There are risks inherent in every business in every industry. Some of them are economy wide, affecting all organizations in your industry. However, other risks are uniquely created by decisions companies make. The former are what we call structural risks while the latter are variable risks. And how you understand, analyze and manage each risk type can have a major impact on the success of your business.
What is structural risk?
Structural risks are those that equate to the cost of doing business. How and when they occur is out of your control. That’s the bad news. The good news is that they affect your entire industry and possibly businesses in all industries. The health of the economy is a structural risk. Everyone is affected by the economy. A strong economy drives consumer confidence, employment, buying power and sales in your industry while a weak economy can create layoffs, margin pressure and even business closings. Everyone is also affected by the labor market. The availability of talent to fill positions at your company is the same challenge faced by your competitors.
Structural risks are capable of being discerned by any competitor in your industry and many of them can be managed in the same way across any enterprise. When creating a risk profile for an organization, we assess structural risks first, looking at all four quadrants of our Risk Wheel to assess how best that organization can allocate resources to minimize the impact these risks could have.
But if that were all there was to it, everyone could manage risk the same way. They don’t. And one reason is because organizations make decisions regularly that create risks that are unique from their competitors.
What is variable risk?
Variable risks are those that your organization creates and are, for the most part, unique to your operation. Businesses create Variable risks all the time. For example, organizations that choose to open facilities along the Gulf Coast in the United States create risks that are not faced by organizations located inland or along the Pacific coast. While these locations may be ideal in many ways, they are also potentially in the path of hurricanes that could damage or destroy the site. If competitors don’t have locations there, then the variable risks created are unique to the organizations that do. It creates costs to prepare for hurricanes to lessen their impact. Other organizations won’t have to include those costs in their budgets. In another example, an organization may choose to purchase a building because the cost is low, but the tradeoff is that the facility is located in a high-crime neighborhood, creating risks of theft, potential harm to employees/visitors and damage to brand reputation.
Risk management and applied risk science
Because variable risks are based on unique choices an organization makes, they should be evaluated prior to making decisions. We use our data-driven Applied Risk Science methodology to forecast what impact a decision can have on your risk profile and the cost to effectively mitigate mitigate these risks. Using a holistic approach is the best way to assess the variable risks associated with business decisions, and organizations can have a holistic and more meaningful view of how their decisions affect enterprise-wide risk management.
For example, if an organization is considering opening a facility in a higher-than-average crime area, risks to employees could increase. A prudent organization will take steps to protect their investment in people by using some of the facility rent savings to install video monitoring systems, enhanced parking lot lighting and digital entrance systems.
The holistic view of risk will also include analysis of the impact a facility location will have on recruiting efforts, since some candidates may choose not to work at your location because of the crime rate. If the hiring process takes longer than planned, the facility may either be delayed in opening or will open with fewer employees than required. That, in turn, creates risks, especially if employees become stressed due to covering for positions not yet filled. Importantly, the costs associated with delayed construction or inadequate labor supply are uninsurable. (Check out the Pinkerton Crime Index for more information on crime risk scores.)
When making your next major business decision, it is critical that you consider both structural and variable risks so that you can budget risk management accordingly into your plans. A good place to start is with a risk assessment that can look at the impact the risk could have, the cost associated with risk mitigation, and what level of risk your organization is willing to accept based on the benefit the decision will have to your company.
Originally published July 25, 2018. Updated September 2022.
