Classic / Mohamed Ogbi, Risk Assessment, Risk Management, Synectics Plc / June 4, 2018
What is Risk Management? – (Synectics Plc) Case study
Risk is any situation that exposes a business venture or company to uncertainty of the outcome of any move. It may result in a profit or loss for the company. As a result, companies need to take action to mitigate the risk. Risk management is one way to mitigate risk. Through it, companies can reduce the possibility of a risk having a significant impact on profitability.
What is Risk Management?
Risk is any situation that exposes a business venture or company to uncertainty of the outcome of any move. It may result in a profit or loss for the company. As a result, companies need to take action to mitigate the risk. Risk management is one way to mitigate risk. Through it, companies can reduce the possibility of a risk having a significant impact on profitability.
Concept of Risk Management
According to Frenkel, Hommel and Dufey (2005), risk management is the process of trying to understand, check and address risks. The aim is to reduce their effect on an organization and ensure business sustainability. Effective risk management seeks to understand risks, rank risks, design ways to mitigate risks and monitor and control risks. In this way, risk management reduces the effect of a risk on a business.
Risk management should be proportionate to the size of an organization. Thus, if an organization operates only within national borders, risk management for such an organization should consider all internal and external risks within national borders. Likewise, if an organization operates as a multinational, risk management should take into account all internal and external risks internationally.
Risk management is not an event, but a process. Thus, meaning it is not a onetime occurrence, but a continuous process that involves many stages. First, the identification of all direct and indirect risks that confront a business. Once a business identifies risks, the second stage involves evaluating the risks. The aim of to determine the effect they may have on the business.
Some of the risks are minimal and have a small effect on a business. It is possible to ignore such risks without exposing the business to significant losses. On the other hand, there are huge risks. These classes of risks cannot be ignored due to the potential effect they can have on a business. After evaluating risk and determining specific risks to be managed; the next move is selecting a way to manage them.
Selection of the method of risk management should minimize risk in the least expensive way so that it maximizes value for a business. After selecting the method of risk management, the next step is implementing the method. Finally, it is important to monitor the chosen method to ensure it effectively addresses the risk.
Types of Risk
There are varieties of risks that confront businesses. Some of these risks are:
- Financial risks – they involve the possibility of losing or gaining money. For example, a business may lose or gain money for extending credit to a customer. A business may also lose or gain money when it decides to make an investment in a particular business.
Operational risks – this type of risks arise from the failures of the business process. For example, the people, systems or even a business process may fail. When they do so, they can have an impact on the business hence they are a risk. - Strategic Risk – strategic risks are the type of risks that can affect the objectives set out in the business plan. An example of a strategic risk is the change in consumer taste and preference that can affect demand for the business’s products and ultimately cause losses or gains for the business.
- Compliance risk – refers to the risk that a business is exposed to due to the requirement to follow certain laws and regulations about the business. For example, business are required to follow laws and regulations about the health and safety of employees, ensuring they follow fair trading practices and paying tax to the government. When a business fails to follow the laws and regulations, it is exposed to the risk of losing business and money.
- Environmental risks – An environment risk arises from the possibility of a natural disaster happening. For example, earthquakes, flooding or cyclones can occur resulting in damage to the property of the business and eventually lead to losses.
- Political risk – businesses are exposed to the risk of the political climate within a nation changing. Changes in the political climate can result in a change in the policies governing business or lead to political instability within the nation. In such cases, the profitability of the business is threatened.
- Technological risk – technological changes happen These changes can affect a business. For example, a change in technology can lead to change in demand for products. For instance, the drive to ensure all countries embrace digital technology by 2015 has affected those businesses that operated using analogue technology. Such a risk can put businesses at a risk of going out of business if they do not adopt new technology.
Methods of Risk Assessment
There are varieties of approaches to risk assessment. These approaches are:
- Probability distribution – in this method the business analyzes all possible outcomes of a random variable. The item with the largest probability is regarded as the riskiest and the analysis continues until all the possible risks have been ranked.
