Limitations of Traditional Risk Management
Organizations in the course of their business activities have to come across a number of risks that can arise from various avenues of the business framework. Therefore, the organization has to be armed with sufficient measures that shall be helpful in managing the risks so that it can successfully carry out its business and increase its profitability. There can be several approaches towards the handling of risks within a given organizational framework depending upon the niche in which the organization operates and the area in which the risk has appeared. Therefore, it can be observed that the management of risks forms a daily aspect of the running of a business and this might lead one to question the significance of Enterprise Risk Management (ERM). ERM presents us with a completely different approach towards the management of risks within an organizational framework compared to traditional risk management processes. The following sections shall elaborate upon the disadvantages of traditional risk management approaches compared to ERM and subsequently the case study shall reveal the pragmatic aspects of ERM within a specific organizational context.
Conventionally, organizations handle risks by assigning responsibilities to leaders to manage risks within their own field of specialization. For example, the Chief Marketing Officer shall be responsible for looking after risks that shall arise in the domain of customer relationships and sales. This approach towards risk management is also referred to as silo or stove-pipe risk management where each leader looks after their own silo of specialization. While this system seems pretty rational and sensible, a closer analysis shall reveal a number of loopholes in this approach and this exposes the organization to a number of undesired threats. The following are the major limitations of traditional risk management:
- Narrowness of Perspective: While the silo system makes sense in letting experts handle risks that arise in their specialized avenues but in most cases risks cannot be categorized under a specific silo. This often results in taking up a restricted view of the risk and it is forcefully assigned to a specific domain. In order to address the risk in a wholesome manner, a holistic view must be adopted. A risk should be analyzed from various perspectives as a risk that arises in the technological field can easily affect sales and customer relationships and thereby degrade the entire reputation of the organization. Therefore, multi-pronged approach towards risk management becomes very essential in this aspect.
- Incomplete Understanding of Risk: Traditionally, the conception of risk is a very limited one in organizations. We need to broaden our understanding of the term ‘risk’. Mostly risk is conceived as immediate threats that might arise for the organization namely, security breach, financial fraud or technical failure in the factory et cetera. The activity of risk management is not extended to the domains of strategy planning, product development, capturing of new markets et cetera.
- Possibility of Further Risks: By compartmentalizing risks into small silos and then assigning them to the person in charge might seem sensible initially but it must also be considered that the person who shall be in charge of handling the specific risk shall not have sufficient knowledge about how that risk or its resolution might affect other aspects of the organizational framework that do not fall under his or her specialization. A certain response in one silo can have disastrous consequences in another but since the entire system is so restrictive in nature, there shall be no possibility of communicating with other silos before attempting to resolve the risk.
- Does not Focus on External Factors: From point 2 one can infer that traditional risk management processes have a very limited sense of the term risk. As an extension of the point it can be asserted that risks are associated only with factors internal to the organization. External factors like market conditions, legal frameworks et cetera are rarely accounted for. For example, a move by a competitor can severely marginalize the organization’s presence in the market or a new legislation by the government can hamper the ongoing business process of the organization. If these factors are not accounted for under the purview of risk management then it will take no time for the organization to be completely broken down.
- Does not Integrate Risk Management with Strategy: Usually risk management is viewed as a separate organizational function and it has no relationship to strategy whatsoever. As mentioned above, as a result of this, risks related to the implementation of a strategy are not given due importance by the traditional approach. If risk management is integrated with strategy, then risks related to the market conditions or other external factors to the organization shall be taken consideration of properly.
The importance of ERM is undeniable and the definition of such was given by the mutual thinking on leadership by a committee of five organizations in 2004. It is “a process, effected by the entity’s board of directors, management, and other personnel, applied in strategy-setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risk to be within the risk appetite, to provide reasonable assurance regarding the achievement of objectives.” Therefore, it can be understood that the most crucial aspect of ERM is its integration with the organization’s’ business strategy. Rather, effective ERM should be regarded as a part of the strategy where the likelihood of risks shall let the management take preemptive measures to avoid them. Organizations find great difficulty in assessing and finding the risks involved to implement ERM in their framework. But whether ERM actually provides suitable and profitable returns is the main question. The benefits of implementing ERM in the organization’s framework are as follows.
- Improves competitive stand: On further evaluation it was found that the ERM provides better reports on emerging risks and the ways in which the risks should be dealt. ERM provides data that helps to improve the tracking down of risks and improve the instantaneous risk managing processes and thus, gives an opportunity for the organization to make its stand in the market.
- Profitable in implementing ERM: Financial statements and auditors have started to encourage implementation of ERM in the management framework to cut costs and run effectively because such audits and reviews have started to show high returns after and for implementing ERM in the system.
- Focusing on risk through the top level of management: It is seen by thorough evaluation and analysis that the ERM provided a more focused approach towards risks starting from the top level of management. This helped in discussing about risks at all levels of management. Thus, risk Management becomes a specialized field in accordance with the respective department in the organization. This shift in culture of management helps to break silos on the management of risks.
