Risk Management
Risk management is the process of identifying, assessing and controlling threats to an organization's capital and earnings. These risks stem from a variety of sources, including financial uncertainties, legal liabilities, technology issues, strategic management errors, accidents and natural disasters
A successful risk management program helps an organization consider the full range of risks it faces. Risk management also examines the relationship between risks and the cascading impact they could have on an organization's strategic goals.
This holistic approach to managing risk is sometimes described as?enterprise risk management?because of its emphasis on anticipating and understanding risk across an organization. In addition to a focus on internal and external threats,?enterprise risk management?(ERM) emphasizes the importance of managing?positive?risk. Positive risks are opportunities that could increase business value or, conversely, damage an organization if not taken. Indeed, the aim of any risk management program is not to eliminate all risk but to preserve and add to enterprise value by making smart risk decisions.
"We don't manage risks so we can have no risk. We manage risks so we know which risks are worth taking, which ones will get us to our goal, which ones have enough of a payout to even take them," said Forrester Research senior analyst Alla Valente, a specialist in governance, risk and compliance.
Thus, a risk management program should be intertwined with organizational strategy. To link them, risk management leaders must first define the organization's?risk appetite?-- i.e., the amount of risk it is willing to accept to realize its objectives.
The formidable task is to then determine "which risks fit within the organization's risk appetite and which require additional controls and actions before they are acceptable," explained Mike Chapple, Notre Dame University professor of IT, analytics and operations, in his article on?risk appetite vs. risk tolerance. Some risks will be accepted with no further action necessary. Others will be mitigated, shared with or transferred to another party, or avoided altogether.
Every organization faces the risk of unexpected, harmful events that can cost it money or cause it to close. Risks untaken can also spell trouble, as the companies disrupted by born-digital powerhouses, such as Amazon and Netflix, will attest. This guide to risk management provides a comprehensive overview of the key concepts, requirements, tools, trends and debates driving this dynamic field. Throughout, hyperlinks connect to other TechTarget articles that deliver in-depth information on the topics covered here, so readers should be sure to click on them to learn more.
Risk appetite and risk tolerance are important risk terms that are related but not the same.
Why is risk management important?
Risk management has perhaps never been more important than it is now. The risks modern organizations face have grown more complex, fueled by the rapid pace of globalization. New risks are constantly emerging, often related to and generated by the now-pervasive use of digital technology. Climate change has been dubbed a "threat multiplier" by risk experts.
A recent external risk that manifested itself as a supply chain issue at many companies -- the coronavirus pandemic -- quickly evolved into an existential threat, affecting the health and safety of their employees, the means of doing business, the ability to interact with customers and corporate reputations.
Businesses made rapid adjustments to the threats posed by the pandemic. But, going forward, they are grappling with novel risks, including how or whether to bring employees back to the office, what should be done to make their supply chains less vulnerable, the threat of a recession and the war in Ukraine.
As the world continues to reckon with these crises, companies and their boards of directors are taking a fresh look at their risk management programs. They are reassessing their?risk exposure?and examining risk processes. They are reconsidering who should be involved in risk management. Companies that currently take a reactive approach to risk management -- guarding against past risks and changing practices after a new risk causes harm -- are considering the competitive advantages of a more proactive approach. There is heightened interest in supporting sustainability, resiliency and?enterprise agility. Companies are also exploring how artificial intelligence technologies and sophisticated governance, risk and compliance (GRC) platforms can improve risk management.
Financial vs. nonfinancial industries.?In discussions of risk management, many experts note that at companies that are heavily regulated and whose business is risk, managing risk is a formal function.
Banks and insurance companies, for example, have long had large risk departments typically headed by a?chief risk officer?(CRO), a title still relatively uncommon outside of the financial industry. Moreover, the risks that financial services companies face tend to be rooted in numbers and therefore can be quantified and effectively analyzed using known technology and mature methods. Risk scenarios in finance companies can be modeled with some precision.
For other industries, risk tends to be more qualitative and therefore harder to manage, increasing the need for a deliberate, thorough and consistent approach to risk management, said Gartner analyst Matt Shinkman, who leads the firm's enterprise risk management and audit practices. "Enterprise risk management programs aim to help these companies be as smart as they can be about managing risk."
Traditional risk management vs. enterprise risk management
Traditional risk management tends to get a bad rap these days compared to enterprise risk management. Both approaches aim to mitigate risks that could harm organizations. Both buy insurance to protect against a range of risks -- from losses due to fire and theft to?cyber liability. Both adhere to guidance provided by the major standards bodies. But traditional risk management, experts argue, lacks the mindset and mechanisms required to understand risk as an integral part of enterprise strategy and performance.
For many companies, "risk is a dirty four-letter word -- and that's unfortunate," said Forrester's Valente. "In ERM, risk is looked at as a strategic enabler versus the cost of doing business."
"Siloed" vs. holistic is one of the big distinctions between the two approaches, according to Gartner's Shinkman. In traditional risk management programs, for example, risk has typically been the job of the business leaders in charge of the units where the risk resides. For example, the CIO or CTO is responsible for IT risk, the CFO is responsible for financial risk, the COO for?operational risk, etc. The business units might have sophisticated systems in place to manage their various types of risks, Shinkman explained, but the company can still run into trouble by failing to see the relationships among risks or their cumulative impact on operations. Traditional risk management also tends to be reactive rather than proactive.
