Strategic risk management is a critical component of any successful organization in today’s fast-paced digital economy, yet despite this, the idea is still largely misunderstood.
Strategic risks are those that result from the choices directors make regarding the goals of an organization.
Any business plan depends on them, and their improper administration could have disastrous effects. Strategic risk, however, what precisely is it, and how does it impact businesses?
Strategic Risk: What Is It?
Strategic risks result from fundamental choices made about an organization’s goals. They are the dangers brought on by failure to meet these goals.
They are frequently classified into two groups: hazards to businesses and dangers to non-businesses. Business risks result from choices made by the firm regarding the goods and services it offers. They cover economic risks affecting product sales and costs, risks resulting from changes in the technology environment that have an impact on sales and production, and risks related to developing and marketing those products or services.
On the other hand, non-business hazards are unrelated to the goods or services offered. These levels of strategic risk are established by how the firm is positioned relative to its environment, including competitor actions and technology improvements. These risks can include risks related with the long-term sources of finance utilised.
Common Forms of Strategic Risk You Must Understand
Businesses should be aware of and prepare for a number of typical forms of strategic risks, such as change risk, regulatory risk, reputational risk, and governance risk.
Change risk is the inherent danger of making any changes to your company’s operating system, business model, marketing plan, goods, or virtually any other aspect of your operations. Change is unavoidable in our rapidly changing digital environment, therefore being able to adapt becomes crucial.
Change creates risk, whether it’s implementing new software or changing how businesses operate. When making any substantial changes, it is imperative that you are aware of the risks involved so that you can be adequately prepared. However, it’s equally critical that you don’t fear change. It’s essential to advancement and maintaining competitiveness.
Regulatory risks are any potential danger from new regulations (or new enforcement of regulations) that could interfere with corporate operations, impose new obligations, or necessitate the use of new technologies. These dangers can range from having to make minor adjustments to your product to paying a charge or even facing a crippling lawsuit.
The need to implement additional governance procedures and control measures could also divert business executives from their core functions. In order to be compliant and minimize unnecessary regulatory risk, it’s critical to be knowledgeable of the pertinent legislation.
The risk of harming a company’s reputation is what is meant by reputational risks. One of a company’s most precious assets is its reputation, and any damage to it can result in huge losses.
This risk could arise from a number of circumstances, including data breaches, unethical behavior, or subpar customer service.
The risks that your firm faces as a result of weak governance, risk management, and compliance procedures are referred to as governance risks.
This can have serious consequences for a business if not managed well and covers everything from poor data management to a lack of internal controls.
Examples of Strategic Risk Explanation
The strategic risk that can affect businesses is illustrated by the following examples:
Example 1: Kodak Cameras’ governance and change risk
The downfall of Kodak is a powerful illustration of governance risk. Due to its late adoption of the digital revolution, Kodak, long a titan of photography and technology in general, found itself on the verge of extinction.
Ironically, Kodak invented digital photography, but because of its excessive reliance on the lucrative film industry and its concern over losing out on film sales, it lacked strategic vigor.
The company was unable to adapt its business strategy to the digital era because it continued to operate under the assumption that film-based photography would always predominate, despite the quick development of digital technology.
While Kodak continued to focus on selling conventional film, the world shifted toward digital cameras and then smartphones. Kodak executives may have placed too much emphasis on the risk of change and chosen to stick with tried-and-true methods rather than developing new ones.
The corporation didn’t start to reorient its plans toward digital technology and services until 2012, after Kodak had already sought bankruptcy protection.
By that point, it had already been too late and showed the disastrous results of governance risk and an overemphasis on change risk.
Example 2: Facebook Meta’s Regulatory Risk
A case in point of regulatory risk in the tech industry is Facebook (now Meta).
The Federal Trade Commission (FTC) imposed a record $5 billion fine on the social media behemoth in 2019 for privacy violations following the Cambridge Analytica scandal.
Due to Facebook’s inadequate privacy policies, which permitted third parties like Cambridge Analytics to access millions of its users’ personal information without their knowledge, this fine was imposed.
In addition to suffering a substantial financial loss, Facebook was forced to alter its business model and operating procedures in order to comply with new privacy regulations.
Additionally, these modifications made it harder for Facebook to target advertising as precisely as before, which had an impact on its revenue sources.
This instance demonstrates how, if improperly managed, regulatory risk can negatively affect a company’s profits and reputation.
Example 3: Volkswagen’s reputational risk
A classic illustration of reputational risk (served with a side of regulatory risk) is the Volkswagen emissions crisis from 2015. It was discovered that the car manufacturer had put software in 11 million diesel engines around the world to rig emissions tests.
In addition to being an operational error, this deception was a deliberate attempt to deceive customers and authorities about the company’s environmental impact. Executives at Volkswagen chose to make this decision despite the significant reputational and legal risks in order to increase sales of inefficient diesel engines.
The consequences arrived quickly and ruthlessly. Volkswagen’s standing as a reliable manufacturer was damaged, which resulted in sharp sales declines and falling stock prices.
The incident left an irreparable stain on the Volkswagen brand and illustrated the broad ramifications of reputational risk. The cost to fix the impacted cars, when added to the fines and legal settlements, reached the tens of billions of dollars.
Example 4: Enron Governance Risk
One of the most notorious instances of governance risk is the 2001 collapse of the energy corporation Enron.
The management of Enron portrayed a very lucrative corporation by concealing debt and inflating profits through a number of special-purpose organizations.
The entire business vanished into thin air when the fraud was eventually discovered. One of the largest bankruptcies in American history resulted from it. The stockholders of Enron suffered enormous losses, and corporate America’s reputation suffered greatly.
The collapse of Enron serves as a stark example of the seriousness of governance risk and serves as a reminder of the need for strong corporate governance frameworks, including transparency and effective internal controls.
The Secret to Strategic Risk Management Success
Strategic risk management calls for the discovery and comprehension of prospective hazards, the assessment of their potential effects, and the implementation of countermeasures.
Risk avoidance, risk acceptance or retention, risk transfer, risk reduction, third-party risk management, and risk spreading are all part of this process.
Facebook, for instance, might have avoided the hefty penalties by implementing more stringent data privacy safeguards (risk reduction).
Volkswagen may have avoided reputational and regulatory consequences by complying with emission requirements (risk avoidance).
Contrarily, Enron might have operated in a transparent, lawful, and ethical manner, preventing the significant losses and legal issues that followed its collapse.
It’s crucial to keep in mind that risk management involves more than just preventing losses—it also involves fostering expansion.
A corporation is better positioned to take advantage of possibilities that others might view as being too hazardous when it correctly recognizes and manages its strategic risks.
As a result, businesses must consider risk management a crucial component of their strategic planning.
What Role Does Strategic Risk Management Play?
Any organization’s success depends on strategic risk management because it identifies potential threats before they materialize and enables proactive management.
The dreadful results of neglecting strategic risks are illustrated by the aforementioned examples.
Businesses can safeguard their assets, boost decision-making, and improve market competitiveness by effectively managing these risks.
Finally, strategic risk management offers the strategic flexibility needed to seize opportunities that arise from uncertainty and change in addition to safeguarding against potential negative outcomes.
Strategic risks should be carefully managed because failing to do so can have serious negative effects.