Entrepreneurs are risk takers who put their time and capital into a business idea that they believe will yield a higher return. However, according to Deloitte, 90% of businesses fail within their first five years, and just a small percentage of those who survive scale up. This statistic implies that entrepreneurs excessively focus on the bright side.
Climate-related disasters, pandemic, cyberattacks, supply chain disruptions, and other events, as we have seen in recent years, all have a negative impact on organizations. Effective risk management (ERM) can help firms mitigate the financial consequences of such events. This article will give entrepreneurs and executives a step-by-step roadmap to improving their company’s risk management capabilities.
What is effective risk management (ERM)?
The process of spotting, evaluating, and minimizing vulnerabilities of an organization is called ERM. Economic uncertainties, potential lawsuits, cyber threats, strategic planning failures, work accidents, and natural disasters are all potential causes of risk.
Depending on the capabilities and sector of the firms there are three main risk management strategies:
- Financial protection against risks: Business insurance policies reduce the financial consequences of unanticipated occurrences.
- Minimizing the likelihood of unintended events: Risk management, on the other hand, refers to taking steps to avoid unexpected events. Businesses, for example, can lower the risk of data breaches by upgrading their cybersecurity procedures.
- Diversification strategy: Especially for finance and insurance companies, risk management refers to a diversification strategy in which corporations form portfolios by investing/insuring assets/customers with varying risk characteristics. In addition, insurance companies can re-insure their portfolio.
Why is ERM important now?
Because of greater interconnectedness, the number of risk elements, their proliferation pace, and geography has increased in the age of globalization and digitalization. Nowadays, businesses face the following threats.
- Climate risk: Deloitte’s report shows that, global warming and environmental challenges affect 97% of organizations, as a result of:
- Extreme weather events.
- Litigations or regulations concerning climate change.
- Pressure from stakeholders (customers, NGOs, employees etc.).
- Cyber risk: Accenture’s report shows that the number of cyberattacks increased 30% in 2021 compared to 2020.
- Risk of Covid-19: Pandemic brought a risk to workers’ health.
- Supply chain disruption: As a result of the post-pandemic era’s negative impact on supply chains, many business operations are disrupted, and the number of legal disputes expected to rise due to contract violations. The Russian invasion of Ukraine, as well as increasing worldwide political tensions, are expected to further affect the global supply chain.
- Traditional risk elements: Fires, non-climate-related natural disasters, and economic cycle-related risks continue to have a detrimental impact on businesses.
Following sections introduce top 6 generic best practices for businesses from a variety of sectors.
1. Natural disasters
Natural disasters can damage buildings and warehouses and negatively affect business operations. Firms can reduce their damages by implementing the following strategies.
- Commercial property insurance: Such policies provide coverage for the damages hit the factory buildings, warehouses and inventories. Especially for retailers or manufacturers such coverage policies can be beneficial.
- Climate risk insurance: Such policies protect entities against the financial costs of extreme weather events such as floods and droughts.
- Strategic planning: Governmental organizations such as US Geology service provide risk maps and reports concerning potential risks of areas in terms of earthquakes, floods, avalanches and droughts (see Figure 1). Thus, you can consider such information before investments and reduce risk elements.
- Engineering service: Companies may not be able to choose a location that is risk-free in terms of natural disasters for a variety of reasons. Firms may, however, protect their building stock by collaborating with the right technical team and experts.
Figure 1: US earthquake risk map
2. Cyber threats and attacks
Data breaches tend to increase in the 2020s which add a further challenge for companies. Successful data breaches might cause business interruption, brand image loss, litigation costs and penalties (see Figure 2). To minimize such losses, firms can imply following strategies:
- Purchasing a cyber liability insurance: They are type of cybersecurity insurance which protects firms against the financial damages of cyber attacks by providing:
- Network coverage.
- Privacy liability coverage.
- Media liability coverage.
- Business interruption coverage.
- Improving cybersecurity posture of the company: Zero trust cybersecurity perspective reduces the likelihood of successful breaches by constantly verifying users, devices and networks. Following technologies help firms to build a zero trust architecture:
To find more information you can read our top 8 cybersecurity best practices article.
Figure 2: Cost of successful data breaches
3. Supply chain disruptions
Supply chain disruption causes delays in the supply of raw materials and intermediate goods. Therefore, many organizations’ deliveries arrive after the dates indicated on contracts, posing a risk to enterprises due to possible legal actions.
