Operational, project, and supply chain risks are critical components of an organization’s risk landscape and play a significant role within Enterprise Risk Management (ERM). Operational risks arise from failures in internal processes, systems, people, or external events, directly affecting the organization’s efficiency and performance. These risks include process inefficiencies, employee errors, technology failures, and compliance breaches. Addressing operational risks involves identifying and assessing potential issues, implementing effective controls such as automation and regular audits, monitoring deviations, and responding promptly to minimize impact. Project risks are specific to individual projects and can threaten timelines, budgets, and objectives. These risks might include budget overruns, delays, resource shortages, and scope changes. Effective management requires proactive risk assessments, development of contingency plans, and clear communication with stakeholders. Post-project reviews are essential for learning from challenges and improving risk management in future initiatives. By addressing project risks, organizations ensure that their projects align with strategic goals and deliver intended value. Supply chain risks, on the other hand, involve disruptions in the procurement, production, or distribution process, potentially causing delays or shortages. Factors such as supplier reliability, logistics interruptions, natural disasters, and geopolitical issues can severely impact the supply chain. Organizations manage these risks by mapping vulnerabilities, diversifying suppliers, using technology for real-time tracking, and establishing contingency plans. Maintaining robust supplier relationships and ensuring compliance also enhance supply chain resilience. Integrating operational, project, and supply chain risks into the ERM framework allows organizations to adopt a comprehensive approach to risk management. This integration highlights interdependencies between different risk categories, improves awareness across all levels, and ensures resource allocation aligns with strategic priorities. By addressing these risks holistically, organizations can build resilience, maintain business continuity, and protect their ability to achieve long-term objectives.
Operational Risk Management
Operational risk management is the process of identifying, assessing, monitoring, and mitigating risks that arise from an organization’s internal processes, systems, people, or external events. These risks can disrupt business operations, reduce efficiency, or cause financial losses. The primary goal of operational risk management is to minimize the likelihood and impact of operational failures while maintaining the organization’s performance and resilience. This form of risk management involves a structured approach to understanding how day-to-day activities and processes could lead to potential risks, such as system outages, human errors, process inefficiencies, or compliance violations. Organizations use tools like risk assessments, process audits, and key risk indicators (KRIs) to identify vulnerabilities and monitor their operational environment. Operational risk management also focuses on implementing effective controls and responses, such as training programs, process improvements, automation, and contingency planning, to reduce or eliminate risks. Regular reviews, incident reporting, and lessons learned from past events help organizations continuously refine their risk management strategies. By effectively managing operational risks, organizations enhance their ability to achieve their goals, maintain compliance with regulatory requirements, protect their reputation, and ensure business continuity.
Managing operational risk has long been recognized as essential for maintaining business continuity and stability. Operational risks are the kinds of risks that can disrupt day-to-day activities, often tied to infrastructure issues as outlined in the FIRM risk scorecard. Historically, these risks have been managed through hazard mitigation techniques, like purchasing insurance. However, the definition of operational risk has expanded, particularly in financial institutions, where it now involves a more precise focus on quantifying potential financial losses. Financial institutions are required to hold enough capital reserves to cover potential losses from operational risks. This requirement is central to regulations like the Basel Accords for banks and the Solvency II Directive for European insurance companies. These frameworks were established to ensure organizations maintain sufficient financial stability, especially after the global financial crisis, where some banks failed to reserve enough capital for high-risk strategies. As a result, operational risk management in financial institutions includes identifying, measuring, monitoring, reporting, and controlling risks to meet regulatory standards. Capital adequacy regulations under Basel require banks to factor operational risk exposure into their capital reserves. This involves calculating “economic capital” to cover potential losses and using one of three regulatory methods to determine “regulatory capital.” Two methods are income-based, while the third requires a detailed statistical assessment of all significant operational risks. The Solvency II Directive applies a similar framework for insurance companies in the European Union. The Basel Accords, particularly Basel II and Basel III, provide global standards for banks to assess the capital required to protect against financial and operational risks. These frameworks aim to strengthen financial systems by ensuring banks and insurance companies maintain sufficient capital reserves to manage potential losses effectively.
Operational risks for banks and financial institutions are similar to the disruptive risks faced by other organizations, but they are often defined more broadly and require quantification. This is because financial institutions must have sufficient capital to cover operational risks, prompting them to reduce these risks to the lowest cost-effective level. While banks have traditionally focused on market and credit risks, the Basel and Solvency frameworks have expanded their scope to include operational risks. Initially defined vaguely as risks unrelated to market or credit risk, Basel later provided a clearer definition: “the risk of loss resulting from inadequate or failed internal processes, people, systems, or external events.” This definition includes legal risks but excludes strategic and reputational risks. Operational risks under Basel are categorized into internal fraud (e.g., embezzlement, tax evasion), external fraud (e.g., theft, hacking), employment practices, damage to physical assets, business interruptions, and failures in execution or process management. The risks are further grouped into people risks (e.g., non-compliance, lack of oversight), process risks (e.g., weak controls, process failures), system risks (e.g., inadequate applications or controls), and external risks (e.g., regulatory changes, vendor issues, or legal actions). While operational risk terminology and definitions may vary, this classification provides a structured approach. Market risk refers to the potential decline in the value of investments due to economic changes, while credit risk involves the possibility of clients failing to repay loans or debts. Insurance companies face underwriting risks related to their exposure through policies. Losses attributed to operational risks can be severe, such as those caused by rogue traders. These are often misclassified as market risks, but the actual issue is a lack of proper operational controls. For example, if adequate operational risk measures were in place, traders would not have been able to endanger significant assets. Thus, the root cause lies in operational risk management failures rather than market conditions.
Principles for the sound management of operational risk as per Basel framework(Basel Committee on Banking Supervision).
- Principle 1: The board of directors should take the lead in establishing a strong risk management culture, implemented by senior management. The board of directors and senior management should establish a corporate culture guided by strong risk management, set standards and incentives for professional and responsible behavior, and ensure that staff receives appropriate risk management and ethics training.
- Principle 2: Banks should develop, implement and maintain an operational risk management framework that is fully integrated into the bank’s overall risk management processes. The ORMF adopted by an individual bank will depend on a range of factors, including the bank’s nature, size, complexity and risk profile.
- Principle 3: The board of directors should approve and periodically review the operational risk management framework, and ensure that senior management implements the policies, processes and systems of the operational risk management framework effectively at all decision levels.
- Principle 4: The board of directors should approve and periodically review a risk appetite and tolerance statement for operational risk that articulates the nature, types and levels of operational risk the bank is willing to assume.
