Understanding the difference between strategic risk and operational risk is critical for any organisation. Operational risk is internal process or external event losses managed by Operational Risk Management (ORM). ORM reduces risk to protect operations and reputation.
Strategic risk is market trends, regulatory changes etc managed by Strategic Risk Management (SRM). SRM aligns strategy to business objectives to reduce risk. Understanding the difference is key to good risk management. By covering both to manage strategic risk and operational risk you can be resilient in today’s fast changing business world and gain competitive advantage.
Summary
- Know the difference in focus, impact and consequences between strategic and operational risk.
- Cover both strategic and operational risk in your risk management.
- Use strategic risk assessment tools like scenario planning and SWOT analysis.
- Operational risk management is about identifying, assessing and mitigating internal and external risks.
- Align risk mitigation with organisational objectives for complete risk management.
What is Risk Management
Risk management is critical to protect an organisation’s interests. It’s about identifying, evaluating and when risks arise, prioritising risk to reduce impact.
Enterprise Risk Management (ERM) provides a full framework for managing risk across the entire organisation.
Why risk management matters
To succeed in today’s business world companies must understand the importance of risk management.
By understanding the difference between strategic risk and operational risk companies can create a strategic risk management framework aligned to their business objectives. By doing risk assessments companies can identify and evaluate significant strategic risks and operational risk including external events.
Reducing strategic risk is key to managing uncertainty and opportunity. Ultimately success in risk management is about how well the strategies in place help the company achieve its objectives and reduce losses.
Risk management protects businesses and enables them to make informed decisions and adapt to a changing world.
What is Enterprise Risk Management (ERM)
Enterprise Risk Management (ERM) is a full approach to managing all types of risk within an organisation, including strategic, operational, financial and reputational risk. ERM helps to identify, evaluate and mitigate risk to align with strategic objectives and improve decision making.
ERM includes:
- Full Risk Assessment: ERM looks at both internal and external scenarios to understand the risks that can impact the organisation’s objectives.
- Strategic Risk Mitigation Strategies: ERM helps to develop and implement risk mitigation strategies to address the risks and improve strategic decision making.
- Risk Management Framework: ERM provides a structured approach to managing risk so that risk is integrated into the organisation’s overall strategy for best risk management outcomes.
Operational Risk
Operational risk is potential losses from inadequate or failed internal processes, systems, people or external events. Examples include fraud, legal risk, human error and system failure.
Operational Risk Management (ORM) is a structured approach to identify, assess, control and mitigate operational risk to reduce impact on the organisation’s objectives.
Definition and examples of operational risk
Operational risk is the potential for loss from internal processes, systems or people, natural disasters or external events.
Examples of operational risk include:
- Employee Error: Mistakes made by employees in their daily tasks can cause financial loss or reputational damage.
- Cybersecurity Event: Breach in cybersecurity measures such as data leak or hacking can be a major operational risk to organisations.
- Natural Disaster: Floods, earthquakes or hurricanes can disrupt operations and cause financial loss and business interruption.
Now you understand the examples you can proactively identify and mitigate operational risk.
Operational Risk Management (ORM) process
Implementing a structured Operational Risk Management (ORM) process is key to identifying, assessing, mitigating and monitoring the risks to your business.
This ORM process includes full risk assessments, robust risk mitigation strategies and mechanisms for continuous monitoring and risk reporting.
By analysing operational risk and taking action you can be better prepared for the unexpected.
The ORM process is about reducing the likelihood of risk and the impact on business as usual.
Through risk management you can protect your financial stability, reputation and overall success in the face of operational uncertainty.
Operational Risk Management Best Practices
Operational Risk Management Best Practices include:
- Developing and maintaining an ORM framework.
- Operational risk governance.
- Risk assessment of new products and systems.
These are key to identifying, assessing and mitigating the risks to your business.
Developing and maintaining an ORM framework
Having a complete framework for managing operational risk is key to organisational resilience and sustainability. Here are three things to consider when developing and maintaining an ORM framework:
- Integration: Make sure the ORM framework is integrated into the organisation’s overall risk management process to manage both strategic and operational risk.
- Risk Controls: Implement risk controls within the ORM framework to mitigate threats and enable informed risk decision making.
