Principles of Risk Management Essay
With an increasingly murky future ahead of them electronics manufacturers have to begin to manage their risk effectively if they are to live long enough to witness the future themselves. An effective risk management strategy will not only help in doing so it might even bring to notice certain activities, event, or possibilities that might be used to the firm’s advantage (QAD, 2004). To understand the various ways in which it can help the firm, the manufacturers have to understand what effective risk management involves by understanding its principles.
ELECTRONICS MANUFACTURERS MARKET
Globalization has been touted as a means to benefit the economies of all the countries that take part in reducing trade barriers. The consequences of this practice, however, for the electronics manufacturers are the shrinking of product lifecycle, the pricing pressures that the companies face, and the creation of fragmented markets. And the biggest impact of these consequences has been on the forecasting accuracy of demand for the products.
It is no longer possible for firms to focus on long-term planning for their companies and so manage their supply chains. As a result these manufacturers are seeking to diversify the risk throughout the chain so as to divert it from themselves, primarily through transferring inventory back up the line, since inventory risk is the most significant type of risk for them. The inventory crisis in the industry is evidence of this type of behaviour occurring throughout the economy (QAD, 2004).
In defining risk most enterprises fail to incorporate a broad enough classification which consequently restricts the scope and influence of risk management, so while this definition helps in attaining the objectives of the firm it unnecessarily restricts the focus to threats. Since risk is linked with performance standards the management of risk should include the development and modification of goals and objectives for the firm, which would allow a focus on future opportunities for the firm as well.
In accordance, risk needs to be redefined to include the possibility of uncertain events and their effect on performance, leading to the use of uncertainty management which allows a focus on managing opportunities as well as threats by considering the origin of uncertain events and how to manage that uncertainty without considering whether that risk would be wanted or not (Ward, 2008). Dependencies Effective risk management incorporates the dependencies of the sources of uncertain events to avoid incorrect measurement of risk and the formulation of prejudiced assumptions.
If most of the sources were considered independent then they would tend to erode each other’s individual effects thus rendering the exercise useless, especially since there is a tendency for most events to occur in correlation, if slightly. Some effective ways to incorporate and understand the effects of dependencies is by using cause and effect models such as the fault-tree and event-tree analysis. Additionally influence diagrams can be used to represent these dependencies diagrammatically and identify any important links between the different sources (Ward, 2008).
Measurement And Evaluation Since risk for each individual differs according to the value that person places on achieving an objective versus the costs that would be incurred in achieving it, assigning a value to specific types of risks is not entirely plausible. For firms performance standards are the key to estimating a value of their variability, and thus risk. By distinguishing between targets, the expected value used to forecast results and contingency allowances, with regards to specific measures of performance, redundant corporate actions by employees are avoided.
Once the measurement has been done, the net effect of the risks must be integrated in order for the firm to develop a certain course of action. A Monte Carlo simulation is usually used for this purpose, using computer software to facilitate the task. But the convenience of the method does not consider the dependencies between the individual sources of uncertainty, nor the insights that can be got from considering the intermediate stages of the process which the simulation does not show.
Herein, using risk analysis, the different risk efficient actions that have been determined can be analyzed and the implication of following those actions can be considered as it incorporates the trade-off between performance and risk in choosing an action (Ward, 2008). Value Each company has various stakeholders who have diverse interests in the firm. These interests may not align with each other but together each stakeholder is necessary for the firm’s sustained growth.
Having their own specific objective in mind these stakeholders assign different perceptions of risk to the achievement of these objectives, and thus employ different strategies for managing uncertainty, not to mention having different perceptions of the source of those uncertainties as well. Risk management allows a firm to identify its various stakeholders and allocate the various uncertainties and their complimentary issues to each of them (Nocco & Stulz, 2006).
By allocating the uncertainties to the various stakeholders risk management allows each of them a chance to use the knowledge that has been imparted and be able to create value from it. The uncertainties that have been determined allow the stakeholders to efficiently use their resources to take risks that will create value by addressing the trade-off between risk and return. In addition, these risks can be internalized into the business to assess the true economic benefit of a project as opposed to the accounting profit which would subsequently allow a more efficient and achievable setting of future corporate targets (Ward, 2008).
Apart from attaining financial benefits, the knowledge of the risk that a stakeholder is incurring in performing a certain activity also allows the stakeholder to hedge against future losses (Meulbroek, 2002). While it can be argued that engaging in speculation is a more potentially lucrative prospect the decision of how to use the calculated risk depends on the stakeholder and the relevant trade-off between risk and return that is considered acceptable.
Regardless of what the final decision will be risk management presents the firm with the option of choosing a course of action with full knowledge of the risks that will be incurred in following it. AS MANAGER In order to initiate a risk management system in the firm the principles behind the system must first be understood and then followed, according to that established by the International Standards Organization. Some of the principles state that risk management should create value, be an integral part of organizational processes, be systematic, and be tailored (ISO, 2007).
Tailored Approach All these principles are in effect related, for example, any systematic effort to risk management needs a tailored approach. A standard framework may provide a basis on which to develop the processes but a focused approach is needed in order to carry out the desired purpose of the process since there is no single approach that has been successful for all firms. As this will be the first time that the firm’s risk management capabilities will be developed this will be the best time to incorporate a focused approach into the system.