- Principle 5: Senior management should develop for approval by the board of directors a clear, effective and robust governance structure with well-defined, transparent and consistent lines of responsibility. Senior management is responsible for consistently implementing and maintaining throughout the organisation policies, processes and systems for managing operational risk in all of the bank’s material products, activities, processes and systems consistent with the bank’s risk appetite and tolerance statement.
- Principle 6: Senior management should ensure the comprehensive identification and assessment of the operational risk inherent in all material products, activities, processes and systems to make sure the inherent risks and incentives are well understood.
- Principle 7: Senior management should ensure that the bank’s change management process is comprehensive, appropriately resourced and adequately articulated between the relevant lines of defense.
- Principle 8: Senior management should implement a process to regularly monitor operational risk profiles and material operational exposures. Appropriate reporting mechanisms should be in place at the board of directors, senior management, and business unit levels to support proactive management of operational risk.
- Principle 9: Banks should have a strong control environment that utilizes policies, processes and systems; appropriate internal controls; and appropriate risk mitigation and/or transfer strategies.
- Principle 10: Banks should implement a robust ICT risk management program in alignment with their operational risk management framework.
- Principle 11: Banks should have business continuity plans in place to ensure their ability to operate on an ongoing basis and limit losses in the event of a severe business disruption. Business continuity plans should be linked to the bank’s operational risk management framework.
- Principle 12: A bank’s public disclosures should allow stakeholders to assess its approach to operational risk management and its operational risk exposure.
Basel II and Basel III are frameworks established by the Basel Committee on Banking Supervision (BCBS) to regulate and strengthen the global banking system. These frameworks aim to enhance the stability, resilience, and transparency of financial institutions by focusing on capital adequacy, risk management, and liquidity requirements.
Basel II
Introduced in 2004, Basel II built upon the foundation laid by Basel I and provided a more sophisticated approach to risk management. It is structured around three key pillars:
- Pillar 1 – Minimum Capital Requirements
Banks are required to maintain a minimum level of capital to cover three main types of risks:- Credit Risk: Risk of a borrower defaulting on a loan.
- Market Risk: Risk of losses due to changes in market prices.
- Operational Risk: Risk of losses due to failures in internal processes, people, systems, or external events.
- Basel II allowed banks to use advanced internal models to calculate these risks, promoting a more tailored approach.
- Pillar 2 – Supervisory Review Process
This pillar emphasized the role of regulators in evaluating banks’ risk management practices. Banks were expected to assess risks not covered under Pillar 1 and hold additional capital as needed. - Pillar 3 – Market Discipline
Basel II stressed the importance of transparency by requiring banks to disclose key information about their risk exposures, capital adequacy, and risk management processes. This aimed to improve market discipline and trust.
Basel III
Basel III was introduced in response to the global financial crisis of 2007-2008. It sought to address the shortcomings of Basel II and ensure a more resilient banking system. The main enhancements included:
- Higher Capital Requirements
- Increased the minimum common equity tier 1 (CET1) capital to 4.5% of risk-weighted assets (RWA), up from 2% under Basel II.
- Introduced a capital conservation buffer of 2.5%, bringing the total CET1 requirement to 7%.
- Added a countercyclical buffer of up to 2.5% to protect against periods of excessive credit growth.
- Leverage Ratio
Basel III introduced a non-risk-based leverage ratio to prevent banks from taking on excessive leverage. This ratio requires banks to maintain a minimum leverage ratio of 3%. - Liquidity Standards
Basel III introduced two new liquidity requirements:- Liquidity Coverage Ratio (LCR): Ensures that banks maintain enough high-quality liquid assets to cover short-term obligations (30 days).
- Net Stable Funding Ratio (NSFR): Promotes funding stability over a longer period (one year).
- Improved Risk Coverage
Enhanced the capital framework to better account for risks like counterparty credit risk and systemic risk. - Systemically Important Banks (SIBs)
Basel III introduced additional capital requirements for globally systemically important banks (G-SIBs) to mitigate the risks they pose to the financial system.
Key Differences Between Basel II and Basel III
- Capital Requirements: Basel III significantly raised capital requirements and introduced new buffers.
- Leverage and Liquidity: Basel III added leverage and liquidity ratios to address weaknesses in Basel II.
- Focus on Systemic Risks: Basel III incorporated measures to address systemic risks and enhance the resilience of large, interconnected banks.
Together, Basel II and Basel III have improved risk management practices, promoted financial stability, and ensured banks are better prepared to withstand economic shocks. Operational risk is a significant concern for financial institutions because they must measure and quantify the level of operational risk they face. This measurement can involve various methods, often relying on historical data, simulated data, or a mix of both. The Basel Framework outlines three approaches for calculating operational risk for regulatory capital purposes. These methods aim to estimate operational risk exposure, but their accuracy can vary significantly for individual institutions:
- Basic Indicator Approach: Uses a single indicator to estimate the overall risk exposure and calculate the required operational risk capital.
- Standardized Approach: Applies a broad financial indicator multiplied by the institution’s operational loss history to determine the operational risk capital.
- Advanced Approach: Combines internal loss data with qualitative and quantitative methods for a more tailored calculation of operational risk capital.
Measuring operational risk requires a systematic approach. After identifying risks, quantification is only possible when the potential damage and likelihood of occurrence are determined. This is challenging because operational risks are difficult to quantify due to the lack of historical loss data and the nature of some risks being inherently harder to measure. Many banks have conducted detailed assessments of their operational risks. Generally, the size of the bank, often measured by the number of employees, correlates with the magnitude of potential losses. Larger banks tend to have larger clients, which could contribute to higher loss amounts. Another trend shows that the number of losses often aligns with the number of customers using the bank’s services.
Operational risk for a bank
- Event: Internal fraud (Losses due to fraud, misappropriation or circumvention of regulations by internal party).
- Risk- Unauthorized activity, theft and fraud.
- Example:
- Unreported transactions.
- Unauthorized transactions.
- Theft and fraud.
- Tax non-compliance.
- Insider trading/
- Event: External fraud (Losses due to fraud, misappropriation or circumvention of the regulations by a third party).
- Risk- Systems security, theft and fraud.
- Example:
- Theft/robbery.
- Forgery.
- Hacking/theft of information.
- Event: Employees (Losses arising from injury or non-compliance with the employment legislation).
- Risk- In a safe environment, damaged employee relations and discrimination.
- Example:
- Compensation claim.
- Discrimination allegation.
- Event: Clients (Losses arising from failure to meet professional obligations to clients).
- Risk-Disclosure and fiduciary.
- Example:
- Fiduciary breaches.
- Disclosure violations.
- Misuse of confidential information.
- Event: Physical assets (Losses arising from loss or damage to physical assets).
