I cannot agree more with a proverb, which says ‘Not taking any risk is the biggest risk in life.’ Future is unpredictable and there is varying degree of uncertainties or risks in any decisions. We also know that success or failure of any person or venture depends on the right or wrong decisions that one takes over a period of time. Risk is defined as the ‘probability of occurrence’ of certain events, which are counter-productive to the business or entity. Despite all decisions containing certain degree of risks, successful people continue to take decisions for expanding, restructuring and bring innovations in their business, and hence in almost all of their actions they take calculated risks.
When we talk about risks, we generally talk about two kinds: Unsystematic risks, which can be mitigated or managed; and systematic, which cannot be mitigated.
Unsystematic Risks
Business pressure from board could prompt excessive risk-taking...
Basically, unsystematic risks are the controllable ones and being proactive, we can decrease or eliminate them. All businesses have ‘Operating Cycle,’ which primarily contains four activities as depicted in the figure below:
Lets discuss few examples from the above diagram pertaining to unsystematic risks in an Airline business.
Supply Risk: Few examples of supply risk in an airline company could be: a) Risk of lower quality aircraft engine; 2) Poor quality of pilots; 3) Poor quality of crew members, etc.
Production Risk: In a service business, production activity refers to ‘Service Delivery’ and hence examples of such risks could be: 1) Lack of proper training in Airline counters; 2) Lower quality of flight-catering services; 3) Improper baggage-handling services, etc.
Demand Risk: 1) Inability to meet certain sales target; 2) Inadequate/Improper branding activities; 3) Inappropriate pricing, etc.
Collection Risk: 1) Untimely/Non-payment by travel agencies; 2) Non-payment by direct customers.
All the above ‘unsystematic risks’ can be mitigated or managed if correct proactive measures are taken. For example, to mitigate collection risk of untimely or non-payment by travel agencies, airline companies can employ a pre-condition of obtaining stand-by letter of credit or bank guarantees from the travel partners before signing agency contracts. Similarly, to mitigate supply risk of poor quality crew members, proper training and development programs can be structured. Risks, which can have damaging effects in business, must be managed with greater focus. Entrepreneurs and business managers must make decisions pertaining to operating cycle, in which taking calculated risk is inevitable.
Systematic Risks
Risks, which cannot be mitigated by the company or individuals are called systematic risks. Strikes and bandas, wars, and natural catastrophes are few examples of systematic risks. While these risks cannot be mitigated when they occur, entrepreneurs can take preventive measures by forecasting correctly in decisions such as where to expand their business, whether to consolidate few branches or network points or choosing a location after doing research on seismological variables and so on. These measures when taken appropriately will certainly decrease the probability of damages, although it might not mitigate the risks fully.
Risks are unavoidable to expand business, create new products, add new branches, and acquire other strategic businesses. There is a certain degree of risk, which companies must manage during day-to-day operations as well. Risks such as credit risk, operation risk and market risks need to be managed efficiently. Financial institutions, guided by Basel III framework of ‘Capital Adequacy’ maintain adequate capital in proportion to the risks that they take. In simple words, higher the risks they assume, higher capital they maintain and vice versa.
In entrepreneurship, it is all about making decisions and hence ‘risk taking.’ The key is to understand the risks and take correct proactive measures, thereby mitigating majority of risks businesses are exposed to.
The author is the founder and executive chairman of KFA.
