The 5 Key Steps of Risk Management

Writer:

Ana-Maria Sanders

Editor:

Jim Hughes

Reviewer:

Sophia Rodriguez

Whether you’re leading a startup or managing a well-established corporation, the process of risk management should be one of your top priorities. While it’s almost impossible to ditch all workplace risks, it is possible to mitigate them. 

A risk management process can help you anticipate and respond to security breaches, cyberattacks, and even human error threatening your workplace. But what exactly does it take to master this discipline?

The process includes designing action plans for all off-the-track situations. In a sense, it is similar to a fire protocol in a building. You aim for the best outcome but create contingency plans in case you confront problems.

In this article, we will examine the risk management process and the steps that lead to successful implementation. 

What Is Risk Management?

Risk management involves identifying, evaluating, and prioritizing potential threats that could have adverse effects on the organization’s finances, market presence, customer relations, and overall success. 

It also involves crafting strategies to minimize the impact of unforeseen events, thereby buffering the company’s financial stability and operational efficiency. Common risks that businesses face often fall into the following categories:

• Financial Risks, such as stock market volatility, outstanding invoices, and liquidity issues, could lead to significant financial losses. This type of risk can affect a company’s solvency and profitability. 
• Operational Risks disrupt the company's day-to-day operations. Most often, this risk results from malfunctioning of failing processes or systems. But it can also result from inefficiencies and mistakes from personnel.
• Strategic Risks often arise from errors in long-term decision-making and strategies. They can also occur due to bad investments or a failure to adapt to market conditions.
• Hazard Risks include accidents or natural disasters that harm personnel, equipment, and other operational systems. 
• Compliance Risks often result from a failure to comply with or adapt to regulatory policies. Often, they lead to penalties, fines, reputational damage, and, in extreme cases, legal action.
• Cybersecurity Risks can result from data breaches, cyberattacks, and security vulnerabilities. If consumer personal and financial information is leaked, it could lead to significant monetary losses, reputational damage, and legal issues. 
• Market Risks are usually caused by external factors such as economic downturns, interest rate changes, inflation, and recessions. The consequences of this risk can include financial losses and decreased profitability.
• Supply Chain Risks disrupt production timelines, leading to availability and stock issues for goods. This risk often results from import and transport delays, natural disasters, and quality issues. 

Unfortunately, some risks are inevitable, and reducing their probability to zero is far-fetched. However, risk management can be incorporated into the business’s strategic and operational processes to minimize the adverse effects of unforeseen events and maximize opportunities for growth and success. 

For strategic processes, risk management ensures that long-term business goals align with the company’s overall risk tolerance and growth objectives. Operationally, risk management helps with day-to-day activities by ensuring the business maintains compliance with safety regulations and protocols.

What Are the Benefits of a Risk Management Process?

Aside from proactively protecting your company from potential risks, a risk management process also offers these additional benefits:

• Improved Decision-Making: With data and insights about potential risks that could occur in the future, management can craft better strategies, make better-informed decisions, and invest more strategically. Risk management provides a comprehensive view of potential future outcomes, allowing business professionals to make more confident decisions and develop contingency plans.
• Financial Efficiency: Undoubtedly, the biggest risk for any organization is insolvency and a lack of profitability. Risk management processes can help anticipate market changes, financial pitfalls, and other issues that could threaten cash flow. Management can better manage investments and financials to maintain solvency. 
• Competitive Advantage: Having a risk management process in place isn’t just about anticipating future issues. It is also about identifying potential opportunities for improvement, investment, and growth. Companies that have a risk management process can be in a better position to seize opportunities to outpace their competitors and gain an advantage in the market. 
• Customer Trust: In the digital age, consumer data is gold. A risk management process prioritizes consumer data security, ensuring you have a policy in place to ensure this information is not jeopardized or compromised. This can help improve customer trust in your brand. 
• Regulatory Compliance: Countless industries must meet strict federal, state, and local regulations. Often, these policies are constantly evolving, and one way to stay on top of the changes is to implement a risk management policy. This not only ensures you are legally compliant and safe from penalties, but it also preserves your reputation. 
• Stakeholder Confidence: A comprehensive risk management process signals your company’s organization and professionalism. Given your commitment to properly managing risks and opportunities, investors and stakeholders may be more likely to invest in your business.

What Are the Risk Management Steps?

The risk management cycle consists of five key steps, and each step is necessary for crafting an effective strategy. 