- Risk– Disasters and other events.
- Example:
- Natural disaster losses
- Terrorism/vandalism
- Event: Systems( Losses arising from disruption of business or system failures).
- Risk- Systems Failure.
- Example:
- Hardware or software failure
- Telecommunications Utility disruption
- Event: Processes (Losses from failed transaction processing or process management).
- Risk- Transaction capture, execution, documentation and maintenance.
- Example:
- Data entry, or loading error.
- Missed deadline or responsibility.
- Failed reporting obligation.
- Incorrect records.
Operational risk in financial and industrial companies
Operational risk affects both financial and industrial companies, but its nature, measurement, and management can differ due to the distinct activities and environments in which these organizations operate. In financial companies, operational risk encompasses disruptions or losses arising from failed internal processes, people, systems, or external events. This risk is inherent in all banking and financial activities, such as payment processing, trading, lending, and compliance with regulatory standards. Financial institutions are required to quantify operational risk to ensure they have sufficient capital reserves to absorb potential losses. Frameworks like Basel II and Basel III establish guidelines for calculating operational risk capital through approaches like the Basic Indicator, Standardized, and Advanced Measurement approaches. Examples of operational risks in financial companies include internal or external fraud, legal risks, data breaches, and failures in transaction systems. Managing operational risk in these firms requires robust governance, compliance frameworks, and risk reporting mechanisms to ensure resilience. In industrial companies, operational risk typically revolves around physical processes, supply chains, safety, and infrastructure. Risks can include equipment failures, workplace accidents, supply chain disruptions, and environmental hazards. Unlike financial companies, the emphasis in industrial firms is often on mitigating tangible hazards and ensuring business continuity. For example, a manufacturing company must manage risks related to machinery breakdowns, worker safety, or delays in raw material delivery. Risk management in these settings relies heavily on preventive maintenance, health and safety protocols, and contingency planning. Both financial and industrial companies share some similarities in operational risk management, such as the need for strong governance and risk culture. However, the tools and focus areas differ. Financial companies prioritize compliance, data security, and fraud prevention, while industrial companies concentrate on physical safety, equipment reliability, and supply chain resilience. Despite these differences, the ultimate goal in both sectors is to minimize losses, maintain operational continuity, and enhance overall organizational resilience.
Difference
- In financial, Errors mostly arise when people reach their mental limits. In Industrial, Errors are mostly due to people reaching their physical limits.
- In financial, Systems are highly complex and widely distributed and the environment is only partly manageable. In Industrial, People work in relatively simple relationships and the environment is highly manageable
- In financial, Loss prevention is concerned with security of value and assets . In industry, Loss prevention is mainly concerned with physical safety, equipment protection and avoiding accidents.
- In financial, Loss prevention is aimed at avoiding financial loss. In Industrial, Loss prevention is aimed at avoiding physical harm to people or equipment and/or the manufacture of faulty goods (scrap).
- In financial, The main incentive for committing mistakes is personal financial gain or self-interest. In Industrial, The main incentive for making deliberate mistakes is reducing effort or (possibly) sabotage.
- In financial, Risk management is a key skill in financial services and has central importance to the organization. In Industrial, Risk management is not central to operations, although the aim is to avoid disruption to manufacturing processes
Interest in operational risk has grown because financial institutions need to measure and quantify it. However, quantifying operational risk is challenging. Even if the likelihood of a loss is known, estimating expected losses is difficult. While statistical methods have been developed, there is no universally accepted approach. Losses from operational risks include both direct costs, like financial losses, and indirect costs, such as losing customers. Losing a customer can result in significant financial impact, including the loss of all future revenue from that relationship. To manage these risks, internal controls and audits are essential. Internal audits ensure that procedures are followed and effective in minimizing operational risk. However, controlling employee behavior in financial institutions is more complex than in manufacturing settings. Operational risk measurement isn’t limited to financial institutions. For example, a transport company can assess the operational risks it faces, such as fuel price fluctuations, tax obligations, and delivery errors. Risks can also arise from traffic accidents, delays, or customer changes not reflected in delivery schedules. Among these, incorrect deliveries and traffic accidents are likely the most significant risks for a transport company. Quantifying these risks helps identify which ones have the greatest potential to disrupt operations. With this information, the company can implement control measures to minimize these risks and maintain efficient operations.
Operational risks are a concern for all organizations, not just financial institutions. While banks and financial institutions may have a specialized approach, the issues they face are similar to those in other sectors, including public, private, and nonprofit organizations. In non-financial organizations, the focus might be on protecting assets and determining appropriate insurance coverage. In contrast, financial institutions often ask how much capital needs to be reserved for their assets and whether they should purchase insurance to reduce the amount of non-productive capital held in reserve. Operational risk management is essential for financial institutions. Many institutions include risk management training for management trainees to build awareness before they move into higher roles. However, measuring operational risk remains challenging, especially after the global financial crisis, which revealed that many banks underestimated their exposure. Some financial institutions are adopting risk management standards like ISO 31000, the IRM standard, and the COSO framework, although Basel II does not mandate a specific framework. Any framework adopted must be conceptually sound and prioritize integrity. There are ongoing challenges in developing operational risk management in financial institutions. Some organizations treat operational risk quantification as a compliance task rather than a strategic opportunity. Since the process can be technical, there is a risk that management may rely entirely on operational risk managers instead of taking collective responsibility. Effective operational risk management requires line managers to implement controls and take ownership of risks. Without this integration, the financial institution could face severe consequences. Basel regulations require financial institutions to calculate operational risk exposure. Increasing regulatory demands and corporate governance pressures have made this a necessity. By raising awareness of operational risk, quantifying exposure, and educating staff about its significance, organizations can identify sources of risk and take cost-effective measures to manage them. This proactive approach helps optimize operational risk levels and benefits the organization overall.
Example of scope of Operational risk
The group risk department defines and prescribes the insurance, market and operational risk assessment processes for the business. It performs second-line reviews, including the reserving and capital modelling processes, and undertakes regular reviews of all risks in conjunction with management, with the results of these reviews recorded in risk registers.
Listed below are the principal operational risks that ABC has identified through its ERM framework:
- People risk: Failure to recruit, develop and retain suitable talent.
- Process risk: A failure in processes or failure of their associated controls.
- Technology risk: Failure to invest and successfully implement appropriate technology
- Cyber risk: Financial loss, data loss, business disruption or reputation damage from IT systems’ failure.
- Customer outcome risk: Failure of products, processes or services to meet customer and regulator expectations.
