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Finance glossary

What is risk mitigation?

Bristol James
6 Min

Risk mitigation is a strategy that businesses employ to reduce the potential impact and severity of risks to their operations, assets, and projects. Risk mitigation is often used interchangeably with risk reduction, but it’s important to note each term differs somewhat. 

While risk mitigation endeavours to find ways to carry out less risky activities, risk reduction is a specific risk mitigation strategy that encourages the business to avoid those activities altogether.

Why is risk mitigation important?

One of the more obvious answers is that business (and indeed life) is inherently risky. In the past few years alone, many companies have been impacted by one or more of the COVID-19 pandemic, war, inflation, chronic skills shortages and numerous data breaches.

While businesses can never avoid risk, they can implement certain measures to reduce potential impact. This idea that forewarned is forearmed is central to any risk mitigation strategy.

What are the risks businesses should mitigate against?

The risks a particular business will face depend on its industry, competition, customers, and internal processes and structures.

Here are the most common types:

  1. Compliance risk – when companies breach their internal standards and practices, they risk losing customers. When they breach external regulations, they risk a hefty fine and damage to their brand.
  2. Strategic risk – a poor (or non-existent) business strategy can impact the company’s performance and lead to inefficiencies such as missed deadlines and cost overruns. Strategic risk affects both the company’s long-term vision and its day-to-day operations.
  3. Reputational risk – any risk that has the potential to harm the company’s standing among its customers, vendors or society itself. Reputational risk is multi-faceted and is associate with financial losses, poor shareholder sentiment, low product quality, unfavourable customer reviews, and service interruptions.
  4. Financial risk – a broad type of risk often caused by a lack of financial management or planning. Macroeconomic factors may also be a factor.
  5. Human risk – one of the most difficult to manage, human risk relates to the decisions and behaviour of employees. These are often influenced by cognitive biases and other motivational drivers that cause undesirable outcomes for both the individual and the company.

Five steps to risk mitigation

With an understanding of the different types of risks that may affect its performance, a company can start the process of risk mitigation planning.

To do this, it must first assemble a team to identify and evaluate risks using a combination of expertise, best practices, and technology.

Step 1 – Risk identification

To start, the team needs to identify current and potential risks to the company, its operations, and its employees.

It is vital to be exhaustive here and consider as many risk types as the company believes are relevant.

Step 2 – Risk assessment

With a list of risks compiled, the team can then determine the level of risk for each.

This means an objective analysis of:

  • The likelihood of a risk occurring, and
  • The severity of the potential negative impact on the business.

The above analysis may be qualitative or quantitative depending on the risk assessment framework used.

For example, the team may assign the likelihood of a specific human risk as “Medium” or give it an equivalent numerical value such as “5” (where 1 is low risk and 10 is high risk)

Step 3 – Risk prioritisation

According to the framework used in step two, it is time to rank each risk according to its likelihood and potential severity.

The business will then be aware of the risks it needs to mitigate as a priority.

It can also be useful at this point to determine what level of risk the company is willing to accept in each of the key risk areas.

Remember that risk, by its very nature, is never completely avoidable.

Step 4 – Monitor risks

Some will risks will evolve over time, while others will become less relevant.

Risk monitoring requires the business to track and evaluate levels of risk periodically.

This is a proactive approach that also enables the business to evaluate current risk mitigation strategies and update or discard older ones that have become ineffective.

With that in mind, the company should track individual risks to determine whether they increase or decrease in severity and relevance. This is especially important if a risk exceeds the threshold a company determines in step three.

Step 5 – Implement a risk mitigation plan

The last step is to implement a risk mitigation plan.

Developing a risk mitigation plan is only half the battle, however.

The plan may look sound on paper, but it needs to be implemented and tested across the organisation to ensure it is effective.

Employees should be briefed and trained on all relevant aspects, and once in place, the plan should be reviewed regularly to ensure compliance.

Longer term, the plan may be refined as new information comes to hand or when organisational priorities shift. Constant and consistent evaluation enables the company to identify potential vulnerabilities and make smarter decisions.

The most effective risk mitigation strategies

Within each risk mitigation plan is a strategy that considers each risk type as well as its likelihood of occurring and the potential consequences.

As we touched on earlier, the strategy also considers the individual tolerance levels of the company itself.

Implementing
A possible risk mitigation implementation framework (Source: www.process.st)

 

Here are four of the most common risk mitigation strategies:

Risk avoidance

As the name suggests, risk avoidance is a mitigation strategy where the main focus is to avoid any action that could result in unnecessary risk.

Risk avoidance is often employed if the outcome of a threat is perceived to be high (such as a threat that would significantly impact a company’s bottom line).

Risk reduction (control)

Otherwise known as risk control, risk reduction requires the business to act in such ways that:

  • The likelihood of a risk occurring is reduced, and
  • The impact of a risk is reduced, should that risk occur

These actions help the business contain the potential negative impacts of a risk and stop them from spreading across the organisation.

Risk transference

Risk transference is the allocation of risk to a third party with the capacity to mitigate said risk.

When a company takes out an insurance policy to cover its infrastructure, for example, the risk of damage to that infrastructure is transferred to the insurance company.

Risk acceptance

When a business employs the risk acceptance strategy, it acknowledges and accepts the risk. This means that it moves forward with a tacit understanding that it may occur in the future.

Risk acceptance is used when:

  • The risk to unlikely to occur
  • When the potential negative impacts of the risk are minor, or
  • When the cost of mitigating the risk is deemed to be higher than dealing with the risk if it were to occur.

Risk mitigation best practices

Risk mitigation planning and implementation can be complex and requires a coordinated, organisation-wide effort.

To maximise the effectiveness of a mitigation strategy, let’s conclude with a few best practices.

Select qualified personnel

Risk managers with the requisite skills and expertise must lead the development of risk mitigation plans.

These plans should address:

  • The actions required (and when they must be carried out)
  • The person(s) responsible for taking action
  • How the action will reduce the likelihood or severity of a risk, and
  • What resources are required

Establish the right culture

In a hierarchical organisation, risk culture starts with senior leaders. They must lead by example and communicate appropriate values and beliefs to managers and subordinates.

Risk mitigation’s relationship to company values and beliefs makes it a mission-critical endeavour.

Utilise risk frameworks

Earlier, we highlighted the importance of implementing a robust risk-monitoring process.

Various risk assessment frameworks such as FAIR and COSO help organisations outline, quantify, and prioritise risks. Alternatively, the company can develop its own standardised framework.

The best frameworks will also enable complex risk-related information to be understood by non-technical stakeholders, which increases buy-in.

In summary:

  • Risk mitigation is the act of reducing the potential negative impact of risks by developing a plan to manage or eliminate them.
  • Risk mitigation is important since business is inherently risky. While businesses can never avoid all risks, they can use mitigation strategies to manage them down to a tolerable level.
  • Effective risk mitigation strategies include risk reduction, risk avoidance, risk transference, and risk acceptance.
  • Risk mitigation can be complex and requires organisational buy-in to be effective. Some best practices include selecting suitably experienced personnel, establishing a risk culture, and utilising risk frameworks.

 

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