (2003). Managing Risks in Organizations: A Guide for Managers, John-Wiley & Sons Publication, Pp. 17 - 20 Gallati, R. R., (2003). Risk Management and Capital Adequacy, McGraw-Hill Professional Publishers, Pp. 289 Great Britain Office of Government, (2007). Management of Risk: Guidance for Practitioners, The Stationery Office, Pp. 122 - 128 Harrington, S., (2004). Risk Management and Insurance, McGraw-Hill Publication, Pp. 484 - 490 Merna, T., Al-Thani, F. F., (2008). Corporate Risk Management, John Wiley & Sons Publication Purpura, P., (2007). Security and Loss Prevention: An Introduction, Butterworth-Heinemann Publication, Pp. 263 - 265, 329 Sadgrove, K., (2005). The Complete Guide to Business Risk Management, Gower Publising, Pp. 18 - 22 Read More