Example of Operational risk management in an oil and gas company
Operational risk management (ORM) in an oil and gas company is critical due to the high-risk nature of the industry, which involves complex operations, hazardous materials, and significant environmental and safety considerations. Here’s an example of ORM in practice:
Scenario: Managing Risks in Offshore Drilling Operations
Risk Identification
An oil and gas company identifies operational risks associated with offshore drilling, such as equipment failure, human error, adverse weather conditions, and environmental hazards like oil spills. Each risk is categorized based on its potential impact on operations, safety, and the environment.
Risk Assessment
The company assesses the likelihood and potential consequences of each risk. For instance:
- Equipment failure could lead to production downtime or a blowout.
- Human error during drilling operations might cause accidents or injuries.
- Adverse weather conditions could halt operations and damage infrastructure.
Risk Mitigation Strategies
To manage these risks, the company implements a range of measures:
- Preventive Maintenance: Regular inspections and maintenance schedules are established for critical drilling equipment to reduce the likelihood of failure.
- Training Programs: Employees, including offshore crew, undergo rigorous training on safety procedures, equipment handling, and emergency response protocols.
- Advanced Monitoring Systems: The company uses real-time monitoring and data analytics to track equipment performance and detect early signs of potential issues.
- Contingency Planning: Emergency response plans are developed for scenarios like oil spills or rig evacuations, ensuring swift action to minimize damage.
- Weather Monitoring: Advanced forecasting tools are used to predict adverse weather, enabling preemptive shutdowns or adjustments to operations.
Implementation and Monitoring
The company embeds these risk management practices into daily operations. Supervisors regularly monitor compliance with safety standards, and the effectiveness of risk controls is evaluated through audits and incident reviews.
Incident Response Example
If an oil spill occurs, the emergency response team activates containment and cleanup measures, such as deploying booms and skimmers to limit the spill’s spread. Simultaneously, the company communicates with regulatory authorities and stakeholders to address environmental and reputational impacts.
Continuous Improvement
After addressing an incident or conducting routine reviews, the company analyzes what worked and what didn’t. Lessons learned are used to refine risk management practices, update training programs, and improve response strategies.
Example of operational risk management in a financial company
Operational risk management (ORM) in a financial company, such as a bank, involves identifying, assessing, and mitigating risks related to internal processes, people, systems, and external events. Here’s an example of ORM in practice
Scenario: Preventing Fraud in Online Banking Operations
Risk Identification
A financial institution identifies operational risks associated with its online banking platform, including:
- Unauthorized access to customer accounts due to weak authentication mechanisms.
- Fraudulent transactions executed by cybercriminals exploiting system vulnerabilities.
- Reputational damage resulting from data breaches or service disruptions.
Risk Assessment
The company evaluates the likelihood and potential impact of these risks:
- Unauthorized access: High likelihood and severe impact on customer trust.
- Fraudulent transactions: Moderate likelihood but can lead to significant financial losses.
- Data breaches: Low likelihood but extremely high potential impact due to regulatory penalties and reputational damage.
Risk Mitigation Strategies
The bank implements several measures to address these risks:
- Strengthening Authentication:
- Introduces two-factor authentication (2FA) for all online transactions.
- Adopts biometric verification, such as fingerprint or facial recognition, for account access.
- Enhancing Cybersecurity:
- Deploys firewalls, intrusion detection systems, and regular vulnerability scans to protect systems.
- Encrypts sensitive customer data both in transit and at rest.
- Fraud Monitoring:
- Implements AI-driven transaction monitoring systems that flag unusual activities in real time.
- Sets up a dedicated fraud detection team to investigate suspicious activities.
- Customer Awareness:
- Launches awareness campaigns to educate customers about phishing attacks and secure banking practices.
Implementation and Monitoring
The bank integrates these controls into its operational framework. Key actions include:
- Continuous system monitoring to detect and respond to unauthorized activities promptly.
- Periodic penetration testing to uncover and fix system vulnerabilities.
- Employee training on fraud prevention and incident response protocols.
Incident Response Example
If the monitoring system flags a suspicious transaction, the bank freezes the affected account, notifies the customer, and conducts a thorough investigation. In case of confirmed fraud, the bank works to recover the funds, compensates the customer if applicable, and reports the incident to regulatory authorities.
Continuous Improvement
Following any fraud attempt or system breach, the bank performs a root cause analysis. Based on findings, it updates its ORM practices, such as strengthening fraud detection algorithms or revising customer verification processes.
Project Risk Management
Project risk management is a systematic process for identifying, analyzing, and addressing risks that could affect the successful completion of a project. It ensures that uncertainties are effectively managed to achieve project objectives, including scope, schedule, cost, and quality. By proactively addressing potential issues, project risk management helps to mitigate disruptions and maximize opportunities. The first step is identifying potential risks that could arise from various sources, such as resource limitations, technical challenges, or external factors like regulations. After identification, risks are assessed to determine their likelihood and potential impact. This prioritization enables teams to focus on the most critical risks, ensuring resources are allocated effectively. Once risks are identified and assessed, response strategies are developed. These may include avoiding the risk entirely, reducing its likelihood or impact through mitigation, transferring it to another party (e.g., through insurance), or accepting it with a contingency plan in place. Each strategy is tailored to align with the project’s goals and risk tolerance. Continuous monitoring of risks ensures timely detection of new threats or changes to existing ones. This phase also evaluates the effectiveness of implemented risk responses and allows adjustments as needed. Clear communication of risks, updates, and strategies with stakeholders fosters transparency and collaboration, increasing the likelihood of project success. Project risk management is closely tied to ERM by aligning project-specific risks with the organization’s broader risk appetite and strategic objectives. This integration ensures that project-level risks are managed in a way that supports the overall resilience and success of the organization.
Organizations undertake projects for various reasons. Often, when changes to strategy are planned, a project or a group of projects is needed to put the new strategy into action. Similarly, improving key operational processes usually requires changes that are carried out through projects. Choosing the right projects and programs helps an organization decide how to implement its strategy effectively. It’s important to understand the difference between managing risks within a project and the reasons the project exists. Project risk management focuses on delivering the project on time, within budget, and meeting the required standards. However, there are also broader risks about whether the project is the best use of resources and whether it will deliver the intended benefits. To evaluate this, you might ask:
- Will the project deliver all the expected benefits?
- Is this project the best way to achieve the organization’s strategy?
