Risk appetite refers to a method that helps an organization with handling risks and applying appropriate risk management. But more importantly, it also refers to the level of risk an organization is willing to take on for the sake of growth, development, and other reasons that increase stakeholder value.
The idea behind risk appetite is that not all risks can be completely removed, and that some of them shouldn’t be avoided in the first place. When an organization plays it too safely and doesn’t take any risks, innovation halts, and soon after, stagnation sets in. In this age when technology goes through exponential changes within just a few years, stagnation for an organization can happen much earlier than usual. If a company wants to stay competitive within its industry, its corporate board has to be comfortable with a certain level of risk-taking.
But the question is, just how big should a company’s risk appetite be? In relation to investments, high-yield results call for high-risk moves. The same can be said for organizations: Great gains usually come from great risks. However, this doesn’t mean that a company should start taking risks indiscriminately. It stands to win a lot when it takes big risks, but on the flip side, it stands to lose a lot, too.
Not all organizations have the same level of risk appetite. There are different factors to be considered, such as the objectives a company wants to achieve, the nature of the industry within which it operates, and the impact a failure will have on its clientele. For example, a software company that develops gaming apps can take more risks given how competitive and ever-changing the tech industry is. To gain an edge over the competition, it needs to make new and good apps first, and then simply improve them in later versions.
A pharmaceutical company that makes medicines, on the other hand, doesn’t have the same freedom to take big risks — not when people’s safety is at stake. Whatever innovations it wants to try should be thoroughly researched, reviewed, and screened. A few bugs in a mobile gaming app causes nothing more than minor inconveniences, but errors in medicine formulations can have adverse effects on one’s health.
As a guide for your own company, here are the different levels of risk appetite that your corporate board can choose from:
This refers to complete avoidance of all risks and uncertainties. The objective of an organization with an averse stance is to take no risk if the situation allows it to do so.
Although a notch higher than the previous level, an organization with a minimal stance is still playing it safe with low-risk moves that offer small rewards.
This level is more daring than the one before it, although the risk options of a cautious organization are still generally safe, and rewards still limited.
This level is where risk-taking becomes more aggressive. An organization open to risks usually considers all possible options (both safe and risky) and picks the one with the best chances for success.
A hungry organization is enthusiastic about innovation. It chooses to make moves that offer big rewards if successful, even if they carry big losses in case of failure.
Organizations don’t necessarily need to choose just one level. Different branches within an organization may have different risk appetites depending on the nature of work they do. But for the sake of consistency and also to avoid confusion, it’s better for an organization to have a single level of risk appetite that defines it as a whole.
Ideally, an organization should find a balance between the desire for innovation and the need for caution. This is where the corporate board can help the company find its footing. Directors should all understand what the company stands to gain and to lose for every risk that comes along its way.
Are your company’s directors seeing eye to eye when it comes to risk appetite? If your answer is no, better get them to agree on this matter with the help of collaborative board meeting software like Convene to address communication gaps. Using only their iPad, iPhone, or Android device, directors can work on and explore documents together. They can also effectively discuss risks during board meetings using Convene’s real-time screen synchronization feature.
Remember, effective risk-taking starts at the top! Getting the foundation right leads to a healthy risk appetite for your company.