- Use of Internal Resources: Use internal resources to support the ORM framework and remember the organisation has the tools and expertise to manage operational risk.
Operational risk governance
When setting up operational risk governance organisations must define policies, procedures and accountability for managing operational risk and external environment. This governance framework ensures operational risk is identified, assessed and mitigated in a structured way.
The difference between strategic and operational risk is in the focus: strategic risk assessment is about managing risks that impact the overall direction of the organisation, operational risk is about risks occurring in day to day operations. To do this risk analysis should be integrated into strategic decision making, internal audit and business unit responsibilities.
You need leadership support and involvement from the leadership team to drive a risk aware culture across the organisation.
Risk assessment of new products and systems
To manage operational risk in new products and systems you must identify and mitigate the risks proactively. Risk assessment is key to minimising losses and getting new projects up and running.
Here are three steps to risk assess new products and systems:
- Full risk assessment: Identify the risks associated with the new product or system.
- Robust risk mitigation: Develop and implement measures to reduce operational risk and its impact on the business.
- Ongoing risk management: Monitor and re-assess operational risk to adjust strategies and prevent future losses.
Strategic Risk
By having a SRM process in place businesses can address threats and opportunities for strategic growth.
The value of effective strategic risk management is in the decision making, resilience and ultimately sustainable success in a changing business environment.
Definition and examples of strategic risk
Part of organisation risk management is understanding and managing strategic risk which is where strategic risk refers to the potential impact on the organisation’s goals due to market trends and regulatory changes. To help here are some examples of strategic risks:
- Market Trends: Changes in consumer behaviour or economic conditions can be a strategic risk to the business.
- Competitor Activity: Intense competition or competitor innovation can threaten the organisation’s market position and strategic objectives.
- Regulatory Changes: Changes in laws or regulations can be a challenge for businesses and require strategic risk management to adapt and comply.
These examples show why senior management need to be involved in strategic risk management to protect the strategic plan from internal and external events including regulatory risk.
SRM process
Managing an organisation’s strategic risks requires a structured approach called the Strategic Risk Management (SRM) process. This process is about identifying, evaluating and mitigating strategic risks that could impact the organisation’s strategic objectives.
Through risk assessments businesses can identify potential risk events from both internal and external sources. By implementing risk mitigation strategies businesses can address the business risks and protect their strategic goals.
Continuous monitoring and reporting is part of the SRM process so that any emerging strategic risk is identified and managed quickly. By embedding SRM into the business businesses can build resilience and adaptability in the face of strategic uncertainty.
Why and benefits of SRM
SRM is key for businesses that want to address threats and opportunities. By embedding SRM into the business businesses can align their risk management with their business model and strategic objectives and get a competitive edge.
This approach allows businesses to not only mitigate risks such risks such as economic risks and external factors but also identify and grab business opportunities. SRM also allows businesses to optimise their risk adjusted return by evaluating and managing risk at a strategic level and have a more holistic and proactive approach to risk management.
In the end it’s all about embedding SRM into the business to have long term success and resilience in a changing business environment.
Strategic vs Operational Risk
Strategic and operational risk need to be distinguished in risk management. Strategic risk is external factors that impact the organisation’s long term goals. Examples of strategic risk might be market trends.
Operational risk is internal processes that can disrupt business as usual. Examples of operational risk might be system failure or employee error.
Strategic vs Operational risk differences
Strategic risk and operational risk have different characteristics in terms of focus and impact within business units of the organisation.
Focus:
- Strategic risk is about alignment to business objectives and strategy execution.
- Operational risk is about day to day activities that can disrupt business or compromise customer safety.
Impact:
- Strategic risks can have long term consequences on economic capital and reputation.
Knowing these differences is key to managing both types of risk and protect against the negative outcomes.
Examples of strategic and operational risk events
When looking at examples of strategic and operational risk events it’s clear each type presents different challenges and potential impact on the organisation’s performance and sustainability.
Strategic risk events might be market trends, competitor activity, regulatory changes that impact long term strategic goals and market position.
Operational risk events might be employee error, cyber breach, natural disaster that disrupt business as usual and cause financial loss and reputational damage.
Strategic risk is about risks related to achieving the organisation’s objectives. Operational risk is about internal conflicts, spending habits and external scenarios.