Project risk management is essentially an extension of regular project planning. Every project aims to meet deadlines, stay within budget, and achieve the expected quality or performance. Risk, in this context, is about uncertainty or deviation from these goals. Since variability in outcomes is undesirable in projects, risk management focuses on reducing this variability and managing any risks that might disrupt the project. Every project faces uncertainties related to events, conditions, or circumstances. Effective project risk management involves identifying potential sources of uncertainty and responding appropriately. The approach most suited to managing project risks is control management, which ensures that risks are addressed and outcomes stay on track. In addition to managing risks, project managers should also watch for unexpected opportunities that might arise during the project. For instance, if favorable conditions allow a task to be finished early, the project plan can be adjusted to take advantage of the time saved. For example, in a road construction project, if favorable ground conditions enable a bridge to be completed earlier than expected, this gain can be factored into the overall project plan. For large-scale projects, like building Olympic venues, certain variables—such as ground conditions or contamination levels—can greatly affect time and cost. Identifying and managing these uncertainties early is crucial to ensuring the project’s success.
Uncertainty in projects
Project risk management is a form of control management focused on ensuring projects meet their goals. Projects often involve specific tasks like building something new, developing products, implementing IT systems, adopting new technologies, or entering new markets. These projects are vital for organizations, usually undertaken to stay ahead of competitors or catch up with them. From a risk management perspective, a project can itself be seen as a way to reduce risk by meeting specific objectives. The main reason for investing in such projects is to create business advantages or achieve better value for money. Project risk management is a well-established field, with a strong focus on controlling risks and managing unexpected events. It is one of the most advanced and successful areas for using risk management tools and techniques. The goal for every project is to be completed within the agreed budget, timeline, and quality standards. Quality can mean meeting a specific specification, like using a particular material for a restaurant floor, or achieving a performance standard, such as ensuring the floor meets a certain level of slip resistance—or sometimes both. Since projects are unique, historical data about risks may not always be available. This means project risk management needs to look ahead to anticipate potential issues before they happen. To manage a project successfully, various types of risks must be addressed:
- Compliance risks: Failing to get required permissions or approvals.
- Hazard risks: Challenges that could delay the project or increase costs.
- Control risks: Problems affecting the final specification, performance, or quality.
- Opportunity risks: Positive developments, like materials arriving earlier than expected, which could benefit the project.
By managing these risks effectively, project managers can ensure projects are completed successfully and deliver the intended value.
To handle uncertainty in projects, organizations can choose from several approaches:
- Accept the risk: Proceed with the project despite the uncertainty.
- Adapt activities and procedures: Adjust processes or introduce controls to manage the risk.
- Adopt contingency plans: Prepare backup plans to deal with potential issues.
- Avoid the risk: Change plans to eliminate the risk entirely.
The response depends on the type of risk:
- For low-impact, low-uncertainty risks, organizations usually accept the uncertainty.
- For high-impact, low-uncertainty risks, they adapt processes, add controls, or even use insurance.
- For low-impact, high-uncertainty risks, they create contingency plans.
- For high-impact, high-uncertainty risks, they aim to avoid the risk altogether.
The figure shows how a risk matrix can be used to map out potential risks in a project. The matrix compares the possible time delays caused by each risk against the potential cost increases. This helps the project manager see if risks fall into one of four zones: comfort, cautious, concerned, or critical. The likelihood of each risk is shown by the size of the bubble representing it. For example, delivering the Olympic Games required a massive construction project. During this process, the global financial crisis occurred, forcing a renegotiation of the project’s financial structure. Despite the challenge, the project was completed successfully. Another common risk in construction is poor ground conditions, which can cause delays or cost overruns. A “bow-tie” model is often used to explain project risk management. This model shows the different stages of a project—starting with inception, then planning, execution, and closure. At the center of the bow-tie are the uncertainties, which are the core focus of risk management. The bow-tie illustrates how controls can be added to:
- Reduce uncertainties at the center.
- Manage uncertainties when they occur.
- Limit their impact on the project’s quality, cost, time, and compliance.
This approach highlights the importance of controlling risks to keep projects on track.
Project Risk Register
A risk register or risk matrix should be regularly updated throughout the project. Using risk management software can save time and effort by automating updates and helping to prioritize risks. Once risks are identified and plans to address them are in place, it’s important to review them often. As the project progresses, both internal and external conditions can change. Some risks may disappear, while new, unforeseen risks could emerge. The risk register should be kept up to date, with reports generated regularly. These reports should clearly show the risks, help prioritize actions, and support decision-making.
A Project Risk Register is a formal document used in project management to record and track potential risks that could affect a project’s success. It serves as a central repository where all identified risks are documented, assessed, monitored, and managed throughout the project’s lifecycle. The purpose of the risk register is to provide a structured approach to managing risks, helping project teams to plan responses, minimize negative impacts, and take advantage of potential opportunities.
Key Features of a Project Risk Register
- Risk Identification: Lists all potential risks related to the project, including those that might impact time, cost, quality, or scope.
- Risk Assessment: Evaluates the likelihood and impact of each risk to prioritize and focus efforts.
- Risk Response: Details strategies to mitigate, avoid, accept, or transfer risks and assigns responsibilities.
- Ongoing Monitoring: Tracks the status of risks, updates assessments, and reviews the effectiveness of response actions.
Importance of a Project Risk Register
- Provides a clear view of potential threats and opportunities.
- Ensures proactive planning and decision-making.
- Helps stakeholders stay informed about risk status.
- Supports alignment with project objectives by minimizing unexpected disruptions.
In essence, a Project Risk Register is a practical tool for improving project outcomes by ensuring risks are identified, addressed, and managed effectively.
Example Project Risk Register Table
Risk ID: 01.
Risk Description: Delay in receiving materials.
Category: Operation.
Likelihood: High.
Impact: Medium.
Risk Level: High.
Mitigation Actions: Order materials in advance; find alternate suppliers.
Owner: Purchase Team.
Status: Open.
Risk ID:02.
Risk Description: Software compatibility issues.
Category: Technical.
Likelihood: Medium.
Impact: High.
Risk Level: High.
Mitigation Actions: Conduct compatibility testing early.
Owner: IT manager.
Status: In progress.
Risk ID:03.
Risk Description: Regulatory approval delay.
Category: Compliance.
Likelihood: Low.
Impact: High.
Risk Level: Medium.
Mitigation Actions: Consult regulators early; prepare documentation.
Owner: legal team.
Status: Open.
Project lifecycle
The Project Lifecycle refers to the structured phases a project undergoes from initiation to completion. It serves as a framework to ensure that all necessary activities are planned, executed, and finalized systematically. In the context of Enterprise Risk Management (ERM), the project lifecycle incorporates risk-focused strategies at each phase, ensuring risks are identified, assessed, and addressed proactively to enhance project success and align with organizational objectives. During the inception phase, the focus is on defining the project’s purpose, scope, and goals while identifying potential risks that could affect its feasibility. This phase also evaluates whether the project aligns with the organization’s risk appetite and strategic goals. Planning involves developing a detailed roadmap that includes timelines, budgets, and resource allocation, while integrating risk assessments to prioritize potential threats and establish mitigation strategies. Risk registers are created at this stage, documenting risks, their potential impacts, and assigned owners to manage them effectively. As the project moves into execution, risk monitoring and management become essential. This includes tracking the progress of risk responses, adapting to changes in the project environment, and managing emerging risks. Effective communication with stakeholders ensures transparency about risks and progress. Additionally, opportunities that arise during execution, such as cost savings or favorable conditions, can be leveraged to optimize outcomes.
