When your organization faces an existential threat, is it because of a flawed business model or a broken process? The answer determines whether you’re dealing with strategic or operational risk. The distinction between the two is important—it can mean minor setbacks and complete failure.
This article cuts through the confusion about these two types of risks that require entirely different risk management processes. We explore how to align your risk appetite with both your long-term vision and day-to-day operations, methods to measure the potential impact and appropriate risk level for each category, and more.
Strategic and Operational Risk: A Brief Intro
Strategic risks threaten an organization’s ability to achieve its goals. They come from technological changes, competitive landscape, poor management, or changes in customer demands.
Operational risks come from problems with internal processes, employee mistakes, cybersecurity issues, or external events like natural disasters. A good operational risk management (ORM) plan helps identify and manage these risks.
The main difference between strategic and operational risks is their focus and scope. Strategic risk management involves high-level decisions that affect the organization’s future. Operational risk management addresses tactical concerns related to systems, people, and daily business processes.
Enterprise Risk Management (ERM)
Strategic and operational risk management is part of the wider effort known as enterprise risk management (ERM). ERM includes financial risk, reputational risk, and compliance risk management.
ERM is a holistic approach that looks at risk management from the perspective of the entire organization, not just specific functional groups or business units. It requires company-wide visibility and management-level decision-making that may not be required for individual business units, but makes sense for the broader organization.
What Is Operational Risk?
Operational risk is potential harm resulting from disruptions to day-to-day business operations. These risks can have a financial impact, affect business continuity, damage the organization’s reputation, and weaken its regulatory compliance. To minimize that harm, ongoing operational risk management is essential.
Why Is Operational Risk Management (ORM) Important?
ORM programs give organizations better competitive advantages, including:
- More exposure for the C-suite
- Better risk-taking in business
- Enhanced product functionality and increased brand recognition
- Improved connections with stakeholders and customers
- It increased investor assurance
- Better reporting on performance
- Better, more accurate long-term financial forecasts
Examples of Operational Risk
Some common examples of operational risk include:
- Inadequate or failed internal processes
- Human error
- System failures and downtime
- Inadequately trained staff
- Breakdown of business process controls
- Fraud
- Cybersecurity events, such as data breaches
- External events, such as natural disasters or pandemics
In general, operational risk can be created by:
- Technology
- Hardware
- Software
- Cybersecurity
- Privacy
- People
- Employees
- Vendors
- Customers
- Other stakeholders
- Regulatory and compliance issues
What Is the Operational Risk Management (ORM) Process?
The organization must consider all of its goals while managing operational risk. The objective is to reduce and control all risks at acceptable levels, as operational risk is widespread.
The process involves these key steps.
- Risk identification: A risk must be identified to be controlled. Understanding the organization’s objectives is the first step. Anything that prevents it from achieving those goals is a risk.
- Risk evaluation: The systematic process of assessing hazards by likelihood and impact. Creates prioritized lists of known dangers, similar to internal audit assessments.
- Risk reduction: Select strategies and implement safeguards to limit specific hazards through
- Transference: Moving risk to different parties via outsourcing or insurance
- Avoidance: Choosing different actions to prevent unnecessary risk
- Acceptance: Taking on risk when benefits exceed potential harm
- Control: Taking action to reduce potential harm, like using firewalls or backups
- Implementing control: Putting risk mitigation strategies into action, prioritizing preventive proactive risk management strategies instead of reactive or corrective ones.
- Observation: Monitoring risk controls to ensure they work properly and remain effective as conditions change. Reporting exceptions to management with action plans.
Operational Risk Management Best Practices
Although ORM is effective, there can be obstacles, including conflicting goals, lack of knowledge, resource allocation problems, and failure to see value in the framework. Complex programs and the lack of standardized methods can make managing operational risk difficult.
Businesses can successfully control operational risk and ensure continuity by following these recommendations.
- Create, implement, and maintain an ORM framework: Integrate into the overall risk management process since operational risk exists in all company products, activities, processes, and systems. Include all organizational levels and new business initiatives.
- Establish appropriate governance: Implement a solid, effective governance system. Top management should create the structure and get board approval before company-wide implementation.
- Evaluate risk when approving new systems: Operational risk exposure increases when an organization does the following.
- Takes part in novel activities
- Creates new products
- Enters new markets
- Adopts new procedures or technology
- Participates in ventures far from headquarters
- Maintain strong reporting mechanisms: Implement reporting processes for everyone involved in risk management, including the board, senior management, and business verticals.
What Is Strategic Risk?
Strategic risks are threats to your organization achieving its business objectives. They are crucial because they directly impact long-term success.