The initial step in the risk management process is to identify potential threats, followed by an analysis of the risks. Once you have assessed the risks and determined the potential impact on the organization, you can create and implement strategies to mitigate the effects. Finally, a risk management strategy is an ongoing effort that requires regular monitoring and updates. 

Below, we look at each step in more detail.

Identifying the Risks

Risk identification involves pinpointing potential pitfalls that can impact your organization and stakeholders. It is the foundation of the risk management process as it uncovers threats as early as possible, allowing you to craft and implement effective strategies to mitigate these risks.

Here are a few common methods that can bring all potential risks to the surface:

Historical Data Analysis

This strategy involves reviewing past business records, transactions, and events to reveal patterns, trends, and anomalies that could indicate potential risks. First, begin historical data analysis by collecting and analyzing financial statements, operational logs, sales records, incident reports, and customer feedback.

Next, clean and prepare the data, ensuring it is accurate and consistent. Then, use statistical tools to identify trends and correlations. Finally, use predictive modeling to forecast future risks that could develop as a result of the patterns identified in past data. 

Historical data analysis is best suited for financial, operational, market, compliance, and cybersecurity risks. By identifying past occurrences and patterns, businesses can identify recurring issues, emerging threats, and underlying issues that could become larger problems in the future. 

As a result, businesses can craft mitigation strategies that outline processes and procedures to tackle the issues before they escalate. 

SWOT Analysis

A SWOT analysis is used to identify a business’s internal strengths and weaknesses, as well as external opportunities and threats. It includes gathering information and data from market research, internal audits, and competitor analysis to create strategies that leverage the company’s strengths, improve weaknesses, capitalize on opportunities, and mitigate threats. 

A SWOT analysis is ideal for identifying internal and external risks, such as strategic, operational, market, financial, and compliance ones. For risk management purposes, your business will likely focus primarily on the opportunities and threats factors. 

Once you have gathered your data, identify each element: strengths, weaknesses, opportunities, and threats. Then, analyze and prioritize the impact and likelihood of each factor to help you pinpoint which issues require immediate action. 

FMEA Analysis

A Failure Modes and Effects analysis helps businesses identify potential risks and failures that could result from their processes, products, and systems. In addition to uncovering potential risks, it also helps determine the causes and negative effects that could result.

The goal of an FMEA analysis is to identify and prioritize potential failures before they occur to improve operational reliability, efficiency, quality, and safety. FMEA analyses are ideal for operational, safety, quality, and supply chain risks.

To begin, identify all the ways the specific process, component, system, etc., could fail and document the potential causes and effects. Then, determine the severity of the effects and assign a rating based on the impact it would have on your business. 

Next, estimate the likelihood and detectability of each failure occurring and assign a rating to each. Using the severity, occurrence, and detectability ratings, calculate a risk priority number (RPN). The RPN will help you determine which potential risks and failures to prioritize based on the severity of the impact and likelihood of occurrence. 

PEST Analysis

This type of risk analysis strategy identifies external factors that could impact the business, such as political, economic, social, and technological issues. A PEST analysis provides a comprehensive market overview to determine how macro-level changes can impact the organization or pose potential risks.

Typically, it is used for economic, consumer sentiment, market, supply chain, cybersecurity, and compliance risks. First, begin by defining the specific external risk that will be analyzed and gather relevant data from government reports, economic forecasts, industry publications, and technological trend analyses. 

Then, identify how these changes could positively or negatively impact your company. Based on this assessment, you can create contingency plans that you can implement should the potential external risks materialize. 

Supply Chain Risk Assessment

Finally, if your company deals in goods, you can conduct a supply chain risk assessment to uncover potential risks that could disrupt the flow of goods. These risks could include supplier reliability, transportation issues, geopolitical factors, import changes, and natural disasters. 

First, map your entire supply chain process, from raw material suppliers to end customers. Determine which suppliers and steps in the supply chain are most important to your operational flow and the risks associated with each failure. 

Next, rank the risks based on likelihood and impact using risk matrices and scoring systems. Finally, develop mitigation strategies, such as diversifying suppliers, increasing inventory levels during peak seasons, or incorporating better technology for supply chain management. 

Analyzing the Risks

After identifying and classifying the threats, the next step involves a deeper understanding of the risks to determine their likelihood of occurrence and the potential impact on the organization.

To effectively assess these risks, you can employ two analysis techniques:

• Qualitative Analysis: This approach involves analyzing risks based on the severity of their impact and the likelihood of their occurrence. For instance, during a risk assessment meeting, a team member might classify the risk of a data breach as “high” based on recent industry trends.
• Quantitative Analysis: This technique uses numerical values and statistical methods to estimate the probability and potential impacts. For example, a company might use historical data on supply chain disruptions to calculate the probability and financial impact of such an event occurring again, providing a numeric value to the associated risk.

