Risk and reward

Another feature of risk and risk management is that many risks are taken by an organization in order to achieve a reward. Figure illustrates the relationship between the level of risk and the anticipated size of reward. A business will launch a new product because it believes that greater profit is available from the successful marketing of the new product. In launching a new product, the organization will put resources at risk because it has decided that a certain amount of risk taking is appropriate. The value put at risk represents the risk appetite of the organization with respect to the activity that it is undertaking.

Figure. Risk and reward

When an organization puts value at risk in this way, it should do so with the full knowledge of the risk exposure and it should be satisfied that the risk exposure is within the appetite of the organization. Even more important, it should ensure that it has sufficient resources to cover the risk exposure. In other words, the risk exposure should be quantified, the appetite to take that level of risk should be confirmed and the capacity of the organization to withstand any foreseeable adverse consequences should be clearly established.

Not all business activities will offer the same return for risk taken. Start-up operations are usually high risk and the initial expected return may be low. Figure demonstrates the probable risk-return development for a new organization or a new product. The activity will commence in the bottom right-hand corner as a start-up operation, which is high risk and low return.

As the business develops, it is likely to move to a higher return for the same level of risk. This is the growth phase for the business or product. As the investment matures, the reward may remain high, but the risks should reduce. Eventually, an organization will become fully mature and move towards the low-risk and low-return quadrant. The normal expectation in very mature markets is that the organization or product will be in decline.

The particular risks that the organization faces will need to be identified by management or by the organization. Appropriate risk management techniques will then need to be applied to the risks that have been identified. The nature of these risk responses and the nature of their impact will be considered in a later chapter.

The above discussion about risk and reward applies to opportunity risks. However, it must always be the case that risk management effort produces rewards. In the case of hazard risks, it is likely that the reward for increased risk management effort will be fewer disruptive events. In the case of project risks, the reward for increased risk management effort will be that the project is more likely to be delivered on time, within budget and to specification/quality. For opportunity risks, the risk-reward analysis should result in fewer unsuccessful new products and a higher level of profit or (at worst) a lower level of loss for all new activities or new products.