Concept of Risk Management - Essay Example

Risk Management Concept of risk management Risk management is a process by which the potential risks which are set to arise in the future are identified and precautionary measures are installed in order to avoid any negative consequences. A successful business must be able to manage risks effectively so that it can continue to earn profits. The inability to identify risks in a proper manner may have a negative impact upon the business of the firm. The business environment is filled with a number of different types of risks such as financial risks, market risks, economical risks and legal risks. Successful managers are required to carefully analyze the potential impact of risks upon the business and plan different activities accordingly. Business activities require a lot of investments. Hence, if the environmental risks are not properly predicted, it may cause the firm to lose a significant amount of revenues. Project management offers various tools to managers who can successfully control the impact of risks. Risk planning technique is one such technique which is used by large organizations to manage the level of risks associated with their work. The risk planning process includes proactively analyzing, assessing and mitigation of risks. An articulate plan of risk management is therefore essential in all projects for their successful execution (Cervone, 2006). Types of risks A project in general is exposed to a variety of risks. These risks are mainly related to the environment in which the project is set to operate. Alterations in the environmental conditions lead to the generation of risks. The risks essentially faced in project management can be elaborated as follows: Scope risks Scope risks arise when there are changes in the pre-established scope of a project. Project scope includes the market conditions in which a given project is undertaken, the technological factors and the overall investments required to be made in the project. Changes in the project scope may cause managers to alter the budget set for a project. Under adverse conditions, changes in the project lead to complete change of project plans. Schedule risks Schedule risks mainly arise if there is a possibility that a project cannot be completed within the planned time. Delay in the attainmentt of raw materials, sanctioning of legal papers, communication barriers or environmental constrains may cause a project to take up more time than which was pre-estimated. Organizations lose immense revenue when projects are not completed and delivered on time. Resource risks Resource risks are mainly associated with the availability and the use of different resources in a given project. The timely and adequate availability of resources plays an important role in the successful completion of projects. A sudden rise in the price of important resources or the scarcity of the same may hamper a project adversely (Chapman and Ward, 1996). Project risk management Organizations are seen to gain immensely from the proper management of risks which are associated with a project. Risk management facilitates the prevention of loss of revenue under adverse conditions. The main objective of project risk management techniques is to minimize the impact of threats that are set to arise in the environment. Risk management also includes seizing potential opportunities and converting adverse conditions in the favour of the firm. Successful risk management includes, the early detection of risks which is only effected when managers have the ability to forecast future scenarios accurately. Once the risks are identified, it is essential to judge the scope of their occurrence and accordingly prioritise the same. The risks which have the maximum probability of occurrence must have remedial plans established in advance. The risks whose probability of occurrence are low, but may cause huge negative impacts, must also have adequate remedial measures planned. The risk management process is only complete when forecasted risks and its associated tasks are carefully analyzed from time to time. Also, if the risk aversion measures are implemented, it becomes important for the management to study whether the remedial measures have actually benefitted the project. Implementation of risk response is as important as planning. Efficient project management techniques include registering project risks as and when they occur. This facilitates future risk management and managers can suitably compare and analyse the types of risks which occur frequently and those which do not (Ward and Chapman, 2003). Identifying and calculating risk Risks which are associated with a project can be identified in a number of ways. Assessment of the business environment is the easiest way of determining potential risks. This includes assessing changes in the financial market such as change of interest rates and value of shares. Risks may also arise out of the changing tastes and preferences of consumers which may render many services and goods as obsolete. Similarly, risks may also arise out of the lack of availability of resources. Once the risks are identified, the next step is to calculate their impact. Project associated financial risks are usually calculated using capital budgeting techniques such as net present value, internal rate of return and payback period. Using variable discounting rates, time period required for completing a project and variable cash inflows, managers are able to determine whether a project can generate adequate returns in the future. It therefore becomes possible to determine the returns which are available from a given project under variable circumstances. Capital related risks can be calculated by using weighted average cost of capital and equity pricing models. Similarly, the risks associated with the market can also be analyzed using different market analysis