What can you do with risks that you have accepted?

In another post I had said that there were three ways to deal with risks. You could take them on yourself, you could get someone else to take care of them or you could try to dodge the risk entirely by not putting yourself in a situation where you could be exposed to it.

In this post I want to talk about the first choice. If you take on the risk yourself, what are your options on what to do with it?

There are only three things that you can do “to” a risk once you have decided to take it on.

The first of these three is you could try to prevent it happening in the first place. For example some time ago some water got into the basement of my house. I was afraid that if we had heavier rains in the future my basement would be completely flooded. To prevent that from happening, I had a weeping tile, a kind of porous drain pipe, built in my basement to capture and redirect the water. I installed a sump with a pump to get rid of that collected water. This two tier protection would prevent the basement from flooding in pretty much any heavy rainfall. Another example is if you were going camping and are worried about getting stung by mosquitos. So you spray your body with mosquito repellent to keep them away. That’s prevention.

Now let’s look at a couple of business examples. Let’s say that you need to buy some equipment in three months for a project that you are working on. You will be buying the equipment from Japan but are worried that the price of the Japanese Yen might shoot up at the time when you will need to pay for the equipment. That would drastically change the profitability of your project. To prevent that from happening you decide to buy a forward contract for the Japanese Yen. That way you don’t have to deliver the money now but are able to lock in the exchange rate. So you have prevented the impact of the exchange rate fluctuation with this action.

Another business example: Let’s say your company processes payments for individuals on behalf of clients. A payroll processing company is such a business. To prevent incorrect payments being made to the wrong recipients, you invest in a lot of training of your staff to reduce the likelihood of any human error. You also make sure that there are good checks and quality assurance processes in place. In the payment processing workflow you have many pairs of eyes to examine payment cheques before they actually leave the door. These actions all amount to efforts to prevent the risk from happening.

The second thing you can do to a risk that you have decided to take on is to have a contingency in case the risk decides to manifest itself. This is like preparing a cure for an illness. If you are going on a camping trip and you know that you’re going to get attacked by mosquitos, to prevent it happening, you could get some mosquito repellent spray. That’s prevention. However, if you still get bitten, then you need to get some after-bite spray to lessen the pain and reduce the swelling. That’s the cure, the contingency.

In a business context, taking the earlier payment processing company as an example, if human error were still able to slip through all the trained staff, the quality assurance reviewers and so forth and an erroneous payment still found itself out the door, then the company needs to have a process to correct that, get the cheque back, negotiate its return from the recipient or have other options such as reducing the next payment to that recipient to make up for the difference. As you can see a cure is always more difficult than prevention. The person who came up with the adage “an ounce of prevention is worth a pound of cure” was most likely a risk management expert.

The third thing you could do to a risk is do nothing. Yep, you could put your head in the sand, pretend it’s not there, expose yourself like a sitting duck. If mosquito bites don’t bother you, maybe you can get away with that. If you have lots of money to burn when exchange rates fluctuate, you can afford to leave yourself open to risks in the foreign exchange markets. If you don’t care about incorrect payments made out to the wrong people for the wrong amounts, you can go ahead and hire anyone off the street to process them, don’t spend a dime on their training and just shrug your shoulders when things go wrong.

Good luck with that.

Muneer

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