- Variance – variance gives information about the possibility and the magnitude an outcome will differ from the expected value. The higher the variance, the higher the risk; thus, risk is dealt with depending on its magnitude on the business. Variance measures the variation of an outcome from the expected value.
- Standard Deviation – standard deviation is similar to variance. The only difference is that it seeks the square root of the answer obtained using variance formula. The difference between the outcome and expected value is squared to reduce the effect of negative differences. It measures the variation of the outcome from the expected value; thus, it measures how far values vary from a mean.
- Skewness – is another method of assessing risk. The method measures probabilities of expected values to determine the symmetry of distribution. The more skewed the probabilities, the greater the possibility of a risk happening resulting in a loss.
- Frequency – frequency looks at events in a company’s past to determine how many times losses occurred. Based on the frequency of losses, a company determines the probability of a loss. For example, if a survey in the company projects that on average there is 1 injury out of every 10 employees, then the probability of an injury occurring is at 0.01.
- Severity – measures the magnitude of a loss whenever it occurs. From the severity of losses, it is possible to determine the average severity of each loss that will occur in the future. For example, if a company estimates that the severity of losses from employees’ injuries in the past was every 2000 injuries cost $2 million. The severity of a loss occurring from an employee injury is $1000.
Methods of Managing Risk
According to Ostrom and Wihelmsen (2012), three methods can are used to manage risks. The three methods are:
- Loss Control – In this method, a business reduces the possibility of a loss happening by lowering or avoiding an activity that may result in a loss. It may also increase the level of caution to guarantee the activities have minimal effect on a business.
- Loss Financing – the technique uses funds to pay for losses when they happen. In this case, there are several options available to business. A business can retain the loss and pay for it using an internal or external source of funding. A business may also buy insurance so that an insurance company will pay for the loss when it happens. Businesses can also hedge risk using contracts or financial derivatives like forwards, options, swaps or futures. Moreover, a business may also transfer risk using contracts through an agreement that in case of a loss, the other party will pay for that loss.
- Internal Risk Reduction – taking action to prevent a risk is another method of handling risk. In this case, a business will diversify. For example, it may hold several businesses to reduce the possibility of a risk affecting its business. Gains in one business can cover losses in another business. In addition, a business can invest in acquiring information on market conditions. Once a business conducts risk assessment and identifies what risks exist, they can choose to search for information to reduce the effect of the risk. For instance, businesses can gather information about the market so that they are aware of changes and take action to mitigate a risk.
Brief Introduction to Company (Synectics Plc)
Synectics plc is a publicly traded company in the UK involved in designing, integrating, controlling and managing advanced systems for surveillance technologies and other security systems on a network. It is a leader in the business in Europe and several international markets.
Risk Assessment
There are several issues within Synetic plc that may lead to losses. One of the reasons that result to losses within the company is the extension of delivery periods for secured contracts. Companies, particularly those in the oil and gas sector, are having problems in their business including a decline in the global price of oils and gas products. The result is that these companies delay beginning projects. Delaying projects is resulting in the extension of contracts that Synectics has secured. As a result, forcing Synectics to extend the time for these projects resulting in losses. Thus, the possibility of delaying projects resulting in contract extensions is a risk for Synectics plc.
Another problem facing Synectics is the length of time it takes to procure items for large projects. The public sector in the UK results in extended procurement cycles creating problems for the time that a project is to begin. The assumption is that when a project delays the company continues to incur losses in the form of revenue. Delayed projects mean they cannot bid for more projects compared to a case where the projects had started. The reason is a delayed project threatens the company with lawsuits if the company fails to perform its end of the agreement. Thus, the company has to be cautious not to take on too many projects that it may fail to perform all. As a result, the lengthened procurement cycle is a risk for Synectics.