Finally, during project closure, a review of the risks encountered and mitigation efforts is conducted to evaluate their effectiveness. This stage also involves documenting lessons learned to improve future risk management practices and ensure that all project deliverables meet the expected quality, budget, and timeline. By embedding ERM into the project lifecycle, organizations can not only minimize threats but also capitalize on opportunities, ensuring projects are delivered successfully while maintaining alignment with strategic risk objectives.Project risk management is one of the most advanced and well-regarded areas of risk management, which makes sense given the fast-paced and high-pressure nature of many projects. These projects can range from installing new software to constructing a large sports stadium. No matter the project’s size, all projects go through four key stages:
- Inception
- Planning
- Execution
- Closure
At every stage, the client’s needs and expectations should be the top priority, whether the client is external or part of the same organization. Understanding the project lifecycle is crucial so that risk management steps can be properly planned, executed, and aligned with the project’s goals. While project risk management follows the general risk management process, its framework may differ because projects are dynamic. Each stage comes with its own risks and uncertainties, such as:
- Defining the project clearly.
- Setting and agreeing on timelines and budgets.
- Confirming performance or specifications.
Plans must also be in place to handle changes, updates, or deviations from the original project scope or circumstances. By addressing these uncertainties, organizations can manage risks effectively and achieve the intended project outcomes.
The figure shows how uncertainty decreases as a project progresses, especially in terms of cost, time, and quality. However, making changes becomes more expensive as the project moves forward. It’s easier and cheaper to adjust plans at the beginning before any work starts. This highlights the importance of managing risks throughout the project to ensure it is delivered on time, within budget, and meeting quality expectations. Many organizations expand the traditional “project triangle” of cost, time, and quality by adding a fourth factor, such as compliance or sustainability. Compliance refers to meeting the expectations of stakeholders, including regulators, while sustainability focuses on environmental and long-term considerations. Some organizations combine compliance and sustainability under the broader goal of quality or performance. For example, consider refurbishing a block of flats. This type of project involves multiple stakeholders, including architects, contractors, and external agencies like planning authorities, building regulators, and utility providers. Managing such a project successfully requires risk management to be integrated into the process, identifying risks early, communicating effectively, and addressing both threats and opportunities. Key steps include clarifying responsibilities, prioritizing and analyzing risks, planning and implementing responses, maintaining a risk register, and monitoring risks and related actions.
Opportunity in projects
Projects are carried out to take advantage of opportunities or to solve challenges. Often, several projects run simultaneously, forming what is called a program. Effective project planning requires preparing for unexpected issues, which is known as contingency planning. This includes allocating extra time or budget to handle unforeseen problems, ensuring the project meets its required specifications. As the project progresses, any difficulties must be addressed, and opportunities to reduce their impact should be explored. It’s common for project specifications to change during the process. A well-managed project will use these changes to improve customer satisfaction and potentially increase revenue for the organization delivering the project. Undertaking projects also helps organizations achieve their strategic goals. In some industries, such as energy, projects are often approved only if they help reduce risks, such as improving efficiency, quality, or output. This can minimize risks related to resource waste, poor quality, or reduced productivity. In addition to meeting the project’s main goals, organizations can benefit from opportunities that arise during the project. These might include saving time, cutting costs, or improving quality. For example, if a construction project anticipates a high level of ground contamination but finds less than expected, it could finish earlier and at a lower cost. Some contracts even include provisions for sharing the savings in such cases. In older cities, construction projects may uncover historical artifacts during excavation. Careful companies plan for this possibility by including potential delays in their timelines and considering the cost of archaeological discoveries. This might involve purchasing archaeological insurance to cover any extra costs if it’s available at a reasonable price.
Project risk analysis and management
Project risk analysis and management is a process that enables the analysis and management of the risks associated with a project. Properly undertaken, it will increase the likelihood of successful completion of a project to cost, time and performance objectives. Risks for which there is ample data can be assessed statistically. However, no two projects are the same. Often things go wrong for reasons unique to a particular project, industry or working environment. Dealing with risks in projects is therefore different from situations where there is sufficient data to adopt an actuarial approach. Because projects involve a technical, engineering, innovative or strategic content, a systematic process is preferable to an intuitive approach. Project risk analysis and management (PRAM) has been developed to meet this requirement.
The Association for Project Management (APM) introduced the Project Risk Analysis and Management (PRAM) Guide in the mid-1990s. One key insight from the guide is that many projects lack prior experience or data to predict the impact of risks accurately. The PRAM Guide outlines a step-by-step approach to managing project risks, similar to standard risk management processes. The PRAM method is a continuous process that can be applied at almost any stage of a project’s lifecycle. It is particularly useful at five key stages: during feasibility, when the project is still flexible and changes to reduce risks can be made at a lower cost; at sanction, where the client evaluates the project’s risk exposure and ensures appropriate steps have been taken; during tendering, where the contractor identifies risks and sets contingencies; after tendering, when the client reviews the contractor’s risk assessment and confirms timelines are achievable; and during implementation, where identifying and managing risks increases the chances of delivering the project on time and within budget. The guide emphasizes the importance of continuous risk management throughout a project and offers advice on achieving successful outcomes. By addressing risks proactively at these stages, both clients and contractors can enhance their ability to manage uncertainty and achieve project goals.
Risk management embedded in projects
The Association for Project Management (APM) introduced the Project Risk Analysis and Management (PRAM) Guide in the mid-1990s. One key insight from the guide is that many projects lack prior experience or data to predict the impact of risks accurately. The PRAM Guide outlines a step-by-step approach to managing project risks, similar to standard risk management processes. The PRAM method is a continuous process that can be applied at almost any stage of a project’s lifecycle. It is particularly useful at five key stages: during feasibility, when the project is still flexible and changes to reduce risks can be made at a lower cost; at sanction, where the client evaluates the project’s risk exposure and ensures appropriate steps have been taken; during tendering, where the contractor identifies risks and sets contingencies; after tendering, when the client reviews the contractor’s risk assessment and confirms timelines are achievable; and during implementation, where identifying and managing risks increases the chances of delivering the project on time and within budget. The guide emphasizes the importance of continuous risk management throughout a project and offers advice on achieving successful outcomes. By addressing risks proactively at these stages, both clients and contractors can enhance their ability to manage uncertainty and achieve project goals.