Understanding and managing both strategic and operational risk is key to protecting the expected after tax return and resilience in the face of uncertainty.
SRM and Risk Identification
SRM involves methods to identify potential risks that could impact the organisation’s long term goals and objectives. By having ‘what if’ discussions and gathering input from stakeholders businesses can proactively identify potential threats and opportunities that may arise.
This helps to develop SRM plans to navigate uncertainty and protect the organisation’s strategy.
How to identify strategic risks
Identifying strategic risks involves using methods such as scenario planning, SWOT analysis and risk workshops to gather input from stakeholders and assess internal and external factors.
To illustrate to the audience consider these:
- Scenario Planning: Create hypothetical scenarios to anticipate risks.
- SWOT Analysis: Evaluate Strengths, Weaknesses, Opportunities and Threats to understand internal and external factors.
- Risk Workshops: Collaborative sessions with stakeholders to identify and analyse risks.
Having “what if” discussions and gathering stakeholder input
Having discussions around hypothetical scenarios and gathering input from stakeholders is key to identifying strategic risks within the organisation. By having ‘what if’ conversations businesses can uncover vulnerabilities and develop proactive plans to address them. These discussions provide a space to brainstorm different scenarios that could impact the organisation’s objectives.
Also gathering input from other stakeholders ensures a wide range of perspectives are considered during the strategic risk assessment process. This inclusive approach will capture different views and insights that may not be apparent otherwise. By using these discussions and stakeholder input the organisation can better anticipate and mitigate strategic risks.
Managing Strategic Risks
Managing strategic risk involves identifying both internal and external factors that impact the organisation’s objectives.
Examples of strategic risks are regulatory changes, competitive pressure, economic fluctuations.
Internal and external strategic risk factors
In the ever changing business environment organisations must constantly assess internal and external strategic risk factors to protect their sustainability and growth.
- Internal strategic risk factors:
- Organisation culture
- Leadership
- Resources
- External strategic risk factors:
- Market trends
- Competitor activity
- Regulatory changes
You need to consider these to anticipate challenges, opportunities and make informed decisions.
By understanding the internal and external dynamics organisations can mitigate risks, leverage strengths and adapt to changes in the market.
This is key to long term success and resilience in today’s complex and changing world.
Examples of strategic risks including regulatory, competitor and economic risks
Organisations face many operational and strategic risks such as regulatory changes, competitor activity and economic fluctuations that can impact their operations and performance.
Regulatory risks come from changes in laws and regulations that affect how businesses operate. These changes require businesses to adapt fast to stay compliant and competitive.
Competitor risks come from competitor activity, market trends and pricing pressure which can directly impact a company’s market share and profitability.
Economic risks include interest rate changes, inflation rates and economic downturns which can impact businesses generally and require them to adjust their strategy to navigate through tough financial times.
Understanding and managing these strategic risks is key to organisations to survive and thrive in the business environment.
Risk Mitigation Strategies
When it comes to risk mitigation strategies you need to separate opportunities and risks to get a clear view.
Also distributing resources and aligning incentive structures to risk management goals is crucial to successful risk mitigation.
Discussing opportunities and risks separately
By separating opportunities and risks organisations can develop tailored risk mitigation strategies to navigate strategic and operational challenges. Discussing these separately will ensure all views are considered in depth understanding and therefore better decision making.
Here are three reasons why you need to discuss opportunities, risk decisions and risks separately:
- Clearer View: By breaking opportunities and risks down you can focus on each individually and not miss important details.
- Tailored Strategies: Keeping opportunities and risks separate allows you to develop strategies to address each’s unique characteristics and impacts.
- Better Decision Making: Discussing opportunities and risks separately will enable you to make more informed and logical decisions based on each factor.
Distributing resources and aligning incentive structures
Distributing resources and aligning incentive structures within the organisation is key to mitigating strategic risks and maximising opportunities. By distributing resources effectively you can ensure the right tools, funding and people are allocated to strategic initiatives and reduce the risk of failure due to resource constraint.
Also aligning incentive structures will motivate employees to work towards the organisation’s strategic objectives. When employees are incentivised to focus on activities that contribute to long term success the organisation can navigate risks and opportunities better.
Measuring Strategic Risk
Economic Capital, RAROC and decision trees are the tools used to measure strategic risk.
