Applying stakeholder risk tolerance strategies in business
Can risk ever be considered a good thing in relation to business? How much risk is too much? And are stakeholders’ attitudes towards risk generally positive or negative? All of these questions are important to consider when looking at risk tolerance in business.
The concept of risk often instils an impending sense of doom in people. This is because risk is not predictable or tangible and therefore issues surrounding it are often difficult to pinpoint and easily misunderstood. Coupled with this is the fact that risk also varies significantly depending on the internal and external environment of a project, and so it is not possible to create a “one-size-fits-all” framework for each and every one that arises. Despite this, however, ignoring risk entirely is both short-sighted and likely to have a negative impact on a business’ progress.
But how do you put a risk tolerance strategy into practice and where do you start?
What is risk tolerance?
Before developing a risk assessment for your business, it is necessary to first define what risk tolerance actually is. Charles Schwab put it well, stating that risk tolerance is the “level of risk an investor is willing to take… [it] can mean opportunity, excitement or a shot at big gains… but it is also about tolerating the potential for losses, the ability to withstand market swings”.
Risk tolerance has three different perspectives: firm, project manager and stakeholder. While a project manager’s risk tolerance is primarily affected by job security, a stakeholder’s is linked to a project’s objective. The success of said project relies on an agreed shared level of risk tolerance between the project manager and stakeholder, as well as pre-planning.
A company’s risk tolerance level can vary significantly depending on its financial stability and diversification (the investment in a variety of different companies and assets to reduce risk). It is also impacted by the constraints of a project, such as cost or scope, as well as specific risks associated with a certain project.
Because of this, it is almost impossible to create a capture-all approach to risk tolerance, as it very much depends on a project’s criteria that is specific to that instance. This makes it a somewhat tricky field to navigate and often leads people to overlook it completely. However, there are some steps that can be taken to aid managing risk tolerance and utilising it successfully.
For a start, one of the most important things that can be done is to document risk tolerance. By doing so you can generate risk thresholds which can help a project team to coordinate a response when faced with the unexpected in the future.
The role of the stakeholder
Stakeholders are a key part of risk tolerance as they, in many ways, set the tone for the amount of risk that an organisation can – and should – take on. They can be classified as the following: risk-averse – these are stakeholders who will not accept any risk exposure; minimal risk – these believe that the less risk, the better, and believe there must be a lot of benefits to compensate for even a small amount of risk exposure; risk-cautious – these typically opt for safer options, even at the expense of benefits; risk-neutral – these balance existing risks with any potential for reward; and risk seekers – these actively pursue high-value rewards, even at the expense of risk.
What’s the point?
Now you know what risk tolerance is, it’s time to look at what it can do for your business. Somewhat antithetically, part of the interest surrounding risk tolerance for stakeholders lies at its seemingly unpredictable nature. Through the duration of a project, a company’s attitude towards risk will change; the more a project progresses, and the more time and energy is put into it, the more is at stake. However, at the beginning and end of the project, the risks are marginal. It is this dynamism that often draws stakeholders in.
What does this mean from a business perspective? While the trajectory of risk tolerance may initially be seen as negative due to its randomness, in actual fact it can have significant positive impacts on a business if harnessed effectively. This is due to the fact that if companies are able to demonstrate an ability to successfully ride the waves of this unpredictability, they can then use this information to make more informed decisions regarding risk in the future.
What’s your tolerance?
Despite these definitions helping to understand sentiment towards risk, it does not reveal how much risk is too much. For that, it is necessary to look inwards.
In order to understand your organisation’s risk tolerance, first you must ask yourself what the view on risk has been in the past. Does it have a high risk appetite, i.e. is risk seen as a critical part of success? Or is it addressed with apprehension? Then, look at what actions have been taken in the past after markets hit a low. Addressing these questions honestly will help project stakeholders’ future attitudes towards risk, even in less-than-optimal conditions.
Solidifying a strategy
After assessing your company’s specific risk tolerance, the final step is to look at your portfolio’s typical performance data. This helps minimise the unexpected and therefore reduce the potential for an irrational or rash reaction. When looking at performance, it is necessary to analyse both risk and return; typically, investments that are expected to bring higher returns also bring higher risks. This information can then be used by the project team to create an effective risk management plan that determines the risks that may arise during the project and demonstrates how to overcome them.
The main conclusion that can be drawn is the important role that risk tolerance can play in your business – but only when dealt with correctly. Although risk is often treated with antipathy by stakeholders and companies alike, it has become clear that it does not have to be, and in fact doing so is not encouraged. In reality, by effectively applying risk tolerance strategies within your own business, it opens many doors in terms of helping manage risks in future projects that cannot be achieved through more traditional methods.
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