Risk management is one of those odd ducks where the term can be used to mean many different things. To a bank, risk management is used to refer to managing credit and determining how much exposure exists on loans. To an insurance agent, risk management refers to determining how much insurance to buy. On the other hand, to their employer, the insurance company, risk management refers to ensuring that claims against the company are reduced and limited.
With all these definitions, is it any wonder that the term is misunderstood and misused?
In fact, if you look at all these definitions there is one constant throughout. They all deal with loss, and the protection against loss.
And that’s just plain unfortunate.
The truth is that risk has a very specific term in mathematics and probability theory. It’s only in general usage that we have allowed the word to morph into a threat-focused term. The word risk actually refers to the probability of occurrence. Risk is the opposite of a certainty. It doesn’t refer to amount of exposure or the nature of the exposure at all. That may not matter for the examples above. However, it does matter in more general situations such as project management and its relative strategic management.
This may seem like semantics but it really does matter. You see at its simplest risk management refers to a set of management processes. The focus of these processes is on ensuring maximum returns when the occurrence is uncertain. To do that it balances the costs of enhancing positive events and their returns on the one side. On the other, it balances the costs of reducing losses and the loss amount.
For example, let’s say that you are building a new business over the internet. There is a possibility that one of your promotional videos could go viral. If that happens your business would receive a major boost in business. You can do three things in this case. The first is to sit back and if it happens, it happens. The second is to do something (like animate cats) that will help to make your video go viral. At least that you hope will make the video go viral. The third thing is that you can ensure that if it happens you have the resources to support all the sales (for example putting extra bandwidth in place). The process of risk management will help you to ensure that you don’t overspend and yet get the most from the upside of the activity.
What about a negative example of risk management? Let’s take the example of a new strategy to build your business. What happens if the customers can’t accept the new strategy? Your sales will go down. You can do three things once again. If you believe that the loss is a matter of short-term pain for long gain, you might do nothing. Or to reduce the risk of this happening, you might do a test on a small group of customers first. Finally, you could go back to the old strategy in order to keep your existing customers happy.
Both of these examples have a good outcome and a bad outcome. The video could go viral or it could offend your existing customers. The strategy could be well receive or poorly receive. Neither of these outcomes is certain. Risk management is a set of management processes that ensures that no matter what really happens, you will come out on top.