Risk Analysis and Risk Management

Risk is made up of two parts: the probability of something going wrong, and the negative consequences if it does.

Risk can be hard to spot, however, let alone to prepare for and manage. And, if you're hit by a consequence that you hadn't planned for, costs, time, and reputations could be on the line. Similarly, overestimating or overreacting to risks can create panic, and do more harm than good.

This makes Risk Analysis an essential tool. It can help you to identify and understand the risks that you could face in your role. In turn, this helps you to manage these risks, and minimize their impact on your plans.

By approaching risk in a logical manner you can identify what you can and cannot control   , and tackle potential problems with measured and appropriate action. This can then help to alleviate feelings of stress and anxiety, both in and outside of work.

In this article and video, we look at how you can identify and estimate risks. You will then learn how a strategy of avoiding, sharing, accepting, and controlling can help you to manage risk effectively.

What Is Risk Analysis?

Risk Analysis is a process that helps you to identify and manage potential problems that could undermine key business initiatives or projects. However, it can also be applied to other projects outside of business, such as organizing events or even buying a home!

To carry out a Risk Analysis, you must first identify the possible threats that you face, then estimate their likely impacts if they were to happen, and finally estimate the likelihood that these threats will materialize.

Risk Analysis can be complex, as you'll need to draw on detailed information such as project plans, financial data, security protocols, marketing forecasts, and other relevant information. However, it's an essential planning tool, and one that could save time, money, and reputations.

When to Use Risk Analysis

Risk analysis is useful in many situations:

• When you're planning projects, to help you to anticipate and neutralize possible problems.
• When you're deciding whether or not to move forward with a project.
• When you're improving safety and managing potential risks in the workplace.
• When you're preparing for events such as equipment or technology failure, theft, staff sickness, or natural disasters.
• When you're planning for changes in your environment, such as new competitors coming into the market, or changes to government policy.

How to Use Risk Analysis

To carry out a risk analysis, follow these steps:

1. Identify Threats

The first step in Risk Analysis is to identify the existing and possible threats that you might face. These can come from many different sources. For instance, they could be:

• Human – Illness, death, injury, or other loss of a key individual.
• Operational – Disruption to supplies and operations, loss of access to essential assets, or failures in distribution.
• Reputational – Loss of customer or employee confidence, or damage to market reputation.
• Procedural – Failures of accountability, internal systems, or controls, or from fraud.
• Project – Going over budget, taking too long on key tasks, or experiencing issues with product or service quality.
• Financial – Business failure, stock market fluctuations, interest rate changes, or non-availability of funding.
• Technical – Advances in technology, or from technical failure.
• Natural – Weather, natural disasters, or disease.
• Political – Changes in tax, public opinion, government policy, or foreign influence.
• Structural – Dangerous chemicals, poor lighting, falling boxes, or any situation where staff, products, or technology can be harmed.

You can use a number of different approaches to carry out a thorough analysis:

• Run through a list such as the one above to see if any of these threats are relevant.
• Think about the systems, processes, or structures that you use, and analyze risks to any part of these. What vulnerabilities can you spot within them?
• Ask others who might have different perspectives. If you're leading a team, ask for input from your people, and consult others in your organization, or those who have run similar projects.

Tools such as SWOT Analysis   , Failure Mode and Effects Analysis   , PMESII-PT   , and PEST Analysis   can also help you uncover threats, while Scenario Analysis    helps you to explore possible future threats.

2. Estimate Risk

Once you've identified the threats you're facing, you need to calculate both the likelihood of these threats being realized, and their possible impact.

One way of doing this is to make your best estimate of the probability of the event occurring, and then to multiply this by the amount it will cost you to set things right if it happens. This gives you a value for the risk:

Risk Value = Probability of Event x Cost of Event

As a simple example, imagine that you've identified a risk that your rent may increase substantially.

You think that there's an 80 percent chance of this happening within the next year, because your landlord has recently increased rents for other businesses. If this happens, it will cost your business an extra $500,000 over the next year.

So the risk value of the rent increase is:

0.80 (Probability of Event) x $500,000 (Cost of Event) = $400,000 (Risk Value)

You can also use a Risk Impact/Probability Chart   to assess risk. This will help you to identify which risks you need to focus on.

How to Manage Risk

Once you've identified the value of the risks you face, you can start to look at ways of managing them.

Avoid the Risk

In some cases, you may want to avoid the risk altogether. This could mean not getting involved in a business venture, passing on a project, or skipping a high-risk activity. This is a good option when taking the risk involves no advantage to your organization, or when the cost of addressing the effects is not worthwhile.

Remember that when you avoid a potential risk entirely, you might miss out on an opportunity. Conduct a "What If?" Analysis    to explore your options when making your decision.

Share the Risk

You could also opt to share the risk – and the potential gain – with other people, teams, organizations, or third parties.

For instance, you share risk when you insure your office building and your inventory with a third-party insurance company, or when you partner with another organization in a joint product development initiative.

Accept the Risk

Your last option is to accept the risk. This option is usually best when there's nothing you can do to prevent or mitigate a risk, when the potential loss is less than the cost of insuring against the risk, or when the potential gain is worth accepting the risk.

For example, you might accept the risk of a project launching late if the potential sales will still cover your costs.

Before you decide to accept a risk, conduct an Impact Analysis   to see the full consequences of the risk. You may not be able to do anything about the risk itself, but you can likely come up with a contingency plan   to cope with its consequences.

However, it's important to bear in mind that everyone's definition of "acceptable risk" is different, so be sure to communicate with others before you make a decision, and use tools like the Prospect Theory   to predict people's different reactions to risk.

Control the Risk

If you choose to accept the risk, there are a number of ways in which you can reduce its impact.

Business Experiments   are an effective way to reduce risk. They involve rolling out the high-risk activity but on a small scale, and in a controlled way. You can use experiments to observe where problems occur, and to find ways to introduce preventative and detective actions before you introduce the activity on a larger scale.

• Preventative action involves aiming to prevent a high-risk situation from happening. It includes health and safety training, firewall protection on corporate servers, and cross-training your team.
• Detective action involves identifying the points in a process where something could go wrong, and then putting steps in place to fix the problems promptly if they occur. Detective actions include double-checking finance reports, conducting safety testing before a product is released, or installing sensors to detect product defects.

Plan-Do-Check-Act    is a similar method of controlling the impact of a risky situation. Like a business experiment, it involves testing possible ways to reduce a risk. The tool's four phases guide you through an analysis of the situation, creating and testing a solution, checking how well this worked, and implementing the solution.

Alternatively, James Reason's Swiss Cheese Model of System Accidents explores how there is no single solution to minimizing risk, but rather uses a combination of methods to get the best results.