To reduces such potential losses companies can imply following strategies:
- Purchase contingent business interruption insurance: If your supplier is unable to deliver intermediate goods or raw materials on schedule owing to physical damage to the supplier’s facilities, such policies provide financial relief.
- Purchase supply chain coverage: Despite the fact that physical damage to your suppliers’ facilities might cause supply chain disruptions, pandemic and today’s political challenges play a larger role. As a result, some insurance firms offer supply chain coverage, which reimburses costs associated with supply chain disruptions that are not caused by physical damage to suppliers’ facilities.
- Take legal consultancy: Legal counsel can help you improve business contracts with suppliers and consumers so that mediation takes precedence over litigation.
- Pick customers and suppliers by considering the political environment: Since Trump’s tariffs in 2018, we’ve seen a new age of protectionism. Thus, political relationships between the countries have a significant impact on ease of trade between businesses. Therefore, firms should consider this factor before making new deals with suppliers and customers.
4. Covid related costs and losses
Covid poses a financial risk to businesses by causing:
- Supply chain disruption.
- Business interruption since some proportion of your employees are unable to work.
To avoid business interruption firms can adopt remote working as much as they can to minimize infection between employees. Firms can also encourage their employees to get vaccinated.
5. Environmental and sustainability challenges
Increasing extreme weather events are not the only environmental challenge that threatens companies. Dutch court, for example, has ordered Royal Shell to reduce its greenhouse gas (GHG) emissions by at least 45% until 2030, compared to 2019. Investors and consumers also want to see a shift in traditional company practices that are environmentally unfriendly.
Therefore, we recommend businesses to:
- Regularly calculate their carbon footprints and circular economy metrics to be aware about their pain points.
- Implement strategies that reduce corporate carbon footprint.
- Implement strategies that enhance supply chains sustainability and circularity levels of the companies.
- Reporting complete environmental, social, and governance (ESG) disclosures on a regular basis using a variety of parameters. To persuade stakeholders, these reports should incorporate companies’ developments on ESG issues.
6. Insurers’ risks
Business insurance policies play a key role to improve risk management capabilities of firms. However, undertaking other firms’ risks might threaten the existence of insurance companies. To minimize this risks insurance companies should implement following strategies:
- Effective underwriting: Underwriting is the process by which insurers determine the cost of a risk. Implementation of following technologies enhance insurers’ underwriting capabilities.
- Optimal diversification: Risk refers to ambiguity. Thus, to manage it professionals use diversification strategy where entities with different risk characteristics combine to create a portfolio that contains minimum risk. Insurers can once again use advanced analytics and machine learning models to establish the optimal portfolio.
- Consider reinsurance policies: Reinsurance policies transfer some fraction of the risk to another insurer in return of the money. Thus, they provide risk management for insurance companies.
- Cooperation with insurtechs: Because of the advent of insurtechs, which use the technologies mentioned, the insurance industry is undergoing rapid transformation. However, all insurers will be unable to implement such technology as in-house models. As a result, we advise them to work with insurtech companies and pay a subscription fee to use their insurance related platforms as a service.
To learn more about minimizing losses of insurance companies you can read our 5 Ways for Managing Risks of Insurance Companies article.
You can also check our list of insurance underwriting platforms.
To learn more about risk management you can contact us.
Cem has been the principal analyst at AIMultiple since 2017. AIMultiple informs hundreds of thousands of businesses (as per similarWeb) including 60% of Fortune 500 every month.
Cem's work has been cited by leading global publications including Business Insider, Forbes, Washington Post, global firms like Deloitte, HPE, NGOs like World Economic Forum and supranational organizations like European Commission. You can see more reputable companies and media that referenced AIMultiple.
Throughout his career, Cem served as a tech consultant, tech buyer and tech entrepreneur. He advised businesses on their enterprise software, automation, cloud, AI / ML and other technology related decisions at McKinsey & Company and Altman Solon for more than a decade. He also published a McKinsey report on digitalization.
He led technology strategy and procurement of a telco while reporting to the CEO. He has also led commercial growth of deep tech company Hypatos that reached a 7 digit annual recurring revenue and a 9 digit valuation from 0 within 2 years. Cem's work in Hypatos was covered by leading technology publications like TechCrunch and Business Insider.
Cem regularly speaks at international technology conferences. He graduated from Bogazici University as a computer engineer and holds an MBA from Columbia Business School.
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