2009/06/13 12:48 CEST ARTICLES AND PAPERS

The six ways of dealing with risk

Classic risk management literature acknowledges four ways of dealing with risk after establishing a risk matrix:  Avoid, Reduce, Transfer and Retain or Accept. However, as it turns out, there are six ways, not just four ways to deal with risk, as the classic risk matrix indicates.  Two more are Exploit and Ignore. The former stems from Enterprise-wide Risk Management (DeLoach, 2003), while the latter is more of a sidenote in On the Value of Mitigation and Contingency Strategies for Managing Supply Chain Disruption Risks (Tomlin, 2006), but nonetheless an important observation.

The Classic Four: Avoid, Reduce, Transfer and Retain

Classic risk management as seen in Enterprise-wide Risk Management (DeLoach, 2003) acknowledges 4 ways of dealing with risk:

  • Avoid
  • Reduce
  • Transfer
  • Retain or Accept

These four strategies can be illustrated using a risk matrix, where the impact of a certain event stemming from an exposure to a certain risk, is plotted against the probability of that event actually happening. For generic definitions of what the terms Avoid, Reduce, Transfer and Retain mean, please see my post on the ISO 73 Risk Management Vocabulary.

risk-management

Naturally, high-impact high-probability risks should be avoided. High-impact low-probability risks are transferred (e.g. insurance). High-probability low-impact risks are sought to be reduced. Low-impact low-probability risks are accepted or retained. In general, as the figure implies, there are two ways of dealing with risk: 1) following the x-axis, reducing the impact of events, or 2) reducing the likelihood of events occurring. This can be termed as mitigative versus contingent actions, as I wrote about in another post.

The step-by-step reduction

In a recent book I read I found another way of looking at risk management: It maintains the four classic approaches, but it does not use a risk matrix approach and it displays the steps differently. I think that way is better in illustrating how larger risks are turned into smaller risks.

The Aggressive: Exploit

DeLoach (2000) Enterprise-wide Risk Management: Strategies for linking risk and opportunity also lists a fifth strategy as a possible opption: Exploit. That is, actively seeking out risk in order to gain competitive advantage, since risk per se does not always carry a negative connotation, but can also lead to beneficial results, depending on the outcome. Exploiting risk is also at the center of Lessard and Lucea (2009) Embracing risk as a core competence.

The Don’t want to know about it: Ignore

Tomlin (2006), in his research, found a “see-no-evil-hear-no-evil”-strategy amongst the businesses he investigated. he discovered that many businesses willingly overlooked the risk they were exposed to, an approach he labeled Ignore, a kind of misunderstood Accept, perhaps?

Conclusion

The four strategies (Avoid, Reduce, Transfer and Retain) arising from the risk matrix are important as hands-on and easy to understand basic approaches towards dealing with risk. There’s more to risk than just avoiding risk. Adding Exploit adds the dimension of ‘positive’ risk, while adding Ignore adds a notion of unwillingness to deal with risks. While oversimplified, these six approaches do not show the full spectrum of risk management strategies, but they can help in setting up a basic framework for risk management. It should also be remembered that risk management needs to have both mitigative and contingent strategies.

Reference

De Loach, J. W. (2000). Enterprise-wide Risk Management: Strategies for linking risk and opportunity. London: Financial Times/Prentice Hall.

Tomlin, B. (2006). On the Value of Mitigation and Contingency Strategies for Managing Supply Chain Disruption Risks Management Science, 52 (5), 639-657 DOI: 10.1287/mnsc.1060.0515

Related

ISO 73 Risk Management Vocabulary provides an overview of the terms and vocabulary of risk management along with generic definitions of each term.

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