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The art of valuing risk reduction
Managing risk is a good thing – everyone agrees on that. But it’s not always very easy to justify proactive expenses on risk management activities. Getting the green light on expending valuable resources on mitigating the impact of future events that may or may not occur is a tough one. So how do you place a value on risk reduction?
What is risk in business?
Risk can be defined as the combination of the likelihood and consequence of a hazard eventuating, which can relate to the safety of people, business risk including commercial and legal, environmental risk, community effects and other potential impacts.
Organisations are required to manage risks, some as a requirement of legislation, some as an obligation to the business and its shareholders and others to the broader community and its surroundings. Risk management not only protects a business from risk exposure but also helps to retain its value.
Risk management when done well both prevents and controls risk outcomes as well as preserving and in some cases increasing value.
In a private company, shareholders carry the risk to the share value and although not managed specifically by legislation, it is good practice for the business to understand its liability.
Balancing the cost to risk ratio
Mitigated savings can be understood as cost reduced or not incurred because of an action taken. Most mitigated savings are the product of controlling a risk issue to minimise the outcome to an acceptable level. Because mitigated savings are generally theoretical, it is difficult to sometimes convince others of the requirement to complete or fund an action. In general, these savings are a reduction in risk, not exclusively safety but can also include business, commercial, legal, environmental or other costs.
Finding an effective cost and risk inflection point is complex, for example deferring maintenance actions can reduce a financial cost but may introduce other risks. Some of these other risks may be acceptable and it is the process of finding the most efficient position between risk tolerance and controls that provides the best benefit.
Preventative, predictive and other forms of maintenance done to prevent failure are costs incurred as part of mitigated savings.
In maintenance, preventative, predictive and other forms of maintenance are undertaken to manage productive output which in turn manages financial risks, reputational, risks to health and safety and more. Maintenance of risk-based control measures is essential in managing business risks and ensuring business value.
So, how do you equate the cost of accepting risk?
Risk reduction generally comes at a cost. To identify risks, assess their impacts, develop the controls, evaluate the control requirements against the risk impacts and to then establish the controls in practice takes a lot of time and resources. Finding the efficient balance between business risk tolerance and the cost of identifying and establishing risk-based controls is a specialised field.
Inexperience in identifying risks gives rise to the possibility of missing risk issues which could unwittingly expose the organisation to a risk event. Inexperience in developing controls can yield unbalanced requirements, typically excessive control requirements. Excessive controls create a separate risk or set of risks under a general control inefficiency.
WHS legislation requires businesses undertaking work to be as safe as reasonably practicable, which requires them to undertake all reasonable steps in managing risk. Publicly listed companies have additional requirements under the Corporations Act to ensure they are undertaking work for the benefit of the shareholders, and to manage and share material risk exposure.
Some activities come with inherent risk and there’s a variety of ways to manage that risk. Finding solutions to manage inherent risk forms part of a business case as resources are allocated. The event of the risk can be theoretically estimated and compared with the cost of mitigation. This is a basis for a mitigated saving. Balancing the benefit of the expense to the reduction in risk exposure can create additional value for a business and exploring efficient risk management steps can reduce risk exposure while improving financial performance.
Finding the perfect midway
Reduction of risk can be a single large hazard event or the cumulative effect of smaller hazards. Equally, the reduction of risk relative to the resources committed provides a theoretical improvement. There are many methods that can be tailored to suit the scale, nature and any other specifics of the business in review. Understanding how resource allocation relative to the risk reduction makes a real difference allows for better communication of risk reducing activities, the need for preventative maintenance and inspection strategies and the alignment of thought from the persons in the business.
Partner with the professionals in risk engineering
At AMREP, we understand the intricacies of valuing risk reduction. We deliver a superior level of expertise and full suite of competencies in risk engineering solutions. Contact our team and experience the AMREP difference.