Scott has been a faculty member in higher education for over 10 years. He holds an MBA in Management, an MA in counseling, and an M.Div. in Academic Biblical Studies.
Risk & Risk Sharing Definition
Did you know that, dozens of times every day, you share risk? Risk is the probability of an event occurring in a given time period. It's important to remember from the outset that, in this context, risk refers only to an occurrence and not necessarily an adverse event. With that in mind, risk sharing doesn't mean pushing the threat of bad outcomes off on someone else. Rather, it means reducing the likelihood and impact of uncertainty.
Here are a few examples of how you regularly share risk:
- Auto, home, or life insurance, shares risk with other people who do the same.
- Taxes share risk with others so that all can enjoy police, fire, and military protection.
- Retirement funds and Social Security share risk by spreading out investments.
Whether you're a project manager or a small business leader, properly managing risk can be the difference between success and failure.
Strategies for Sharing Risk
With only a few exceptions, business leaders and project managers should share risk whenever possible. Most of the time, sharing risk is a win-win scenario where stability is increased for all parties. We'll look at some real-world examples in a minute, but first we should look at some broad strategies.
One strategy for sharing risk is to diversify. To an investor, diversify means to put a little money in a lot of places so that the demise of one investment doesn't wipe out the investor. That strategy has a direct corollary in business risk. In this strategy, a business or project leader allocates resources so that a problem or disruption has minimal impact on other aspects of the business.
A second common strategy for risk sharing is outsourcing. Outsourcing means taking the business unit or function, removing it from the organization itself, and subsequently contracting another entity to do the work. In many cases, when you outsource services, you are also outsourcing risk. This is especially true when the outsourced function is already far outside the businesses core competency and primary mission.
Examples of Risk Sharing
During a project, risk can be shared with other project participants and resources. Organizations share project risks when everyone understands deliverables and expectations clearly. In business, risk can often be shared by working closely with other business partners in a mutually beneficial partnership. Here are a few real-world examples of risk-sharing through diversity and outsourcing.
When an airline faces unforeseen cancellations that exceed their capacity, they use their contractual arrangements with other diverse competitors. The airline with cancelled customers pays an agreed-upon rate so that a single flight cancellation doesn't strand all passengers at the airport. This mitigates both the risk of losing a customer and the risk of uncertainty associated with another airline's ticket pricing.
Many governments and nonprofits diversify their revenue streams to reduce the risk of sharp declines in revenue. In the government arena, the risk of plummeting tax revenue is mitigated by collecting taxes through income, property, and sales tax. Although it will still cause the government entity to suffer, the plummeting revenue will not be nearly as detrimental as having only a single revenue stream. Likewise, nonprofits that rely on donations reduce risk by maintaining a diversity of donors and donor categories.
A few industries rely on a very unique way of sharing risk through diversification. Many agricultural businesses and energy companies share risk by purchasing through a cooperative. In cooperatives, many small entities pool their resources to purchase bulk goods like coal or livestock feed. By doing this, they pay much lower prices since they can buy in bulk. This shares the risk of being forced to pay higher prices than much larger competitors.
An ever-increasing number of companies (even some Fortune 500 companies) are turning to the cloud as a way of outsourcing risk. While there are numerous ways to do this, outsourcing email to a company like Google (Gmail) is a lucrative option for two reasons. First, it reduces or even eliminates the need for on-site infrastructure like data centers and mail servers. It also lowers costs associated with the physical space occupied by servers, the utility costs to run them, and the personnel required to maintain them. Second, it dramatically reduces the risks associated with information security. Essentially, outsourcing email also outsources the risk of data breach or loss since the contracted email providers assume those risks when a contract is signed.
Many organizations share risk by outsourcing legal services. Although a corporate counsel is an all-around legal adviser, businesses often face the risk of litigation in very unique and specialized areas of the law. This could include energy rights, water rights, employment law, or tax law. It is usually cost prohibitive for an organization to keep all the required expert lawyers on retainer. To fulfill this need, many organizations choose to outsource their specialized legal resources by paying a fixed monthly or annual fee. Outsourcing these services minimizes the risk of losing a lawsuit due to lack of expert advice.
Businesses can also outsource security functions. Businesses have a legal obligation to maintain a reasonably safe and secure workplace, but there are substantial risks associated with keeping security functions in-house. By contracting these services to a private company, organizations reduce the risk of litigation associated with use of force, misconduct, or even a poor business image.
All right, let's take a moment or two to review what we've learned. Businesses and project managers both face risk that can often be shared with other participants. Risk is the likelihood that an event (not necessarily a bad event) will occur. Risk sharing helps businesses make sure they are not the only entity that would be affected by an adverse event.
There are many ways to share risk, but two common methods are diversification and outsourcing. Diversifying risk means that many participants share a small portion of the risk instead of one organization taking it all. Outsourcing is the act of sharing risk by placing responsibility for certain functions in the hands of others. In general, both business leaders and project managers should share risk whenever the opportunity presents itself.
To unlock this lesson you must be a Study.com Member.
Create your account
Register to view this lesson
Unlock Your Education
See for yourself why 30 million people use Study.com
Become a Study.com member and start learning now.Become a Member
Already a member? Log InBack