Risk Analysis & Risk Management in Business: Overview, Objectives & Comparison

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  • 0:02 What Is Risk?
  • 0:37 The Five Risk…
  • 2:57 Managing Risk
  • 3:58 Mitigating Risk
  • 5:14 Lesson Summary
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Lesson Transcript
Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

A successful business requires careful attention to the allocation of resources and, just as important, to the degree to which those resources are exposed to risk. In this lesson, we'll discuss the importance of risk analysis and management in business.

What Is Risk?

In an everyday, general sense, risk is simply defined as the possibility of something dangerous or unfortunate occurring. In the business world there is a slightly more vague definition. Managers and owners of companies in the business world define risk as anything that disrupts their ability to accomplish the mission of the organization. For most companies, their first mission is to make money. But, that doesn't mean the only type of risk a company should worry about is financial risk; there are five types of risks that can get in the way of a company accomplishing its goal.

The Five Risk Categories Analyzed

While an individual company may face a very specific risk, such as a freight delivery company in a catastrophic weather event or a real estate developer during a severe economic recession, all possible risks can be classified into one of five categories of risk:

  • Strategic Risk: Strategic risks are those associated with the overall industry and environment in which a company operates. For example, if a company decides to merge with a competitor, that is taking a strategic risk - the merger may end up being a costly endeavor. Even developing a strategic plan can be a strategic risk. If a company decides to pursue a low-price strategy with the goal of always being the cheapest option for consumers, those low prices might not provide the required profit to pay overhead costs or sustain the business plan.

  • Compliance Risk: Compliance risk is anything related to legal or regulatory costs, such as being sued for product liability or being fined by government agencies for not following important rules.

  • Financial Risk: Any risk involving the fiscal management of the organization can be considered a financial risk. This includes foreign exchange risk for companies that operate internationally, fraud, bad pricing strategies, and excessive inventory. Financial risk can also consider external risks, such as a bad economy or an unanticipated increase in material costs.

  • Operational Risk: Operational risk includes anything that might impact the day-to-day working of the business. This can have just as much to do with people as it does with machinery or transportation. An expensive, broken machine is just as much of a risk as a couple of people not showing up for work or quitting suddenly.

  • Reputational Risk: Whenever bad news about a company is reported so that consumers question the reliability of the company, the company is suffering from reputation risk. This bad news could be an accident (such as prepared salads not being refrigerated correctly and getting bacteria that gives consumers salmonella) or from an intentional, bad decision by management (such as setting up vehicles to report inaccurate miles per gallon readings). In the end, if something leads to customers, investors, or employees thinking less of the company, the company has suffered from reputational risk.

Managing Risk

Hopefully, management has processes and people in place to proactively manage risk. This is something an internal audit department might do, as well as a legal office or communications office. Really, every employee should have some component of the job that helps the company optimize the amount of risk it takes.

Notice that we said 'optimize risk' instead of saying 'minimize risk'. That's because risk is part of a cost vs. benefit analysis. If management identifies that a broken machine is a very high risk, management can go out and buy three extra machines, so that if one breaks, there are at least two backups.

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