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External Environmental Changes Drive the Need for Risk Management

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  • 0:03 Risk Management
  • 1:34 External Environmental Factors
  • 2:06 Change and Risk Management
  • 4:50 Lesson Summary
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Lesson Transcript
Instructor: Shawn Grimsley
Businesses operate in a dynamic world where the only thing for certain is that things will change. Change can bring both risk and reward. In this lesson, you'll learn how change in the business environment drives the need for risk management.

The Basics of Risk Management

Meet Marvin, a risk manager for a large corporation that does business internationally. Risk management is a process that businesses use to address risk. Risk can be thought of as a chance that an event will occur, resulting in negative consequences.

For example, there is a risk that a business's factory will burn down by fire. There is a risk that a foreign country will nationalize all business in which a company is operating. There is a risk that the company will be sued for product liability, and there is a risk that a technology will make the company's product or service obsolete.

In managing risk for his company, Marvin goes through some specific steps. First, he will identify risks. For example, he may determine that the company's vehicles need insurance and that the company's products may cause harm if used in an inappropriate manner. Second, Marvin must assess each risk. He must determine the probability of the occurrence of an event and the magnitude of the loss if the event occurs.

Finally, Marvin must determine how the company should mitigate, or limit, the risk. For example, Marvin may decide to transfer the risk of loss from a fire by insuring the company's factory from fire. If the company's factory burns down, the insurance company pays Marvin's company for the loss.

External Environmental Factors

Marvin needs to have a firm understanding of the company's external environment in order to properly manage the company's risks. A business's external environment is all the factors outside of it that can affect it. The external environment includes economic factors, legal factors, political factors and technological factors. External factors present companies both risks and opportunities. Marvin is concerned with the risks.

Change and Risk Management

Let's take a look at how change in a company's external environment can affect risk management by following Marvin through the risk management process. Marvin assesses the current economic environment and notes that there is currently some instability in the currency exchange market. Since his company engages in a large degree of international transactions requiring foreign currency, Marvin sees this as a potential risk and recommends that the company engage in currency hedging, which is a way to reduce the risks of dramatic shifts in currency rates.

Next, Marvin turns to legal factors. He just reviewed a recent court of appeals decision regarding product liability that will make it easier for plaintiffs to win. He has set up an appointment with the company's general counsel to determine what action can be taken to reduce the company's exposure given the new court ruling. He'll then meet with the relevant division managers to develop new policies to mitigate the risk.

Political changes to the environment can be challenging, especially if they occur overseas. Marvin reviews an internal memo regarding civil and political unrest in a third-world country where some of his company's key manufacturing operations are located. In fact, the city where its most important factory is located is undergoing violent riots. Marvin is concerned about the safety and security of the company's employees and property. He decides to recommend that the company increase its private security force at the factory and prepare for the possible evacuation of its foreign-born employees if the need arises.

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