Okechukwu Onwuka The Risk Professor

MD/CEO Business Risk Solutions, 07087814760

Developing A Business Risk Acceptance Criteria

Some people say they are risk takers. Others say they hate taking risks. In reality, everybody takes one form of risk or another. Leaving home to go to work involves a measure of risk. In driving your car to the office, you accept the risk that some drivers may be reckless on the road but you also accept as adequate the available risk control measures in place such as; your car is in sound shape with new tires including the spare, functional wheel spanner and jack, you are a good defensive driver, you have not had an accident before, you will not overspeed and that should you work late, youll join public transport as your night vision is poor and as such, unfit for night driving. For others, driving is too risky and they prefer to be driven by others. There are people who will never eat any new or foreign meal for fear of intestinal reprisals. Interestingly, others crave for new delicacies and keep medical remedies in close proximity to deal with any eventual fallout. While some consider air travel a high risk venture, others consider road travel risk high and air travel low risk. A famous Dutch footballer, Dennis Bergkamp is so frightened of air travel that he never travels with his Club, Arsenal FC or Country Holland to any location that cannot be connected by road or rail. Dennis Bergkamp was put off flying for life after an engine cut out during a flight to the USA 94 World Cup with his national team. The experience had left the Holland international afraid to take to the air again. Our experiences usually contribute to our perception and estimation of risks. Similar scenarios exist in business. Some people or companies prefer to research thoroughly their options before committing their money while others prefer to commit funds first and take their chances. Another group prefer to identify a mentor or someone they trust their judgment and invest into anything the mentors invest in. The fear of not having a definite income at the end of the month is one risk too high for a lot of people. Consequently, while many people desire to own their own businesses and enjoy the obvious benefits of a successful enterprise, the lack of a guarantee of incomes or profits is a risk too high to accept. It is also for this reason that a lot of investors rush to commit funds into a business that has publicly been seen to be lucrative. The risk of property owners increasing rents inordinately at the expiration of first tenure is unacceptable risk level to some entrepreneurs who would rather own the
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2009 Okechukwu Onwuka The Risk Professor

properties they operate in. Some others accept the risk based on the lower startup costs and take the chance on the outcome after two years. A number of entrepreneurs have been known to hit successes after major losses or set-backs. May be such experiences teach a lesson that lectures and text books dont teach. This is subject for another day. Whatever our preferences are, it is important that we understand who we are and what constitutes our Risk Acceptance Criteria (RAC) within the framework of our Risk Management Strategy. A clear understanding of this set of personal or company rules will make it easier for you to take decisions in personal and business life. It is not often that individuals have a written documentation on what their risk acceptance standards are but it is of prime importance for every entrepreneur or business to have a clearly documented set of standards that guide business decisions. This way, the criteria will be known by every member of your organization. In developing your risk acceptance criteria, your fundamental values will be called upon. Someone who holds the integrity of his name and that of his family very highly will be strongly opposed to venturing into any business venture with a high probability of bringing shame and dishonor if discovered. Such considerations will not matter to people who believe that the end justifies the means. The same applies to those who accept that money, irrespective of source or method, is the only key to happiness and consequently accept the risk of paying their way out of any trouble with enough money. There are three broad zones of risk classification used in defining a typical risk acceptance criteria. These are Unacceptable Tolerable Acceptable

Risk acceptance standards are usually defined graphically by using a Risk Matrix. A simple Risk Matrix is illustrated below.