"The pandemic is a great example of a risk issue that is very easy to ignore if you don't take a holistic, long-term strategic view of the kinds of risks that could hurt you as a company," Shinkman said. "A lot of companies will look back and say, 'You know, we should have known about this, or at least thought about the financial implications of something like this before it happened.'"
Here's a primer on risk exposure and how it is calculated.
In enterprise risk management, managing risk is a collaborative, cross-functional and big-picture effort. An ERM team, which could be as small as five people, works with the business unit leaders and staff to debrief them, help them use the right tools to think through the risks, collate that information and present it to the organization's executive leadership and board. Having credibility with executives across the enterprise is a must for risk leaders of this ilk, Shinkman said.
These types of experts increasingly come from a consulting background or have a "consulting mindset," he said, and possess a deep understanding of the mechanics of business. Unlike in traditional risk management, where the head of risk typically reports to the CFO, the heads of enterprise risk management teams -- whether they hold the chief risk officer title or some other title -- report to their CEOs, an acknowledgement that risk is part and parcel of business strategy.
In defining the chief risk officer role, Forrester Research makes a distinction between the "transactional CROs" typically found in traditional risk management programs and the "transformational CROs" who take an ERM approach. The former work at companies that see risk as a cost center and risk management as an insurance policy, according to Forrester. Transformational CROs, in the Forrester lexicon, are "customer-obsessed," Valente said. They focus on their companies' brand reputations, understand the horizontal nature of risk and define ERM as the "proper amount of risk needed to grow."
Risk averse?is another trait of traditional risk management organizations. But as Valente noted, companies that define themselves as risk averse with a low risk appetite are sometimes off the mark in their?risk assessment.
"A lot of organizations think they have a low risk appetite, but do they have plans to grow? Are they launching new products? Is innovation important? All of these are growth strategies and not without risk," Valente said.
To learn about other ways in which the two approaches diverge, check out technology writer Lisa Morgan's "Traditional risk management vs. enterprise risk management: How do they differ?" In addition, her article on?risk management teams?provides a detailed rundown of roles and responsibilities.
Risk management process
The risk management discipline has published many bodies of knowledge that document what organizations must do to manage risk. One of the best-known sources is the?ISO 31000 standard, Risk management -- Guidelines, developed by the International Organization for Standardization, a standards body commonly known as ISO.
ISO's five-step risk management process comprises the following and can be used by any type of entity:
Identify the risks.
Analyze the likelihood and impact of each one.
Prioritize risks based on business objectives.
Treat (or respond to) the risk conditions.
Monitor results and adjust as necessary.
The steps are straightforward, but risk management committees should not underestimate the work required to complete the process. For starters, it requires a solid understanding of what makes the organization tick. The end goal is to develop the set of processes for identifying the risks the organization faces, the likelihood and impact of these various risks, how each relates to the maximum risk the organization is willing to accept, and what actions should be taken to preserve and enhance organizational value.
"To consider what could go wrong, one needs to begin with what must go right," said risk expert Greg Witte, a senior security engineer for Huntington Ingalls Industries and an architect of the National Institute of Standards and Technology (NIST) frameworks on cybersecurity, privacy and workforce risks, among others.
When identifying risks, it is important to understand that, by definition, something is only a risk if it has impact, Witte said. For example, the following four factors must be present for a negative risk scenario, according to guidance from the NIST Interagency Report (NISTIR 8286A) on identifying cybersecurity risk in ERM:
a valuable asset or resources that could be impacted;
a source of threatening action that would act against that asset;
a preexisting condition or vulnerability that enables that threat source to act; and
some harmful impact that occurs from the threat source exploiting that vulnerability.
While the NIST criteria pertains to negative risks, similar processes can be applied to managing positive risks.
Experts weigh in on how enterprise risk management is evolving.
Top-down, bottom-up.?In identifying risk scenarios that could impede or enhance an organization's objectives, many risk committees find it useful to take a top-down, bottom-up approach, Witte said. In the top-down exercise, leadership identifies the organization's mission-critical processes and works with internal and external stakeholders to determine the conditions that could impede them. The bottom-up perspective starts with the threat sources -- earthquakes, economic downturns, cyber attacks, etc. -- and considers their potential impact on critical assets.
Risk by categories.?Organizing risks by categories can also be helpful in getting a handle on risk. The guidance cited by Witte from the Committee of Sponsoring Organizations of the Treadway Commission (COSO) uses the following four categories:
strategic risk (e.g., reputation, customer relations, technical innovations);
financial and reporting risk (e.g., market, tax, credit);
compliance and governance risk (e.g., ethics, regulatory, international trade, privacy); and
operational risk (e.g., IT security and privacy, supply chain, labor issues, natural disasters).
Another way for businesses to categorize risks, according to compliance expert Paul Kirvan, is to bucket them under the following?four basic risk types for businesses: people risks, facility risks, process risks and technology risks.
The final task in the risk identification step is for organizations to record their findings in a risk register. It helps track the risks through the subsequent four steps of the risk management process. An example of such a risk register can be found in the NISTIR 8286A report cited above.