It will not only allow a more cost effective method of determining and dealing with risk, it will also mean that the firm can then carry on this approach for as long as the business environment remains unchanged. Such an approach may introduce rigidity in the process but for the proposed twelve months it should remain efficient. A focused approach involves scoping and planning the process to determine the analysts, the detail in which the analysis is to be conducted, the receivers of the analysis, and the scope of the uncertainty being assessed.
This will help in the development of a model to be used, the complexity of which depends on the requirement of the analysis (Ward, 2008). Context To ensure that the analysis is made in the proper context, the process is to be started with identifying whether it is to be done with regards to the strategic, programme, project or operational level, each of which correspond to the levels of decision making in an organization. Establishing the focused approach to be used will help in determining the context of the analysis by presenting the analyst with a framework from which to operate.
The context can also be arrived at by determining the parties, their interests, required achievements, the resources to be used, the time period, and the strategy to be used (Ward, 2008). Identifying Risk Once the context in which the analysis is to take place is determined, the potential risks associated with the specific context must be identified. The risk can be an uncertain event or the variance in the performance standard. Read also about sources of accounting standards
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It can be identified by either figuring out the source of the risk or the problems that will be created due to engaging in a particular project or action. This will help in determining the cause and effect relationship the mitigation, or occurrence of said risk will bear with the project to be considered. However, in order to identify the risks the specific terminology must be established which defines risk. The framework on which this whole process will be built can be based on the standards that have been set by various associations, institutions and government departments.
But, as mentioned earlier, that framework must then be manipulated to address the issues which are relevant to the context of the analysis. The presence of a framework ensures that quality is maintained in the firm since the employees are clear about their role in the firm (Ward, 2008). Culture Some companies are just more risk-preferring than others, and in of itself a strong culture such as this is not a problem. But when the presence of an already established ‘successful’ culture impedes the process of risk management it can turn into a problem.
In cases like that it is considered disloyal to the firm if an employee raises a voice against a certain practice, even if it were to be beneficial for the firm. Therefore, since this manufacturer is only now introducing risk management into its culture it will take some time for the value system that the new department espouses to be embedded into it. To facilitate this, the organization needs to recognize that risk management is not just a one man show; it is not just the risk manager who is supposed to manage risk but every person in the organization as a collective body.
The process is meant to be able to deal with risks arising in any part of the organization, in any management context. So while the process has to be made specific to the firm, it must be developed in a way to be easily understood and implementable by the whole of the parts of the organization. This decentralization ensures that the firm enjoys a culture where all levels of decision making, from strategy to operational, have risk management embedded in them (Culp, 2001). Supply Chain Management
The greatest of risks that an electronics manufacturer will face is that of inventory risk: who is left holding the inventory when the product becomes obsolete. The result is that all along the chain there is general inefficiency and substantial lead time between parties involved as only when an order is placed are the raw materials for that product ordered. To mitigate this risk partnerships must be developed between the various parties involved that allow there to be greater and more efficient communication between them.
This will allow the use of pull replenishment where inventory buffers provide a smoothing out effect on any short term variability from predicted demand (QAD, 2004). Partnerships with suppliers and distributors allow them to plan sales and operation aspects of business in a concerted manner and thus the possibility of achieving lower costs is greatly increased. Lean manufacturing can be a direct result of this partnership as greater information is shared, once the parties realize that the success of each one depends on the success of the entire chain (QAD, 2004).
By engaging in risk management as an organization, and then as the entire chain in the industry, the firm ensures that it gains the faith of its stockholders, who will trust that poor performance by the firm is not because of poor management but ill luck, as well as gain more internal equity with which to finance projects through more effective matching of risk with return. CONCLUSION Electronics manufacturing is a risky business in which a company may end up writing off a significant amount of inventory amounting to thousands or even millions of dollars if the product being manufactured becomes obsolete.
However, with the proper risk management technique in place it is possible for the firms to minimize their risks, in not just inventory but other aspects of operation or finance as well. The key is to establish a tailored framework, based on principles of risk management, that will serve every person in the organization, and which will allow the identification, and the following measurement and assessment of risk. By establishing partnerships along the supply chain this process will be greatly facilitated, but it needs to be employed by everyone in the organization, as well as the chain for it to be truly successful.
Books Culp, C. L. (2001) The Risk Management Process: Business Strategy and Tactics. John Wiley and Sons. Ward, S. (2005)
Risk Management: Organisation and Context. Witherby & Co Ltd. Papers Committee Draft of ISO 31000 (2007)
Risk Management — Guidelines on Principles and Implementation of Risk Management. International Standards Organization [Internet]. Available from <http://www. nsai. ie/uploads/file/N047_Committee_Draft_of_ISO_31000. pdf> [December 25, 2008]
QAD (2004) Successful Risk Management in the Electronics Supply Chain. White Paper. QAD [Internet]. Available from <https://www. qad. com/Public/Documents/rm_electronics_supply_chain. pdf> [December 25, 2008]
Meulbroek, L. K. (2002) Integrated Risk Management for the Firm: A Senior Manager’s Guide. Social Science Research Network [Internet]. Available from < http://papers. ssrn. com> [December 25, 2008]
Nocco, B. W. , Stulz, R. M. (2006) Enterprise Risk Management: Theory and Practice. Social Science Research Network [Internet]. Available from < http://papers. ssrn. com> [December 25, 2008]