A two-dimensional risk matrix is a common tool to analyze potential risks. This matrix visualizes the impact and likelihood of risks, helping to prioritize them effectively. Here’s a typical design of the risk matrix:

We discuss how to use this information in the next step.

Evaluating the Risks 

Once you have identified and analyzed the risks, it’s time to evaluate them to determine which ones need immediate attention. Start with establishing clear evaluation criteria that focus on the severity of the consequences and the likelihood of occurrence. 

A practical way to evaluate risks is to score or rate them based on a standardized scale. Usually, risks are rated from low to high by assigning a number of one to five for their impact and likelihood – one being low and five being high. 

For instance, a risk with the highest impact (5) and likelihood (5) would receive a score of 25, meaning that this is a high-priority risk and should be addressed promptly. Conversely, a risk with a low impact (1) and low likelihood (1) would score 1, meaning it is a low-priority risk.

You can also use the risk matrix outlined above to map out and visualize the risks. For instance, risks falling into the high-impact and high-likelihood quadrants should be prioritized for immediate action. In contrast, those in the low-impact and low-likelihood quadrants can be monitored but not with the same amount of resources and attention.

Put in practice, if a business has identified a high likelihood of data breach, it must prioritize investing in cybersecurity measures, training employees on data protection, and developing a contingency plan.

In the end, decisions on risk treatment typically involve choosing whether to avoid, reduce, share, or accept such risk, which we will look at in more detail in the next section.

Treating the Risks

As we mentioned earlier, effective risk management procedures are not about eliminating all risks but rather developing and implementing strategies to decrease their negative consequences. 

That said, there are four main ways you can address risks:

• Avoiding Risk: This approach involves eliminating all activities that may lead to risk. If a given process or product line continuously generates unacceptable risks, the best strategy would be to cease those operations. For example, a company might stop using a supplier with a poor safety record to avoid the risk of product defects or delays.
• Reducing Risk: With this technique, the organization implements measures to minimize either the likelihood of the risk materializing or its impact if it does occur. This could involve upgrading technology, improving workplace safety protocols, or enhancing data security measures. For instance, a manufacturing firm could reduce the risk of workplace accidents by employing stricter safety protocols and training to decrease the probability of accidents and the potential severity of injuries.
• Sharing the Risk: Sometimes, it’s possible to distribute the risk among other parties, often through insurance, partnerships, or outsourcing. This allows businesses to transfer a portion of the risk to entities that are better equipped to handle it. For instance, a business might purchase cybersecurity insurance to share the financial burden of a potential data breach or phishing attack.
• Accepting the Risk: Finally, this approach is typically for risks that are low in both likelihood and impact or when the mitigation costs outweigh the potential benefits. For example, a small retail business could accept the risk of minor shoplifting incidents, considering them an occasional and manageable loss rather than investing in advanced security measures.

Monitoring and Reviewing the Risks

Finally, an effective risk management process requires constant monitoring and regular adjustments to stay ahead of new challenges. Here’s how you can implement effective risk management monitoring:

• Monitor Key Risk Indicators (KRIs): KRIs monitor risks that have the potential for the highest impact and likelihood. You can set up KRI automation monitoring to signal relevant team members when these KRIs exceed their ranges. 
• Conduct Periodic Risk Reviews: On a quarterly basis, review your KRIs, mitigation policies and procedures, and new internal and external developments that could contribute to new threats. Based on these discussions, update your risk management processes and software. 
• Set Up Feedback Loops: Also, gather feedback from employees, stakeholders, and customers quarterly to determine how well your risk management process is working or if there are new issues you should prioritize. Update your procedures accordingly and maintain open communication with all parties involved.
• Use Risk Dashboards: Use data visualization tools to create a dashboard that tracks and monitors your KRIs in real time. Ensure key team members and departments have access to this dashboard to monitor risk levels and identify emerging trends before they cause significant impact. 

Sum Up

Ignoring risks is not always the best solution. But managing them is a process that can help you act in case anything goes wrong. By planning for potential risks, you can design defense mechanisms against them.

A successful risk management process starts with listing all possible risks by likelihood of occurrence and level of impact. It is followed by risk assessment, plan development, and solution implementation. Since we live in a fast-paced environment, you should also remember to upgrade your action plans regularly.