How Do American Companies Manage Risk?
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Approaches to Risk Management
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Business leaders understand as well as anybody that if nothing is ventured, nothing can be gained. At the same time, successful capitalists are seldom willing to take anything but well understood and adequately managed risks. Publicly traded companies must report their potential operating risks every quarter when they report their results. Thus, risk management is a huge focus of any major corporate operation and encompasses many different topics and approaches -- as many as there are types of businesses. Most risk management, though, falls into four basic categories no matter the specific business context. For example, avoidance is a risk management strategy that simply means not engaging in the activity that could produces a specific risk, but this limits potential benefits as well. Reduction, a more innovative approach, seeks to take steps that don't entirely eliminate risk, but minimize the potential damage. Risk transference is probably the most efficient approach to risk in that it moves the burden of negative outcomes to another entity such as an insurance company. Lastly, a company can simply conclude a risk is unlikely or tolerable and simply accept the risk as it is, a strategy called retention.
Identifying Risk
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The first step of risk management is always to identify potential risks in all their forms. Obviously, invested capital can be lost through poor investment, but intangible assets like a company's reputation can be damaged. Identifying risks can be more challenging than it appears, especially in times of rapidly changing social norms and technological communication. For example, it's unlikely the pizza delivery company Domino's adequately assessed the possibility that unsupervised employees would film themselves soiling food products on camera and posting the video to the Internet -- even after a similar tactic damaged the reputation of fast-food company Burger King the year before. The next step after identifying a risk is to assess its potential negative effects and likelihood of happening. One common way to do this is to quantify the probability as a number less than one and multiply it by the potential detrimental cost. In Domino's case, given the demographic of its employees, the probability should have been considered high, and given the nature of their business, the potential damage could be considerable.
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Implementing Risk Management
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Though the Domino's example is a bit sensational, it's a relatively rare occurrence. The risks most commonly associated with American companies involve politics, currency and interest rates, legal risks and investment risk. Once a risk management strategy is adopted, it must be effectively implemented. Because virtually every company has to plan in advance how much money to invest in production based on how much product they believe they can sell (or how many employees to hire based on how much service they can sell), one of the most common risk management implementation programs revolves around communication with suppliers to effectively manage inventory. Many large companies also maintain large in-house legal teams that advise on virtually every aspect of the company's actions, sometimes counseling avoidance, other times reducing risk through the use of contract language or the application of legal analysis. Currency risk can be avoided by not conducting business overseas in foreign markets, but for some companies this is undesirable. They might instead reduce currency risk, which occurs when earnings are eroded by fluctuations in currency values, by allocating resources to more favorable markets or even by investing in currency hedges like futures contracts. Complex derivatives called swaps allow currency risk to be transferred entirely to other market participants.
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