2009 Okechukwu Onwuka The Risk Professor

In the concept of Risk Acceptance Criteria, events that fall into the UNACCEPTABLE risk zone are those that companies and businesses must stay away from or identify practical controls that will move them away to at least a TOLERABLE zone. Lets take a simple example. You buy a brand new car worth N6m and plan to use it in Lagos. Given the rate of vehicle accidents, dents and general recklessness of driving in Lagos, evaluate the risk of getting your new car hit or dented. The probability estimate is, say OCCASIONAL. If the accident occurs, what is the likely impact? For a new car, the financial implications could be SEVERE (Given the usually high cost of repairing new cars. In some cases it could go as high as N2m or more). Combining the probability estimate with that of Consequence severity will result in a HIGH risk scenario (i.e. OCCASSIONAL x SEVERE). This is clearly in an UNACCEPTABLE zone. One way to reduce the risk to an acceptable level is to insure the vehicle comprehensively, probably at a premium of less than N180, 000/annum. The insurance will have the effect of reducing the resulting financial impact on you or your business to MINOR in the event of an accident. The residual risk of the insured car is now a LOW (i.e. OCCASSIONAL x MINOR).

2009 Okechukwu Onwuka The Risk Professor

In another example, if you plan to set-up a school using rented property, what happens if at the expiration of your current tenure, the landlord refuses to renew your tenancy or asks for exorbitant renewal rates? If your school is doing very well, chances are that this event will likely occur based on the property owners perception of your business success. When it happens, how do you relocate the school without extensive negative consequences? If your business involves lending, what-if your potential client has a poor history of repaying loans even though his net worth and political clout is high, would your risk acceptance standards approve granting him the loan? In a scenario where the borrower has more political influence than your organization, meaning increased difficulty in recovering the loan through repossession or other similar means in the event of a default, granting him credit facilities might significantly impact your companys liquidity as forceful recovery potential is low. Seeking a loan is usually easy. The payback is the more difficult terrain. Creditors should be wary of the lure of interest at the risk of losing the capital. Developing the Criteria To help develop the risk acceptance criteria, companies should start by listing business goals, objectives based on limits or acceptable range for exposures in terms of finances, reputation/integrity, safety to personnel and Environment. This activity will be fairly easy for individuals but more difficult for partnerships or members of a company board as personal values might differ significantly. However, partners must reach an agreement on common acceptable value definitions. The next step is to list all the events and incidents you can possibly think of that will be unacceptable to your business if they occur. Classify these events under three categories: SEVERE MAJOR and MINOR. The definitions for probability of occurrence are made for UNLIKELY OCCASSIONAL and FREQUENT. Risk assessments will usually involve analyzing the likelihood of occurrence, together with the impact of the risk. Where risks are assessed to fall into the UNACCEPTABLE zone(High Risk), the practice is to identify cost-effective ways to reduce the risk to tolerable levels by either lowering the probability of occurrence or reducing the degree of impact. At all times in your business or project implementation, test all changes, opportunities and growth initiatives against your risk acceptance criteria (RAC). When they fall outside your tolerable or acceptable zone, you know what to do. Use the companys RAC to develop plans and processes to ensure that everyone or at least the decision makers
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2009 Okechukwu Onwuka The Risk Professor

clearly understand what guides the companys business or operations. RACs help business owners take effective decisions, proactively identify controls and safeguards and stay on the track of defined business objectives. Sometimes, these standards save entrepreneurs money by timely halting or re-directing High risk investments or expansion plans. The four broad areas of consequence definitions are as highlighted below; Risk to Personnel (Injury, death, etc) Risk to Reputation (Major smear, reported by News media etc) Risk to Environment (Pollution, Damage to environment, Aquatic life, ecosystem) Risk to Business continuity (Financial Loss, Property Damage, Business Disruption etc) If your business involves transportation and frequent movement of people, what happens if company drivers are injured or cause the death of others in accidents? Can you accommodate the consequences of being caught violating Federal or state laws? Risks that fall within TOLERABLE zones can be accommodated if the cost of what is required to eliminate them is grossly disproportional to the risk reduction achieved. As you gain more insight into risk assessment strategies, youll develop working definitions for various levels of probability and Consequence estimates for use in quantifying risks on a Risk Matrix. This is clearly outside of the scope of this write-up. The simple presentations here is intended to provide the basics thatll enable a wide range of business owners grasp the fundamentals sufficient to make functional risk management decisions.

2009 Okechukwu Onwuka The Risk Professor