- Proper allocation of resources to manage risks:Though the regular risk management practices will not be thwarted, the ERM will provide an impetus to the protocol of risk management by eliminating useless actions and driving the resources towards better allocation and authorization under certain heads.
- Provides precise and statistical data on emerging risks: ERM also provides the organization better reports on risk data and gives prior notice about probable risks that might emerge. This is made possible by reports that are presented in structured, precise and standardized formats. This gives the organization scope for clarification and decision making by evaluating those reports of a department with the other departments and levels of the organization. The types of data that the reports after implementing ERM provides are statistics on emerging risks, strategy of mitigation, et cetera.
Coca Cola Hellenic Bottling Company is an organization based in Switzerland which manufactures bottles of Coca Cola beverage. The Coca Cola Company owns 23.2 percent of its stocks, 23.6 percent is owned by Kar-Tess Holding and the remaining 53.5 percent are free floating stocks. Coca Cola HBC has a sturdy risk management program that relies on rational categorization of risks and constant monitoring of avenues that are susceptible to risks. As the company website reveals, risks are classified under four heads namely, community trust, consumer relevance, customer preference and cost leadership. One of the key features of HBC is that it integrates risk with strategies and ethical factors concerning business. By the creation of a clearly defined universe of possible risks, it becomes much easier to identify and resolve risks in case of they arise. Furthermore, the management is duly involved with the processes of risk mitigation and as a consequence, the idea of risk management becomes and intrinsic part of the organizational culture.
Advantages of Enterprise Risk Management
Insurance can go a long way in doing away with possible risks. Therefore, an appropriate insurance policy must be purchased by the organization that shall help it in the proper management of the risks associated with its operation. Coca Cola HBC relies on a constant evaluation of its insurance policy by the management with reference to the likelihood of risks.
The Board of the company is the ultimate arbitrator of the decisions that are to be taken in times of crisis. However, it does not mean that the Board is free to act as it wishes. The process through with risks are addressed is indeed systematic and there is a well-coordinating structure within the organization specialized for the analysis and the handling of risks. The Group Risk Forum which is an independent forum operating within the organizational framework which is solely dedicated to the identification and the resolution of crises. Moreover, there is the Chief Risk Officer who presides over feedback meetings and brings together the various departments within the organization along with the Board so that a holistic understanding of the risks can be reached at. In addition to the Group Risk Forum, there is the Operating Committee (OPCO) comprising of the senior leaders of the organization whose responsibility is to make recommendations regarding the issues that have been taken up by the Group Risk Forum. Subsequently, the decisions of the OPCO are then communicated to the Audit and Risk Committee. There is also a hierarchy maintained between the country and regional levels. There are regional risk officers who submit reports bi-annually for review by the officers in the country level which are then communicated to the Group Risk Forum for further review.
Thus, it can be observed that Coca Cola HBC has an elaborate structure of ERM addressed to mitigate risks that might arise from any avenue concerning the organization. The approach adopted by HBC is dedicated to the management of risks that are both internal and external to the organization. Furthermore, there is hierarchy that is involved in the successive evaluation and supervision of the activities of the units. This provides ample opportunities for reviewing the actions of lower units and mistakes that are made can be rectified after proper supervision.
Coca Cola HBC’s approach shows an indeed innovative appropriation of the idea of risk management. It also provides an example on how ERM can be effectively implemented within an organizational framework. The hierarchical system is very beneficial in evaluating the likelihood and the probable magnitude of the risks that might arise. However, there were certain gaps within the structure that could be observed. For example, there is the need for a research team within the management structure that shall be focused exclusively on researching the market conditions and also supervising the internal structure of the organization to accurately predict the possibility of risks both inside and outside the organization. Elaborate market research is a necessity in the modern world of information technology so that the condition of competitors in the market can be analyzed. In order to extensively implement the culture of properly handling risks within the workplace there should be training programs conducted that shall aim at educating and inculcating values in the employees that are conducive towards the avoidance and resolution of risks that shall arise in the workplace. There should also be an internal set of rules and regulations based on prior research that shall standardize procedures related to the mitigation of risks that are likely to recur in the future.
Conclusion:
The above assignment substantiates the theoretical foundations of ERM as well as, contrasts the advantages of ERM over traditional methods of risk management. The case study on the other hand illustrates the practical aspects of ERM within an organizational framework. Every organization has its own set of customized approach towards ERM depending upon the market in which the organization is functioning. A close analysis of the case of Coca Cola HBC makes apparent certain gaps that could be repaired according to the recommendations that were made. There can be no telling about when and what magnitude of risks might arise for the company. Therefore, ERM should be an ongoing process that shall evolve depending upon the kinds of risks that might emerge in the future. With the rapid changes that are affecting the global business climate with increased competition it becomes necessary for an organization to develop techniques that are better equipped in handling risks. Moreover, there are greater expectations on the part of the Board to implement foolproof risk management. Therefore, as a result, ERM is becoming the preferred approach towards the addressing of risks.
References:
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