There are almost as many definitions of risk management as there are people and organisations involved in managing risk. Anyway I am going to use the following definition:-
“Risk management is the practice of identifying potential risks in advance, analyzing them and taking precautionary steps to reduce or curb the risk.”
So What Is Risk?
My 1990 edition of The Concise Oxford Dictionary says risk is “A chance or possibility of danger, loss, injury or other adverse consequences”.
There is a modern trend to equate risk with uncertainty, for instance ISO 31000 defines risk as “the effect of uncertainty on objectives” and some commentators therefore say risk can be positive as well as negative. However, as the word is derived from the French risque (noun), risquer (verb), which itself comes from the Italian risco ‘danger’ and rischiare ‘run into danger’, this goes in the ‘rewriting history’ category and risk here will only mean the possibility of something bad happening.
Risk Appetite & Risk Tolerance
Frequently, the terms risk appetite and risk tolerance are used interchangeably. However if we wish to separate them these definitions may be useful, together with some other realted ones. These all come from The Chartered Institute of Internal Auditors, and I think they are the clearest definitions available
Risk/Reward universe – The full range of risks which could impact, either positively or negatively, on the ability of the organisation to achieve its long term objectives.
Risk appetite – The amount of risk that an organisation is willing to seek or accept in the pursuit of its long term objectives.
Risk tolerance – The boundaries of risk taking outside of which the organisation is not prepared to venture in the pursuit of its long term objectives.
Risk capacity – The resources, including financial, intangible and human, which an organisation is able to deploy in managing risk.
In this context risk tolerance has a wider scope than risk appetite as it represents the outer limits beyond which the organisation could not cope in terms of risk capacity or performance (how much the organisation is able to live with if things go wrong).
Whereas risk appetite is the bandwidth the organisation aims to work within to achieve its objectives.
The Prudent Company
In other words stop eating before you are full, i.e. the prudent company manager will not use up all the company’s ability to cope if the worst happens and the chickens come home to roost. To paraphrase Harry S. Truman – If you can’t stand the heat, don’t even go in the kitchen.
The Cowboy CEO
On the other hand a gung-ho CEO, let’s call him a cowboy, who just has his ‘eyes on the prize’ will ignore the advice from his Financial Director and just go for it, risking more than can be paid for, in order to satisfy his own ego. As my grandma used to say, “If your eyes are bigger than your stomach, you will make yourself sick”, and we all know who made the whole world very sick in 2008.
Risk in Product Development
Investing in new products is a lot more complex than investing in the stock market, whatever the so-called ‘Masters of the Universe’ may say, because we have to deal with:-
Product development is a project, so any product development project has the same kinds of project risks as any other project
- Project cost over-runs
- Project time over-runs
- Project quality targets not being met
There are essentially 2 risks when the product is released
- Market Risk
- Not selling sufficient quantity to make enough, or any, money. In the worse case, no sales at all, so all the investment is lost.
- Technical Risk
- The product having failures in the customer’s hands, possibly with disastrous consequences.
Unlike a financial investment on the stock market, where the most you can lose is the stake you have invested, in product development if it all goes wrong, you can potentially lose a lot more than that, due to:-
- The cost of a recall
- The cost of developing a fix
- The cost of lawsuits
- The cost of lost reputation
The total cost of a serious product failure could put a company out of business.
In the context of product development, if you can’t stand the potential losses if the product fails to sell, or has technical problems, then don’t proceed with the project. – ‘Heat and Kitchen’ again.
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