Business

The risk appetite

Qualitative risk assessments often involve assessing the risk management plan against the risk appetite of a company. A risk appetite represents the willingness an organization to take risks. This notion is against the common belief that all risks should be minimized and organizations should not be involved in taking risks. Taking risks is not only necessary, it is a common happenstance in the business world. 

Lets discuss what a risk is first. In the turmoil filled business operations, occurrences fall under three categories. Things that have been predicted to occur, things that could occur that cannot be predicted, and things that come out of the complete blue.  These three categories form the basis of risk management, alternatively referred to known knowns, known unknowns, unknown unknowns. Here is Donald Rumsfeld talking about the same thing about invasion of Irag.

So why is he talking about risk management in relation to a invasion of a foreign country? There was a risk involved and the USA took risk averse moves to take care of the risk. The move is more commonly referred to the 1% doctrine; if there was a 1% chance of risk occurring, then the USA would eliminate the risk. Had USA not taken care of the risk, they would have been a more risk taking country.

While the previous example supports the notion of avoiding risk as a good thing, taking risks can also have its benefits. Without Apple taking risks, we wouldn’t have had great new innovative products. Without takings risks, we wouldn’t have built aeroplanes, shuttles, satellites, landed on the moon, sent probes to other planets and eventually out of the solar system. Taking risk is equivalent to hit and miss, when you hit the mark you will reap benefits and when you miss, you might not be able to stay in the game.

How do businesses know when to take risks? Had Kodak known how digital cameras would revolutionize the industry, would they have let the world first digital camera prototype sit in the laboratory? Had they brought it out to the market, they might still be relevant today. Same can be said of many different companies or even countries. Failure to innovate is linked to eventual demise of companies and innovation and creativity is associated with taking risks.

Which brings us to the topic of risk appetite.

The risk appetite describes the willingness to take risks. It’s an inherent behavior in individuals as well entities as complex as businesses. When it comes to organizations, the risk appetite is also largely dictated by the company’s culture. Risk takers are those that have more willingness to take risks and where else risk averse companies will try to avoid taking risks. This can also be shown as a risk appetite diagram, which while seemingly simple, is a tool that greatly assists qualitative risk management. The difference between the risk takers and risk averse parties are shown below

risk appetite

Risk appetite diagram

risk taking risk seeking

Risk seeking vs risk averse behavior

The risk seeking/averse nature for the US government under George W Bush administration took a grim turn post 9/11 terrorist attacks. The policies adopted at that time reflected a risk averse nature unprecedented before. In his book, The One Percent Doctrine, Ron Suskind mentions of the turn of events that lead to this risk averse nature within the administration. A policy adopted tried to neutralize terror attacks, even if there was a ‘1% chance’. This, of course, eventually led to the Iraq invasion and the rest, along with Donald Rumsfeld explaining Risk Management 101, is history.

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