For nearly every small business, risk is a part of life no matter what industry they are in. It is the possibility of something happening to your business that causes unexpected – and often harmful – consequences.
A businesses risk management strategy will help determine the likelihood of that risk to occur and the impact of its consequences.
This blog analyses the differences between two risk management strategies – risk avoidance and risk reduction – and the types of situations you may use them in.
While the two strategies may not sound too different, the path you take could have very real consequences.
It could sometimes be the difference between staying in business or closing up shop for good.
How to identify a risk?
Before going into the different strategies of managing a risk, it’s important to know what is risk in business and how to identify one before it occurs.
Consider these five elements when determining what constitutes a risk to your small business:
- The event – Will this event, if it happens, cause unexpected results?
- Triggers – What factors are likely to trigger the event to happen?
- Probability – How likely is this event to happen?
- Impact – What is the potential consequences of the event?
- Timeframe – How long could the event last? How long will you feel the consequences?
Determining these elements will help identify the severity of the risk before it occurs and help you decide on what strategy to take.
What is risk avoidance?
There are many options for dealing with different types of risks. Risk avoidance is one such method.
While avoiding risks may seem counterintuitive, risk avoidance is a legitimate strategy that business owners can plan for.
With risk avoidance, small business owners will avoid doing something that puts them at specific risk.
For example, you may realise that sending your employees to work in residential buildings creates the risk of third-party injury and property damage.
So rather than reducing the risk, you avoid it all together by not offering that service. Rather than reducing the triggers or the probability of the risk happening, you cut it off at the source by removing the event itself.
Risk avoidance can help you control how much overall risk you face and therefore is an effective strategy within your risk management plan.
When to use a risk avoidance strategy?
Risk avoidance is best used when the risk could cause too much damage to your small business. If the risk is likely to happen, have a massive impact, or last a long time, then perhaps avoiding the situation all together is the best option available.
However, in some situations avoiding the risk could prove more costly in the long run. In the example above, if your business’ main source of income was through working in residential buildings then perhaps removing the risk doesn’t make sense.
This is where risk reduction can be an important strategy to use.
What is risk reduction?
Whereas risk avoidance removes the risk completely, risk reduction minimises the risk to make it less likely to occur and the consequences less severe.
A small business owner’s goal when using a risk reduction strategy is recognising that the risk will still exist while lessening its impact.
For example, rather than stopping your employees from entering residential buildings, train your staff to recognise the risks of the workplace.
Ensure that your staff take frequent breaks to reduce the risk of making a mistake or get them to use different tools that make getting the job done safer.
While these risk reduction strategies mentioned above reduce the likelihood of the risk, they may not reduce the severity of the consequences if it does occur.
Even though the chances of something bad happening are greatly reduced, a mistake could still happen.
When to use a risk reduction strategy?
If it can’t be avoided, it’s important to reduce the risks whenever possible. Business insurance is an important risk reduction strategy designed to safeguard small businesses against the consequences of risk.
For instance, it’s nearly impossible to entirely remove the risk of a cyberattack yet many businesses need to operate online. And while you can invest in cybersecurity as part of your risk mitigation strategy, the consequences of an attack could be catastrophic.
This is where Cyber Liability insurance could be an effective risk reduction strategy, as it helps protect you from claims and support your profitability in the event of a cyber breach or attack. Costs associated with defending a cyber claim are also covered further reducing the impact of the risk.
Or perhaps you are worried about the risk of giving advice in your small business. What if you get it wrong and your client suffers as a result?
Professional Indemnity insurance is there to reduce this type of risk, providing protection for financial loss and legal costs in the event of a claim.
Finally, what if the consequences of sending your employees to work in residential buildings are still too great despite your best efforts to reduce the risk?
If you use a risk avoidance strategy, you might significantly reduce your leads to the point where you might have to close down.
Luckily, Public Liability insurance can protect you if a third party is injured or sustains property damage as a result of your negligent business activities.
The bottom line
Risk is an inevitable part of running a small business and you will need to consider a risk management strategy to keep you trading for a long time.
Understanding the difference between risk avoidance and risk reduction will help you make clear decisions about what path you will take and whether you can cover the risk with business insurance.
This information is general only and does not take into account your objectives, financial situation or needs. It should not be relied upon as advice. As with any insurance, cover will be subject to the terms, conditions and exclusions contained in the policy wording.
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ABN 68 127 707 975; AFSL 501769