Supply chain Management
Supply chain management (SCM) involves the coordination and oversight of the flow of goods, services, information, and finances from the origin of raw materials to the delivery of finished products to customers. It ensures that each step in the supply chain is efficient, cost-effective, and aligned with organizational objectives. In the context of Enterprise Risk Management (ERM), supply chain management plays a crucial role in identifying, assessing, and mitigating risks that could disrupt the supply chain. These risks might include supplier failures, transportation delays, geopolitical instability, natural disasters, or cyber threats. Effective supply chain management within ERM requires organizations to develop robust strategies, such as diversifying suppliers, enhancing transparency, and using predictive analytics to anticipate potential disruptions. By integrating ERM principles, organizations can proactively address vulnerabilities, protect their operations, and ensure continuity, ultimately strengthening their resilience and maintaining competitive advantage. ISO 28000 ‘Specification for Security Management Systems for the Supply Chain’ provides the following definition of supply chain:
A supply chain is a set of interconnected processes and resources that starts with the sourcing of raw materials and ends with the delivery of products and services to end users. Supply chains may include producers, suppliers, manufacturers, distributors, wholesalers, vendors, and logistics providers. They include facilities, plants, offices, warehouses, and branches and can be both internal or external to an organization.
Many organizations rely heavily on outsourcing for major operations and support services, such as cleaning, transportation, communication, and manufacturing. For instance, many fashion brands design their products and sell them through franchised retail stores, while outsourcing all manufacturing and distribution to third-party providers around the globe. This widespread reliance on outsourcing has made supply chain management increasingly critical.
In a globalized and competitive market, managing supply chains is challenging due to uncertainties in supply and demand, shorter product lifecycles, rapid technological changes, and globalization. These factors have increased the risks involved in supply chains. While it’s impossible to eliminate all risks, effective risk management can reduce the chances and impact of supply disruptions. As more organizations turn to overseas manufacturing, they also face growing corporate social responsibility (CSR) concerns, requiring them to address ethical and sustainability issues in their supply chains. For example, during the COVID-19 pandemic, Apple experienced significant supply chain disruptions when factories in China shut down, delaying iPhone production. This caused shortages of components and logistical challenges. To address this, Apple diversified its manufacturing to countries like India and Vietnam and invested in digital technologies to improve supply chain visibility and flexibility. This response demonstrates how proactive risk management can help minimize disruptions and maintain operations during global crises. Another example is an organization outsourcing its merchandise procurement. It aims to ensure that the products are desirable, high-quality, and cost-effective, while also meeting ethical standards. However, to balance the conflicting expectations of stakeholders—such as profitability versus CSR—the organization might choose a low-cost manufacturer through a third-party procurement agency. The agency is tasked with ensuring ethical sourcing while maintaining product quality and cost-efficiency. Despite this, risks like quality issues, supply delays, or CSR concerns could arise, potentially leading to dissatisfaction and reduced sales. The shift in supply chain strategies from focusing on “lowest risk at any cost” to “lowest cost at any risk” highlights the importance of managing both the risks and benefits of outsourcing. Organizations must assess and mitigate the potential downsides of outsourcing with the same care they apply to leveraging its advantages. Balancing these hazards and opportunities is key to a resilient and responsible supply chain.
Scope of supply chain
As outsourcing becomes more common, organizations are paying more attention to the risks of depending on third parties. Outsourcing is often pursued with the expectation of reducing costs and shifting risks to others. However, before deciding to outsource, it is crucial to carefully evaluate the balance between potential risks and rewards. Organizations must recognize that outsourcing not only requires managing their own risks but also considering the risks associated with every link in the supply chain. Supply chain management and risk management are closely connected, and supply chain decisions are becoming increasingly complex. Outsourcing is just one part of managing a supply chain. Success often depends on building strategic partnerships or even engaging in joint ventures. Supply chain risks are not limited to large-scale operations but also include smaller outsourcing decisions, such as hiring cleaning or catering services. During the 1980s, many organizations began outsourcing facilities management tasks, a trend that continues today. The scope of supply chain management can range from strategic collaborations and joint ventures to outsourcing transportation, warehousing, and even the operation of retail stores through franchise agreements. For example, Nike faced significant criticism in the mid-2000s over ethical sourcing issues. The company acted quickly to address these concerns and protect its reputation. This highlights the importance of managing risks throughout the supply chain, whether related to sourcing raw materials or delivering finished goods. Supply chain discussions often refer to “upstream” and “downstream” activities. Upstream refers to the goods or services received from suppliers, while downstream relates to the goods delivered to customers. However, these terms can sometimes cause confusion, so it may be simpler to think of the supply chain as what you receive from suppliers and the delivery chain as what you provide to customers. Regardless of terminology, most organizations rely on goods and services from suppliers or outsourced providers. They also act as suppliers to their own customers. To ensure smooth operations, organizations must evaluate risks associated with their suppliers and manage the risks involved in delivering products or services to their clients. Balancing these risks at both ends of the chain is essential for effective supply chain management.
An eample of supply chain challenges comes from Apple, which has faced labor and ethical concerns with its suppliers in China. One of the most well-known incidents involved Foxconn, a major supplier responsible for assembling Apple products like iPhones and iPads. Investigations revealed issues such as excessive working hours, unsafe working conditions, and underage labor. Reports also surfaced about falsified records, including manipulated work logs to comply with labor laws. Apple took steps to address these issues by working closely with its suppliers to improve conditions. The company implemented stricter oversight through regular audits and introduced initiatives to ensure compliance with labor standards. Apple also joined organizations like the Fair Labor Association to enhance its monitoring efforts. Moreover, the company encouraged its suppliers to adopt better grievance mechanisms, improve workplace safety, and reduce excessive overtime. This example highlights the complexities of managing a global supply chain, especially in countries with rapidly changing legal and economic environments. It also emphasizes the need for multinational corporations to maintain rigorous standards and continuously monitor their suppliers to uphold ethical and legal responsibilities.