tools. One of the significant challenges which managers face is accurately determining the extent of change in different external conditions. If the changes cannot be determined correctly, then calculations in respect of risk cannot be carried out effectively (Kerzner, 2013). Limitations of calculating risks Risk assessment and planning processes is faced with a number of limitations. Risks are perceptions regarding future events which may or may not occur. For this reason many organizations consider risk management to be a wasteful process and there are no guarantee that the perceived risks will occur. Risk assessment mainly involves analyzing the changes which may occur in the environment. If the assessment is not conducted accurately, the effort given in respect of risk planning becomes a waste. Project managers are faced with the critical issue of identifying the various types of risks. Since the business environment is constantly changing, new types of risks keep emerging. As a result, managers are required to monitor the business environment at a continuous basis which many at time become a tiring venture. There are also uncertainties regarding the extent of impact of different types of risks. Unperceived impacts many at times are left without correction, due to constrain of time or resources. Information gap and the lack of proper tools may also cause problems for managers for developing and implementing risk management plans (Sumner, 2000). Risk management planning steps Risk identification The first step of risk management process is to identify those types of risks which have a probability of occurrence. The identification of risks can be done through effective forecasting of the economic, social, political, technological and legal environment. While forecasting, managers are required to consider changes which may occur in the present environment situations such as an increase in interest rates, increase in tax rates, changes in tastes of consumers and loss arising out of resource scarcity. Such situations are required to be forecasted and analyzed in advance so that suitable remedial measures can be planned. Risk analysis The perceived risks associated with a project can be analyzed either quantitatively or qualitatively. Quantitative analysis is usually undertaken if the aspects of impact can be quantified such as revenue or the level of stock. Qualitative analysis is done if the risk element causes changes in the behaviour, attitude, culture or the manner of functioning of the employees involved in the project such as agitation between managers and employees or the loss of stock due to an accident. However, it must be noted that even the risks which have a qualitative risk elements can lead to loss of profits, which gets determined quantitatively. Therefore it can be stated that almost all types of risks can be analyzed in a quantitative manner. Risk response strategy Once the potential risks have been identified and suitable plans for the mitigation of the risks have been developed, it becomes necessary that the firm establishes suitable response strategies. The response strategies effectively state when and how risk mitigation process must be initiated. The whole purpose of risk assessment and planning becomes a waste if they are not put into use at the right time. Risk control and monitoring Once when the risk mitigation strategies are implemented, managers are required to continuously check if the risk implementation process is as per the plan. This prevents any deviation from the main objectives of the firm (Raz and Michael, 2001). Cycle of risk management Figure: Risk management cycle (Source: Ruleworks, 2014) Risk management is a continuous process and requires being implemented by a firm on a continuous basis. The cycle of risk management begins with the identification of potential risks in the external and internal environment of the business. Due to the existence of high risks in the external environment, business projects are also subjected to a number of changes. The priorities which are associated with a project and their relative risks are seen to frequently change. It therefore becomes essential to accurately identify the risks which are associated with a project. The second stage in the risk management cycle is the assessment of the extent of impact of the risks and the probability of their occurrence. Not all types of risks have equal probability of occurrence or similar types of impact. The next step in the cycle is the planning of the risk management process. Planning is one of the most important stages in the risk management processes. The planning stage includes determining the different types of resources required for risk management and the manner in which issues must be handled so that there are no negative impacts. The final stage in the cycle of risk management is implementation. The implementation stage involves the actual implementation of the risks plans which have been formulated. Mangers must accurately deduce when and how risk management plans must be implemented. The process of risk management does not stop once the plans are implemented. Since it is a continuous process, mangers are again required to begin identifying the potential risks in the business environment and begin the cycle all over again. The cycle of risk management is kept on repeating due to the constantly changing phenomenon of the business environment (Raftery, 2003). Models of project risk and procurement management The models which organizational managers use while determining project risks can be differ from organization to organization. The most common risk model used by organizations for the evaluation of project risks is the 5 step risk management model. The stages in this model are: 1) Risk identification 2) Qualitative risk analysis 3) Quantitative risk assessment 4) Risk response planning 5) Risk monitoring