The first type of risk that every company faces is financial risk. This includes the risk of not having enough money to pay for the goods or services your company needs. The amount of money you need to cover a given period of time depends on many factors, such as the size of your company, the amount of revenue you generate, the expenses you incur, and whether or not there are unexpected costs associated with a particular project. Operational risk is another major concern for companies.
It refers to the possibility of something going wrong during normal operations. For example, if you're running out of product on your shelves, the machine breaks down, or has an excessively high defect rate, then you're facing operational risk. Environmental risk refers to everything related to environmental compliance. Examples include natural disasters, pollution, waste disposal, and hazardous materials.
Political risk is the risk of political instability in your country or region. This could lead to changes in government regulations, which could affect your business. The types of risks, such as data breaches, cyber attacks, identity theft, embezzlement, money laundering, criminal records, and intellectual property theft. All of these are examples of how security and fraud risks for companies are increasing, especially as the volume of online transactions increases and trends such as remote work are increasingly taking internal processes to the cloud.
While this may have some technical aspects, such as vulnerabilities in software or previously undiscovered gaps in new technology, the risk of security and fraud is often “human” in nature. The central bank of the Philippines, Bangko Sentral ng Pilipinas (BSP), recently tightened its selection rules for current and potential bank employees as a means of addressing this problem. By implementing more rigorous protocols in the industry's hiring and talent management processes, the new guidelines hoped to ensure that banks had “a sufficient understanding of the applicant's personal background and character, conflict of interest, and susceptibility to collusion, fraud, or illegal activities” before making hiring decisions. Operational risks can be internal, external, or a combination of both.
Some examples of operational risks include a natural disaster that damages your physical facilities or equipment, a pandemic that forces people to take refuge on site or work from home, or a server outage that causes technical problems, such as a power outage or interruption of Internet connectivity. Internal business risks are often related to human error, such as an accountant entering an incorrect payment amount or a developer entering the wrong code. Most companies have a business continuity plan to address operational risks, which often details how to respond and recover in the event that something goes wrong. It also often describes proactive measures, such as having a backup system to ensure that interruptions, if any, are not too serious.
Strategies to mitigate financial or economic risk often aim to alleviate cash flow problems, and the most common tactics include obtaining insurance, diversifying income flows, and limiting the amount or duration of loans. Defective products or services, poor customer service experiences, negative publicity about your employees or your leadership, or high-profile failures in the press. All of these are reputational risks that will affect your results and your relationships with customers and partners. It is a fact that the above business risks are amplified when third parties intervene.
Your own reputational, operational, financial, security, and compliance risks are expanded to include the other party's procedures and practices, which are beyond your control. And since most current value chains are outsourced to subcontractors and suppliers, it's understandable that most companies insist on thoroughly researching and vetting potential external partners before committing to a business relationship. In this first tutorial, we'll look at the main types of risks your company may face. You'll get an overview of strategic risk, compliance risk, operational risk, financial risk, and reputational risk, so you understand what they mean and how they could affect your business.
Then, we'll discuss the details of identifying and treating these risks in the next tutorials in the series. It's the risk that your company's strategy will become less effective and, as a result, your company will struggle to achieve its objectives. It could be due to technological changes, the entry of a powerful new competitor into the market, changes in customer demand, spikes in raw material costs, or any other large-scale change. A classic example is Kodak, which had such a dominant position in the film photography market that, when one of its own engineers invented a digital camera in 1975, it saw innovation as a threat to its core business model and was unable to develop it.
It's easy to say in retrospect, of course, but if Kodak had analyzed the strategic risk more closely, it would have come to the conclusion that someone else would eventually start producing digital cameras, so it was better for Kodak to cannibalize its own business than for another company to do it. The failure to adapt to a strategic risk led Kodak to bankruptcy. It has now emerged from bankruptcy as a much smaller company that focused on corporate image solutions, but if it had made that change earlier, it could have retained its dominance. However, facing strategic risk doesn't have to be disastrous.
Think of Xerox, which became synonymous with a unique and highly successful product, the Xerox photocopier. The development of laser printing posed a strategic risk to Xerox's position, but unlike Kodak, it was able to adapt to the new technology and change its business model. Laser printing became a multi-billion dollar line of business for Xerox, and the company survived the strategic risk. That's great, but you're also incurring significant compliance risk.
European countries have their own food safety regulations, labeling rules and much more. And if you create a European subsidiary to handle everything, you'll have to comply with local accounting and tax regulations. Meeting all of these additional regulatory requirements could end up costing your company a significant amount. Even if your company isn't expanding geographically, you can incur new compliance risks simply by expanding your product line.
Let's say your California farm starts producing wine in addition to food. Selling alcoholic beverages exposes you to a whole host of new and potentially expensive regulations. And finally, even if your business remains unchanged, you could face new rules at any time. Perhaps a new data protection regulation requires you to strengthen the security of your website, for example.
Or, employee safety regulations mean that you must invest in new, safer equipment in your factory. Or maybe, without knowing it, you've been breaking a rule and you have to pay a fine. All of these things involve costs and represent a compliance risk for your company. Operational risk refers to an unexpected failure in the company's daily operations.
It could be a technical fault, such as a server outage, or it could be caused by your staff or processes. In some cases, operational risk can also come from events beyond your control, such as a natural disaster, a power outage, or a problem with your website's server. Anything that disrupts your company's core operations falls under the operational risk category. While the events themselves may seem quite small compared to the big strategic risks we talked about earlier, operational risks can still have a big impact on your company.
Not only does it come at the cost of fixing the problem, but operational problems can also prevent the delivery of customer orders or make it impossible to contact you, leading to a loss of revenue and damage to your reputation. Most risk categories have a financial impact, in terms of additional costs or loss of revenue. However, the financial risk category refers specifically to the money that comes in and out of your company and the possibility of a sudden financial loss. In that case, you have significant financial risk.
If that customer can't pay or is delaying payment for any reason, then your company has a big problem. Having a lot of debts also increases financial risk, especially if most of them are short-term debts due in the near future. And what if interest rates suddenly rise and, instead of paying 8% of the loan, you now pay 15%? This entails a large additional cost for your company, so it is counted as a financial risk. Financial risk increases when you do business internationally.
Let's go back to the example of the California farm that sells its products in Europe. When you sell in France or Germany, your revenues come in euros and your sales in the UK in pounds. Exchange rates always fluctuate, which means that the amount the company receives in dollars will change. The company could make more sales next month, for example, but receive less money in dollars.
It's a big financial risk to consider. It doesn't do much good, for example, to say: “Our business is subject to operational risks. You need to be very detailed and analyze every aspect of your operations to find specific things that could go wrong. Then, you can devise a strategy to deal with those risks.