In addition, there is the high cost of repaying the capital that comes with project extensions. Synectics has secured various forms of funds from the stock market and other sources and has to repay. However, when the company experiences delays in a variety of projects there are problems with cash flows. The problem of cash flows is an assumption based on the fact that companies depend on revenues from projects to payback debts. Money invested is repaid from the cash flows coming from the investment. Thus, the challenges with cash flows result in an inability to pay back debt incurring higher penalties. In this case, the probability of higher cost of capital is a risk for Synectics.
Political instability is also having a huge impact on Synectics plc. The company is heavily reliant on companies in the oil and gas sector as the major customers. Most oil-producing countries are facing various political challenges affecting business for companies. For example, in the Middle East, since the “Arab spring” started, we have witnessed political instability in Libya, Tunisia and Egypt. And the rise of the ISIL phenomenon after the unrest in Syria and in other countries like Nigeria there is Boko Haram. The political instability leads to delay in projects leading to problems for Synectics. Consequently, Synectics has the possibility of losses occurring due to political instability in various parts of the world.
Moreover, Synectics has issues arising from reputational risk. The company is heavily reliant on securing contracts for its core business. Most companies check into the history of companies they intend to give contracts. However, the problem with extended contracts periods leads to a bad history for the company putting Synectic’s reputation at risk. As a result, the possibility of the reputation of Synectic plc declining is another risk that confronts the company.
Finally, as an international player, Synectics handles various forms of currencies. Using various currencies to conduct business, means the business has to exchange the money or denominate it into local currency when preparing financial statements. Market forces determine the exchange rates of currencies. The result is that the rates will fluctuate depending on the level of demand and supply. There is a possibility that the rate will drop leading to a loss for the business. Consequently, Synectics plc is prone to exchange rate risk.
After looking at the various forms of risks that face Synectics plc, it is important to look at the options that the company has to manage these risks. First, there is the risk of extended projects due to customer delays in beginning projects. An assumption is that these creates problems with cash flows due to money held up as material required to start the project. There are various ways to manage this type of risk. The company could adopt loss control mechanism. It could begin to look at all companies before bidding for a contract. The aim is to determine which companies are at greatest risk of downturns in the oil and gas sector. This will help the company to reduce the potential effect a downturn can have on it profits and cash flows. Additionally, the company can seek credit facilities to tap into when cash flow problems emerge. It may also create a buffer fund by retaining some of the profits gained from completed contracts.
Further, the company has problems with procurements for large projects. The risk may be difficult to manage but it is possible to mitigate in a similar manner like the extended projects. The company can control losses by looking at the reputation of companies that have supplied material in the past. When a company has a good reputation, it can receive procurement contracts in the future and denied a contract in the opposite case. In this way, the company reduces the possibility of procurement challenges.
Financial derivatives can mitigate the challenges arising from the high cost of capital.
The company has limited options on how to deal with political instability as a potential risk. However, like all systematic risk, diversification can mitigate political instability. Synectics should look at the country of origin for all businesses that it bids for contracts. It can diversify the companies to ensure political instability in one region does not affect business significantly. Profits in one region compensate losses in another region arising from political instability.
Reputational risk can be overcome by building a strong reputation in the market. The company should establish strong customer relationships. When problems emerge customers are willing to support the company. In this way, the company is able to deal with the risk of a damaged reputation. Consequently, the company is able to mitigate reputational risk.
Finally, exchange rate risk may also be overcome through financial derivatives. Synectics can buy put options in the derivatives market. A put option will give the company an opportunity to sell foreign exchange at an agreed price. The company can use the right to sell foreign exchange whenever they suspect a decline in the exchange rate. In this way, Synectics will have mitigated the risk of the exchange rate falling.
Conclusion
Risk management is important in businesses to prevent the possibility of incurring losses. It is important to remember that risk management is not a one-time event but a process. Synectics should conduct risk management within the organization to reduce the possibility of a loss occurring. The various types of risks such as reputational risk and financial risk necessitate risk management. Through risk management, Synectics can prevent the likelihood of any of these risks ruining business and resulting in losses.
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References
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