and control Procurement management is also associated with a number of different types of risks. It is related to the obtainment of important resources and raw materials so that production activities can be carried out effectively. The general risks which are associated with procurement are shortages, increase in price and increase in the lead time for obtainment of goods. Effective supply chain management process and materials management models facilitate in anticipating such risks. Critical path identification and economic order quantity are the most common techniques which are used for the evaluation of the risks associated with projects. These models can be used for critically evaluating the variability associated with procurement, by altering a number of factors. Business organization who procure raw materials using complex network chains, face more risks than those which procure locally using simpler networks (Stevenson and Hojati, 2007). Theories of project risk and procurement management Adolescent risk and science of judgement This theory states that young managers can take on risks more confidently than experienced managers. Highly risky project and those decisions which require critical risk analysis are usually tasks which are given to young managers. It is usually perceived that the risk endurance capability of young managers is comparatively high. Also, since risk management requires managers to remain alert regarding the market conditions, young managers are preferred. The theory also suggests that effective risk evaluation depends largely upon the ability of managers to evaluate risks in a proper manner. Hence, the judgemental ability of managers plays a critical role in risk management. Cultural and perception theories The Cultural theory of risk takes into consideration the relationship which exists between societal conflict and risk. The Cultural states that social thinking and attitude are factors which influences risk identification and assessment. Cultural theory is largely associated with behavioural sciences. The risk perception theories take into consideration economic and cognitive influences. Survey and case analysis are important areas of risk perception theories. In general, there are a number of risk management theories related to projects and procurement. These theories vary according to the environment, resources and the nature of the organization. Usually organizations are seen to favour the perception theory as it provides the scope to incorporate quantitative analysis. The theory of functionalism is also considered effective by managers for effective risk evaluation in projects. This theory is associated with the functional objectives of a given project or procurement process and accordingly identifies the impact of change of the different variables (Raftery, 2003). Importance of risk management in sustainable procurement Sustainable development is given huge importance in the business environment of today. The impact of business activities upon the environment such as the loss of important resources and climate change are important factors which organizations are required to consider while planning for risk management. Projects must not ignore sustainability needs and only consider the economic benefits which are associated with a project. Projects are therefore, required to consider the potential risks which the environment is likely to face due to different types of human activities. Project planning requires to be done in a manner such that there are no negative impacts upon the society of tomorrow. Resource conservation, efficient use of power and effective waste management are important factors to be considered in this respect. Long term assessment of environmental risks such as climate change must also be evaluated effectively. Understanding the environmental threats which different projects may cause helps managers to think more responsibly. Policy makers therefore seek to attain equilibrium between the needs of the environment, society and the business. Many at times it is observed that in order to diminish the negative impact of risks which were not perceived earlier, managers forego sustainability objectives. In order to avoid such circumstances, it is essential that firms effectively identify potential risks in advance and plan risk mitigation in a sustainable manner. However, while planning risk management; managers are often faced with the issue of foregoing organizational interests so that the needs of the present and future societies are met (Miller and Lessard, 2000). This guarantees the effective implementation of sustainable development in the risk management process. Reference list Cervone, H. F., 2006. Project risk management. OCLC Systems & Services, 22(4), pp. 256-262. Chapman, C. and Ward, S., 1996. Project risk management: processes, techniques and insights. New Jersey: John Wiley. Kerzner, H. R., 2013. Project management: a systems approach to planning, scheduling, and controlling. New jersey: John Wiley & Sons. Miller, R. and Lessard, D. R., 2000. The strategic management of large engineering projects: Shaping institutions, risks, and governance. Massachusetts: MIT press. Raftery, J., 2003. Risk analysis in project management. London: Routledge. Raz, T. and Michael, E., 2001. Use and benefits of tools for project risk management. International Journal of Project Management, 19(1), pp. 9-17. Ruleworks, 2014. The risk management guide. [online] Available at: [accessed 10 October 2014]. Stevenson, W. J. and Hojati, M., 2007. Operations management. Boston: McGraw-Hill/Irwin. Sumner, M., 2000. Risk factors in enterprise-wide/ERP projects. Journal of information technology, 15(4), pp. 317-327. Ward, S. and Chapman, C., 2003. Transforming project risk management into project uncertainty management. International Journal of Project Management, 21(2), pp. 97-105. Read More