Risk Management

The final of the three concepts to consider is Risk Management.

Risk Management is an often-misunderstood technique.  People see it as negative, looking for problems … when in fact that is only half the story.

Let’s start at the simplest level … what is a risk?

In Risk Management terms, a Risk is a ‘deviation from the expected’ … or in other words, something happening other than what you predicted.  Note the language here isn’t negative … things could be worse than expected, but they could also be better than expected and still fall into our definition of ‘risk’.

That’s a very important point to note.  Risk Management includes opportunities too.  So, when we talk about Risk Management, what we’re actually looking for is risks and opportunities equally.

Risk Management as a technique is where we start to look at what could have a different outcome to what we expect, and how we could try to influence either the likelihood or the impact of that event taking place.    

Think of a very simple example.  Imagine your business sells cupcakes.  You plan to sell 50 cupcakes a day.  Now think of these two potential deviations:

  • There is a risk you may sell less than 50 cupcakes a day, and have goods going to waste
  • There is the opportunity that demand for your cupcakes is greater than 50 a day

So, how could you handle these in a more formal Risk Management way?

There are several things to consider for each potential deviation:

  • The impact if the deviation occurred
  • The likelihood of the deviation occurring
  • What could we do to influence the deviation’s impact, likelihood or both
    • What would the cost to implement the action
  • How does the cost relate to the adjusted impact/likelihood

We can now start breaking down our two deviations.  Let’s consider the first deviation:

  • The impact of not selling enough cupcakes is wasted cupcakes, or a waste of materials.  We can say the cost of this waste is medium.
  • The likelihood of it occurring (hopefully) is low, but it depends on past sales experience, special occasions, etc.
  • We could reduce it’s likelihood by increasing marketing, for example.  The cost of this could be medium to high.
  • We could reduce it’s impact by baking less cupcakes.  The cost of doing this is zero.
  • If we implement our two actions, we’ve reduced the impact to low, and the likelihood to very low

Let’s consider our second deviation:

  • The impact of demand outstripping supply is disappointing customers, which we clearly don’t want to do.  That could damage our brand, so the impact could be medium to high
  • The likelihood of it occurring is hard to judge.  We want high demand for our cupcakes (which is why we market them) but it depends on past experience
  • We could reduce the impact by giving discount vouchers for their next purchase if we run out.  The cost would depend on the discount offered and our profit margins, but could be low to medium.
  • We could reduce the likelihood by allowing people who want to buy multiple cupcakes to pre-order, giving us a better picture of our demand each day, and flexing baking volumes accordingly.  The cost of this is minimal.
  • If we implemented our two actions, we’ve reduced our impact to low, and our likelihood to low

I chose these two deviations deliberately as they’re both deviations on the same area, demand vs supply.  When you perform a risk analysis, don’t forget to consider what could happen on both ends of the spectrum for each area.

It’s worth noting that in a real-world example, you would try not to use ‘high/medium/low’ for assessing likelihood, impact and cost, but would use actual percentages and costs.  The advantage of this is you can properly assess whether the expenditure of an action is justified by a corresponding reduction in other costs.  An action that costs £1,000 but saves ten times that amount within a year is clearly worth it.  An action that costs £1,000 but saves £100 a year is more of a debate depending on the industry.  If an identified action does not change the impact or likelihood in a measurable way, question if it’s the best action to take … there may be better ones

We can use a Risk Management table to summarise these actions:

DeviationImpactLikelihoodActionCostAdjusted ImpactAdjusted Likelihood
 Wasted stock at end of dayMediumLowIncrease marketingMediumMediumLow
 Wasted stock at end of dayMediumLowReduce productionZeroMediumLow
 Run out of stock before end of day Medium/High Low/ Medium Discount offer Low/ Medium Low Low
 Run out of stock before end of day Medium/High Low/ Medium Pre-book batches Zero Low Low