2.3 Risk classification

There are general models for classification, but it is possible for an organization to develop its own taxonomy. One of the most used classifications is to divide risks into four categories:

  1. Strategic risks
  2. Operational risks
  3. Economic risks
  4. Hazard risks

In the following, we shall discuss these in more detail.

Risk classes

Strategic risks

The risks related to the development of operations and the operating model are critical. For example, if a company does not have sufficient knowledge of the market and customers, it will not be able to take advantage of new business opportunities or innovate. There is a risk that the organization’s products and services will not meet customer expectations and will not stand out from the competitors. In this case, the company’s growth will be stunted.

There are several potential risks associated with the operating environment. If the organization is not aware of the state of the economy and the future, it will not be able to take advantage of cyclical fluctuations or react proactively to them. Another environmental factor is regulation. If the organization is not aware of it and its changes, it will not have time to implement the required changes. This may result in financial penalties being given.

An internationalizing organization must be aware of the conditions in its target areas, which may be different to that in  the home country. In this case, the organization will have to invest more than expected in its adaptation or even withdraw from the new market completely.

The organizational structure and management model may create risks if they are not flexible enough in changing situations. The organization may also lack the ability and desire to change. In the worst case, the existence of the entire organization may be jeopardized.

Business reorganizations are commonplace for many, but some companies may have shortcomings in the acquisition process. They are also often not prepared for the post-acquisition integration process. As a result, risks include uncommitted personnel, reduced customer satisfaction and inefficient internal operations.

Collaborative partnerships are vital for many organizations. If they are not committed to the selection and management process, the benefits of partnerships may not be achieved. Outsourcing requires principles and a decision-making model. A dependence on poorly functioning partnerships may slow down or prevent operational activities and, thus, weaken financial results and customer satisfaction.

Operational risks

Operational risks are related to the everyday life of an organization. At their root is the clarity of operational management goals, operational planning and information supporting decisions: reporting, metrics and monitoring. Operational risks are usually organization-specific and depend a great deal on their industry, operating model and operating environment.

The implementation of decisions is an essential part of management. If there is no clear schedule and system for the implementation and the dependencies between different decisions have not been identified, the implementation may fail. In this case, the organization may lose its credibility in the eyes of employees and other stakeholders. Ultimately, the organization will be unable to implement its strategy and customer promise.

Technology is vital to today’s operations. The monitoring of technological developments, timely changes and compatibility with the system architecture are critical. Wrong technology choices endanger the smoothness of operations and negatively affect the well-being of the personnel. Information quality and information security risks are still associated with technology, which, if realized, may paralyze the entire organization and lead to significant reputational damage.

Personnel competence and availability are a challenge for all organizations. Poorly committed personnel may be on the lookout for a new employer. If the transfer and training of skills are not in order, personnel changes may quickly jeopardize operations.

We discussed project risks earlier. The implementation of planned projects is challenging, but what is even more significant is the scaling of the results and exporting them into practice. A lack of commitment, planning and resources may make a project fail.

Operational risks also include issues related to contracts and liabilities and direct crimes. For example, an insufficient protection of intangible assets can lead to large financial losses.  Similarly, an incomplete implementation of GDPR regulations may be expensive. Inadequate contracts and controls in production and the supply chain have led to the reputation and reliability of companies being damaged.

Economic risks

Economic risks are related to solvency, capital adequacy and the functionality of monetary processes.

Deficiencies related to liquidity management are immediately visible in the company’s operations. The growth of interest expenses, risks related to credits and currency and market instruments are also critical for many companies.

Changes in taxation create risks if the organization is not prepared for them. In addition, for example, a rapid increase in energy and material costs may lead to expenses that cannot be compensated for by increasing sales prices.

Keeping one’s own and debt capital at a sufficient level may increase the debt ratio, making it difficult to acquire additional financing or increase its price. In this case, the organization also has to give up profitable investments.

If an organization’s financial reporting is slow and does not support the management’s decision-making, the organization is not necessarily aware of its financial situation and will be unable to detect the need for changes in time.

Hazard risks

Different risks related to fires, leaks, crimes and accidents vary depending on the organization’s industry. Hazard risks are often covered by possible insurance policies. However, regarding the continuity of the organization’s operations, it is good to identify hazard risks that can be prepared for through one’s own actions and reduce their effects.

Risk descriptions in the portfolio

In addition to the category and short description, a longer description of the risk and its causes should be attached to the risk identified in the risk portfolio. This will help in future risk assessment and management measures planning.

In the risk portfolio, the risk is allocated to a specific organization and function. The risk also has a named owner (organization and person) and a named registrar who answers related questions.