Effective strategic risk management helps organizations:
- Protect long-term goals. By identifying external risk factors like market shifts, competitive pressures, and regulatory risks, companies can adapt their business strategy accordingly.
- Improve decision-making processes. Using tools like SWOT analysis allows leaders to evaluate potential risks alongside opportunities.
- Allocate economic capital efficiently. Understanding strategic risks helps organizations invest resources where they’ll have the greatest impact, while minimizing threats.
We divide strategic risk into two sub-categories: business risks and non-business risks.
Business Risks
Any risk from business decisions made by senior management is a business risk. For example:
- The management team might make poor decisions about expanding into new markets or developing new products.
- The company might price its offerings too high and lose market share or too low and miss profit goals.
- The company might use technology that limits operational flexibility, such as on-premises IT instead of cloud-based services.
Non-Business Risks
These risks happen in the external environment, but affect your company’s strategic plans. For example:
- A competitor might implement a radical new business model that appeals to your customer base (such as Airbnb threatening the hotel industry).
- Economic conditions might make your product less appealing; think of the decline in cryptocurrency values disrupting online trading apps.
- Consumer preferences might move in a new direction that threatens your product offerings and value proposition.
Other Examples of Strategic Risk
The list of possible strategic risks is long. Among them:
- Business decisions that are unclear or poorly communicated
- Introduction of new products or services
- Changes in senior management
- Unsuccessful mergers or acquisitions
- Changes to customer expectations
- Damage to the company’s reputation
- Financial challenges (such as poor cash flow)
- Emergence of new competitors
- Problems with supply chain, vendors, or other stakeholders
Strategic Risk Management
Strategic risk management (SRM) is essential to identify, assess, and reduce strategic risks. It focuses on internal and external scenarios that introduce risk into the enterprise. Its goal is to help the organization to achieve its strategic objectives.
The organization may accept some strategic risks in the short term, but take action to eliminate or reduce them over time. For example, the company might risk supply fluctuations of particular raw materials to maintain business continuity. But in the longer term, the company may redesign its product to minimize (or eliminate) its dependence on that material.
For maximum effectiveness, the SRM program must account for all risks related to the following:
- Shifts in customer demand
- New competitive pressures
- Technology changes such as the evolution of big data, artificial intelligence (AI), and machine learning (ML)
- Increasing performance pressures from stakeholders
Management must also clarify when a particular risk should be avoided, either because pursuing some business opportunities may be harmful or because potential losses (risks) are likely to exceed potential returns (rewards).
Which Risk Assessment Methodologies Can Be Used?
There are several different ways to do risk assessments, but they all have the same basic steps.
- Identify the dangers
- Determine who could be the most harmed and how
- Make a security risk assessment and a strategic decision
- Record discoveries and decisions in a risk register
- Repeat the risk assessment regularly (say, annually) to see whether any circumstances have changed
For any risk assessment to be successful, the person doing the evaluation should understand the type of risk: financial, compliance, security, operational, etc. The assessor should also be competent in the mechanics of risk assessment.
1. Qualitative Risk Assessment
Qualitative risk assessments gauge risks by their potential severity or disruptive threat when there’s no data to make specific estimates. Typically these risks are graded on a high-medium-low scale. For example, the company might evaluate the threat of specific IT systems going offline or certain physical locations suddenly not being available.
2. Quantitative Risk Assessment
The quantitative risk assessment uses numbers and data to estimate the cost of risk. For example, if an organization does $1 million of sales daily, you can calculate the aggregate cost of downtime due to an operational loss event.
3. Generic Risk Assessment
Generic risk assessments are designed to save paperwork and duplication of effort. As a result, they will frequently be applied for similar activities or equipment across several sites, divisions, or business units. Also, it can serve as a template for risk assessments, outlining the dangers and risks often associated with a specific action.
4. Dynamic Risk Assessment
A dynamic risk assessment is a method for determining risk at the moment. This risk assessment often addresses unknown dangers or emerging and evolving conditions.
For instance, emergency services or healthcare professionals may use dynamic risk evaluations. In these risk scenarios, the setting, circumstances, and individuals will vary from case to case, so the risks must constantly be evaluated given the shifting conditions.
Manage Strategic and Operational Risks with ZenGRC
ZenGRC can help you better manage your strategic and operational risk. The platform includes risk management, compliance, audit, and policy management capabilities to manage these critical tasks easily.
Our centralized dashboard gives you a complete view of risk across the organization, showing you where your gaps are and how to address them. Plus, with universal control mapping and automation, ZenGRC can tie a single command to multiple risk management frameworks so you can avoid duplicate work.
Click here to schedule a demo of ZenGRC.