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What Is A Business Risk And How Should You Plan For It?

Updated: June 19, 2024 | Published: August 5, 2021

Updated: June 19, 2024

Published: August 5, 2021

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The old adage goes, “No risk, no reward.” When it comes to business, the ultimate goal is to provide value and reap a profit. That doesn’t happen without assuming some risk. However, good business owners understand business risk and how to approach it. Some risks can be avoided, and others are inevitable, so mitigation is the only approach.

To know how to approach business risk, it’s necessary to know the types of business risk that exist and the strategies to handle them. This guide will give you everything you need to know.

Source: Unsplash

What is Business Risk?

Business risks are situations that businesses face which could negatively impact output or profits. There are various kinds of business risk, but they all have one thing in common: they threaten the business’ ability to accomplish its goals.

Risk can come from internal sources like the leadership style of those in charge. Or, it could be something totally uncontrollable, like natural disasters.

While it’s impossible for any organization to exist with zero risk, there are several ways to manage risk. These analytical and forward-thinking approaches can be the difference between having a thriving business and one that fails.

Types of Business Risk

There are four commonly noted types of business risk, which are:

  • Strategic Risk: A strategic risk exists when a business doesn’t operate according to its plan. Businesses have their business model outlined, which includes a strategy of how they will reach their goals. Once a business has to stray from their intended plans to meet their goal, they could be facing a strategic risk. For example, if a market has positioned itself to provide low-cost and organic produce straight from farmers to the local community and another farmer’s market opens nearby and undercuts their prices, the first company may have to pivot and offer another strategy (like delivery) to meet its customers’ demands.
  • Compliance Risk: There are many types of businesses that are highly regulated, such as insurance, finance, and travel. These industries must comply with numerous governmental rules and regulations. Compliance risk happens when a business fails to meet the regulations and adhere to the rules. For example, if an airline company fails to meet the FCC’s regulations, they can be shut down.
  • Operational Risk: Operational risks can decrease a business’ ability to provide value to their customers when the inner workings like day-to-day processes face failed systems. This could come in the form of fraud, privacy risks, legal risks, physical risks, or environmental issues. Operational risks cannot ever be fully avoided, but they must be actively managed.
  • Reputational Risk: When an internal or external event affects how people perceive a company, they may lose customers or the business entirely. One example of reputational risk would be if an ecommerce retailer is hacked numerous times. Then, people will lose trust and likely stop making online purchases, which would greatly affect the store’s bottom line.

What Causes Business Risk?

As mentioned, business risk can stem from internal or external sources. These can be broken down into three main categories, namely:

  • Nature: Natural causes can affect businesses by slowing down production, hurting people, or destroying physical locations and property. This may be a delivery truck that never makes it to deliver a customer’s package because of a tornado, or an earthquake that destroys a factory’s equipment.
  • Humans: People can provoke business risk by striking, being negligent, not fulfilling their job duties, or being mismanaged.
  • Economy: Economic and market factors like a change in consumer demand or an increase in the cost of raw materials will impact businesses.

How to Plan for Business Risk

There’s a process-based approach to plan for business risk. Every type of business faces a different degree of risks. To be best prepared, it’s necessary to define a business’ risk appetite and plan for said risk.

The process looks like this:

  • Identify: First and foremost, you need to understand what situations could arise and cause risk. This is the identification phase of risk management which involves brainstorming and a well-equipped team. Identifying risks calls for involving employees and team members in each department as they each have their own perspective of what kind of risks may occur.
  • Act: Executives and owners can define a plan based on each type of risk identified in step one. Then, if the risk comes to fruition, every person on the team knows how to act and what needs to be done to mitigate the negative outcomes.
  • Record: Keep a running report of risks, the plan of action taken, and the results. This helps to pave the way for improvements to be made, if needed.

Source: Unsplash 

Approaches to Manages Business Risks

There are four main approaches to manage business risks. Each approach will rely on the said risk that is posed. However, most companies end up mixing and matching these approaches to risk, based on the issue at hand.

  • Avoidance: Like the name implies, this would require changing your plan entirely to avoid the potential risk. So, if you want to introduce a new product, for example, but the supplier is out of the country, you could face natural disasters as a risk affecting the supply chain. Instead, you may avoid using a foreign supplier and choose a local supplier instead, thereby avoiding the risk that is tied to the foreign business.
  • Acceptance: Some businesses accept small-scale risks because the cost of avoidance, prevention, or transference would be greater than the outcome of the risk occurring.
  • Mitigation: Some risks are unavoidable and a core aspect of operating business. As such, one of the most common strategies is to mitigate risk. This is having a plan in place that will lessen the impact of the consequences of the risk on the business.
  • Transference: Businesses also often transfer risk, or pay someone else to take on the risk. This is the business of insurance. This strategy will rely on analysis to decide how much insurance is worth it to protect your business from risk.

The Bottom Line

There are a lot of upsides to running and/or owning a successful business. However, every business is faced with business risk. Understanding the variety of risks that could impact your business is a crucial step in preparing to manage it. By categorizing risks in their four main compartments and then choosing an approach for each, you can be the most prepared to handle business risk.

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