Managing risk is essential for running a successful business and staying ahead of the competition. But how do we define operational risk, and what are the processes that can help you identify and manage the issues you face while ensuring you continue to reach key goals and milestones?
In this post, we’re exploring what operational risk is and the ways you can manage it by implementing software that encourages more efficient systems and processes.
What is operational risk?
Operational risk refers to the possible losses as a direct result of failed or ineffective internal processes, people, systems, or external events disrupting business operations.
The loss from operational risk can either be direct or indirect, meaning that financial loss isn’t necessarily a natural consequence, but this could still be the case.
Operational risk can also refer to the risk in implementing, training, and enforcing policies within an organisation and its processes.
This type of risk can be viewed as part of a chain reaction within the business’ processes. Previously overlooked issues can mix with control failures of any size to create greater risk and could even lead to failure on a financial or reputational level.
Therefore, operational risks can come in all different sizes while posing differing threats to business continuity.
What are some examples of operational risk?
Operational risk can cover a range of areas within a business. It can cause losses in any part of the business, from processes to technology.
Some areas that can generate operational risk include:
- Employee error and conduct
- Private data breaches because of cybersecurity attacks
- Internal or external fraud
- Business processes and controls
- Technology risks linked to automation, robotics, and artificial intelligence
- Physical events causing disruption, such as natural disasters
For example, an employee lacking proper training could miss out on a sales opportunity, resulting in a direct operational risk. Meanwhile, an indirect threat would be the company’s reputation suffering due to poor customer service output. Since the reputation loss is a direct result of the training deficit that led to the poor level of customer service, this causes it to be an indirect operational risk.
How to manage operational risk
Operational risk management (ORM) can help a business identify risks, introduce controls and provide solutions for risk monitoring. The process allows you to rank and categorise risks based on the threat level. From this, you can decide which risks can be accepted and which require addressing.
The first step to mitigate and reduce operational risk is to identify the risks concerning the objectives and goals of the business.
Businesses must assess any and all technology and systems they have in place across the board and look for areas that could produce risks. Technology, processes, and controls all need to be risk-assessed to identify opportunities where human error, data breaches, and fraud could present potential risks to your business.
Elsewhere, if your business is in an area where natural disasters are common, then you should identify the risks around this. For example, your office or warehouse could be damaged by hurricanes or earthquakes.
The training requirements of staff must also be taken into account at this stage, since issues around employee error and conduct play a big part in business operations.
Data can also come into play at the risk identification stage since it prevents the task from becoming subjective and instead quantifies it. While managers and leaders in the business can converse about the strengths and weaknesses of a project, the conversations are limited without hard data and facts. Business intelligence (BI) software can bring in data from across the business to aid with risk identification. It can pull data together quickly and seamlessly, meaning you can easily see where numbers could be lacking.
Once the operational risks are identified, each one must be evaluated based on the likelihood of occurrence and the potential harm it poses. This will ensure your business is fully aware of which risks you should prioritise through ORM and why.
The assessment will depend on the business goals and what you want to achieve. An example would be assessing your customer service satisfaction levels to see if they meet your pre-set standards.
Business intelligence software can aid risk assessments as it offers instant access to accurate, real-time data from across your business. However, it can only go so far.
Businesses should set up their own policies and practices to help them assess the level of more complex risks such as future staff shortages, technology security, etc.
Learning how to control the specific risks
Controlling specific risks will look different depending on the area of the business that’s affected and the scale of the issues.
For example, you might choose to employ an agency so that high levels of staff shortages would have less of an impact.
Keep the goals of the business in mind when deciding how to control the risks identified.
Business intelligence software is essential for data gathering, analysing, and aiding informed decisions. Controlling risks can be aided with BI since it allows you to access the information you need to identify many risks in the first place.
For instance, sales trends will highlight your busiest times of the year, so you’ll need to ensure you have the stock, staff and logistics available to manage these busy periods.
Customisable business software will offer greater flexibility to change your system, processes, or controls to reduce operational risk. Today’s ERP software offers the flexibility required for quick adaptation and simple business changes that can mitigate some threats associated with operational risk.
For example, if you’re finding your debtors days extending, you can mitigate the risk of not getting paid by automating invoices to be sent out as soon as an order is placed and automating reminder emails. Or, you can highlight the customer in red to ensure sales personnel don’t sell any further items to that customer until the account is paid up.
However you choose to control the risks, they must be regularly monitored for any changes, with progress being key to the process.
Implementing ORM controls
Implement the necessary controls for risk mitigation, considering your goals and the risks you’ve identified. The execution of ORM controls will again differ depending on identified risks.
For example, if customer service is lacking due to training gaps, then the control would be to address these and ensure any missing training is caught up.
Solutions for monitoring risks
Operational risks must undergo continuous monitoring to determine whether prevalence and severity have changed. The original list of identified risks should be modified accordingly as things develop.
Guiding principles of ORM
For successful operational risk management, certain principles should be followed. These are:
Accept no unnecessary risks
Any risk that won’t – or can’t – meaningfully contribute to the task, project, or objective is unnecessary and may even threaten the overall organisation. These risks shouldn’t be accepted under any circumstances since they pose too much danger.
Unnecessary risks that shouldn’t be accepted might include high-risk situations, where fraud or data breaches may pose a greater risk. For example, employees must be educated about the risks of phishing emails – a lax approach to potential security breaches like these qualifies as an unnecessary risk.
Make risk decisions at the appropriate levels
The person who makes decisions about risk should have a full understanding of it and be able to delegate the correct resources toward it. They’ll also be required to implement the necessary controls for successful mitigation.
If the risk decision falls to somebody at the wrong level, they could make a judgement that might have significant consequences for the company.
Accept risk when the benefits outweigh the cost
Risk can be accepted if the benefits outweigh the costs to the company. The cost doesn’t necessarily need to be financial – instead, it could negatively impact reputation. Every business will evaluate this differently, and the decision as to how much benefit needs to outweigh the cost to make it acceptable should fall to someone that can take on the responsibility.
For example, implementing new software may temporarily pose operational risks to your business processes that might lead to some downtime or additional training costs. However, the temporary nature of these risks means that the benefits attached to new software implementation outweigh the potential costs to your business.
However, risk should be rejected if the costs outweigh the benefits.
Anticipate and manage risk through planning and regular monitoring
Thorough planning can help you identify potential future risks and create proactive mitigation plans for these
You need to regularly monitor and review your risk management policies and procedures regularly to ensure they are effective. You should also monitor operational risks and adjust your business rules and controls as needed.
Finally, be sure to continuously improve your risk management processes to ensure you are keeping up with changes in the business environment and evolving risks.