Economic Capital quantifies the amount of capital required to cover potential losses from strategic risks, RAROC (Risk-Adjusted Return on Capital) helps to assess the risk return of strategic decisions.
Decision trees provide a visual representation of potential outcomes and probabilities to aid strategic risk assessment and decision making.
Economic Capital, RAROC, decision trees
Decision trees visually represent potential outcomes, organisations make informed decisions about strategic risks. When measuring strategic risk organisations use Economic Capital to measure potential capital loss.
RAROC assesses the return on investment while taking into account the risk. By including decision trees in their strategic risk management process organisations can analyse different scenarios and their probabilities and make better decisions.
This approach allows organisations to quantify potential losses and assess risk adjusted returns on their investments. In the end understanding Economic Capital, RAROC and decision trees gives organisations the tools to navigate and mitigate strategic risks.
Strategic and Operational Risk Management
When you compare strategic risk examples and operational risk management you will see the threats and opportunities.
By combining these two risk management approaches companies can develop a more integrated strategy that covers long term goals and day to day operations.
Having a detailed risk management strategy that combines strategic and operational will help you navigate uncertainty and make informed decisions for long term success.
Strategic and operational risk management approaches
Combining strategic and operational risk management approaches will give you a full view of all types of risks facing the organisation.
When you compare the two approaches note the following:
- Focus:
- Strategic risk management is about the organisation’s overall strategy and long term objectives.
- Operational risk management is about the day to day functions and processes within the business.
- Scope:
- Strategic risk management looks at risks that could impact strategic goals, such as market shifts or technological disruption.
- Operational risk management is about risks to routine operations, such as human error or system failure.
- Integration:
- By combining strategic and operational risk management you can have a full risk management framework that covers all levels of the business.
Implementing a risk management strategy
To manage risks you must align strategic and operational risk management to have a holistic risk management strategy. By combining strategic and operational risk management activities you can cover a wide range of risks such as financial and reputational risks fully.
This will allow you to mitigate threats and seize opportunities for growth and innovation. Having a full risk management strategy is key to achieving your strategic objectives and staying competitive in today’s fast paced business world.
Summary
In summary combining strategic and operational risk management will help you achieve your strategic objectives and stay competitive.
To sum up managing strategic risk vs operational risk consider the following:
- Strategic Alignment: Make sure risk management is aligned to the organisation’s overall strategy for success.
- Continuous Monitoring: Have a system for ongoing monitoring and review of risks to adapt to changing circumstances.
- Collaboration: Get different departments to work together to have a risk management strategy that covers both strategic and operational risks.
FAQs
How do organisations communicate strategic risk to stakeholders?
Organisations can communicate strategic risk to stakeholders by being transparent, providing clear and concise information, having open dialogue and aligning communication to the organisation’s overall objectives so everyone understands and buys in.
What role does technology play in operational risk management?
Technology plays a big part in operational risk management by providing real time monitoring, data analytics and automation. It helps decision making, identifies threats and streamlines processes so organisations can mitigate risks and improve operational efficiency.
Can you eliminate strategic risk entirely through mitigation?
You can’t eliminate strategic risk entirely through mitigation. While you can reduce the impact non business risks through proactive measures, inherent uncertainty and external factors mean you can’t eliminate it completely. Strategic risk management is about resilience and adaptability.
How do global economic trends impact strategic risk assessment?
Global economic trends impact strategic risk assessment by changing market conditions, consumer behaviour and regulatory environments. You must monitor these trends to adapt your strategy and mitigate risks.
What’s the difference between strategic risk and reputation risk?
The key difference between strategic risk and reputation risk is the focus. Strategic risk is about potential threats to long term objectives, reputation risk is about harm that will impact the entity’s image and standing in the public eye.
Summary
In summary managing both strategic and operational risks is key to any organisation’s success. By understanding the differences, following best practice and integrating risk management you can identify and mitigate potential threats.
So you can adapt.
Chris Ekai is a Risk Management expert with over 10 years of experience in the field. He has a Master’s(MSc) degree in Risk Management from University of Portsmouth and is a CPA and Finance professional. He currently works as a Content Manager at Risk Publishing, writing about Enterprise Risk Management, Business Continuity Management and Project Management.