Strategic partnerships
When outsourcing parts of its operations, an organization must carefully choose its strategic partners. For instance, if an organization decides to outsource the production of an in-house magazine, the level of importance placed on the magazine might lead to forming a strategic partnership with the publisher. Managing supply chain risks becomes even more critical when manufacturing is involved. A supermarket, for example, must evaluate whether its supply chain partner can consistently deliver goods on time, within budget, and sustainably. To secure a reliable supply, the supermarket might form a strategic partnership with its suppliers, ensuring priority treatment during disruptions. This guarantees the supermarket a steady supply and lower costs, while the supplier benefits from a secure market and long-term contracts. However, there are drawbacks. Suppliers may have to agree to fixed prices, even if higher prices could be obtained elsewhere. Additionally, suppliers might become overly dependent on a single customer for orders, increasing their vulnerability. The use of “just-in-time” delivery and single-supplier models can also heighten the risk of business interruptions. While insurance can cover financial losses, it may not fully protect the organization’s reputation or market share. To address these risks, organizations must develop business continuity strategies and build resilient partnerships. Strategic partnerships, which sometimes even involve competitors working together, are valuable alliances that benefit all stakeholders and enhance organizational resilience.
Joint Venture
To ensure a secure supply chain, organizations might seek priority status from their suppliers. However, for essential components or services, priority status may not be enough. In such cases, organizations often explore joint ventures with suppliers to guarantee priority access. Joint ventures allow organizations to gain some control over the supplier’s operations, reducing the risk of the supplier prioritizing competitors during challenging market conditions. They can also help prevent competitors from accessing the joint venture’s products, providing a strategic advantage. Additionally, joint ventures are a practical way to adapt to technological changes, as they spread the financial burden of adopting new technologies across both parties. Competition and technological shifts in the supply chain can be significant and may exceed the resources of individual organizations. Joint ventures can help maintain supply chain continuity while offering competitive advantages and minimizing the capital at risk. For organizations aiming to reduce dependency on suppliers, joint ventures offer a tactical alternative to fully acquiring a supplier. Instead of outright ownership, which demands significant capital and resources, a joint venture allows the risks to be shared between the parties. The main benefit of joint ventures is the shared risk and reward structure. Both parties distribute the venture’s risks and benefits by establishing clear agreements or forming a new company with shared capital. This arrangement is ideal for organizations that want to seize opportunities while minimizing their financial exposure, especially when they prefer not to fully fund the venture on their own.
Outsourcing
Outsourcing the manufacturing of components to specialized subcontractors offers many benefits, but it also comes with risks that need to be carefully managed. While outsourcing can transfer some responsibilities, it does not entirely eliminate the risks tied to the activity. To address this, a clear contract must be established to define how risks are shared, often including penalty clauses for poor performance and rewards for exceptional results to encourage collaboration. Outsourcing non-core operations can also introduce supply chain vulnerabilities, so organizations must carefully define the scope of services in the outsourcing arrangement. Additionally, in many countries, laws protect employee rights during outsourcing transitions. For instance, if cleaning or catering services are outsourced, the rights of the existing employees may be safeguarded, which can complicate cost-saving efforts. Despite these challenges, outsourcing is often a way to shift non-essential tasks to specialists, reducing costs while benefiting from their expertise. For example, an office might outsource cleaning, catering, or facilities management to achieve cost efficiencies and improved service quality. Outsourcing agreements should address key points such as the scope and duration of the arrangement, services provided, sub-contracting limits, pricing and performance expectations, monitoring and auditing processes, confidentiality and data security, default and termination conditions, dispute resolution, and insurance and liability requirements. These elements ensure that both parties clearly understand their roles, responsibilities, and expectations in the outsourcing relationship.
Most businesses outsource certain tasks, but deciding to outsource is a big decision, and the benefits are not always easy to define. Outsourcing can lower costs by reducing overheads and letting a professional handle the task. However, cost reduction alone shouldn’t be the only reason for outsourcing. The benefits of outsourcing can be grouped into two categories: direct and indirect. Direct benefits come from having a specialized company manage the outsourced tasks, while indirect benefits include the ability to focus more on the company’s core activities. Some key direct benefits include lower costs, faster processes, and better customer satisfaction. Specific advantages are:
- Greater focus on core business activities.
- Lower manufacturing and logistics costs.
- Fewer staff needed, reducing headcount and management responsibilities.
- Higher accuracy in operations.
- Flexibility and access to a broader range of services.
- Use of global networks and advanced technology.
- Better service quality and overall improvement.
- Reduced need for capital investment and better cash flow.
Contracts
Risk management is a key part of setting up supply chain contracts or outsourcing tasks. The complexity of these contracts depends on several factors, including the level of risk involved, the contract’s value, its scope and duration, the skills required for the job, and how critical the goods or services are to the organization. Organizations often outsource parts of their operations to save money and access specialized expertise while focusing on their main business activities. However, this has led to more complex and fragmented global supply chains, which are more vulnerable to disruptions caused by external factors like natural disasters, pandemics, or terrorism. Companies must carefully assess the risks of outsourcing and supply chain arrangements to ensure they are well-managed. Outsourcing doesn’t mean all risks are transferred to the third party. For example, if outsourced manufacturing produces poor-quality goods or operates unethically, the organization’s reputation could still be damaged. Outsourcing should only be done if it is cost-effective and efficient. Decisions based on the assumption that all risks are passed to the third party can be misleading. For instance, if goods produced in low-cost countries fail to meet safety standards, such as toys with lead-based paint, the risks and costs could outweigh the benefits. Organizations need to ensure that the risks associated with outsourcing fit within their risk tolerance and capacity. A detailed evaluation should be conducted to understand the risks of complex supply chain arrangements. While insurance may cover certain events like fires or natural disasters at the supplier’s premises, it usually doesn’t cover issues like poor quality, late deliveries, or supplier bankruptcy.
Oil and gas Supply chain
In the oil and gas industry, supply chain disruptions can have significant impacts on operations, similar to the challenges faced in the automotive sector. One notable example is the aftermath of Hurricane Harvey in 2017, which disrupted oil and gas production and supply chains in the U.S. Gulf Coast region. This area is a critical hub for refining and chemical manufacturing, accounting for a significant portion of the country’s fuel and petrochemical output. The hurricane caused widespread flooding, which led to shutdowns of refineries, pipeline disruptions, and delays in the transportation of raw materials and finished products. Many companies faced challenges in resuming operations due to damaged infrastructure, workforce availability, and logistical bottlenecks. In response, oil and gas companies adopted several risk mitigation strategies:
- Diversifying supply sources: Firms worked to secure alternative suppliers or increase inventory levels to reduce dependence on a single source for critical inputs.
- Investing in resilient infrastructure: Some companies upgraded facilities to withstand extreme weather events, including raising critical equipment above flood levels.
- Strengthening logistics networks: Businesses re-routed transportation and explored alternative ports and pipelines to minimize disruptions.
- Developing contingency plans: Suppliers must have disaster recovery plans, ensuring rapid recovery and continued supply during future crises.
- Expanding insurance coverage: Companies reviewed and enhanced their insurance policies, including coverage for business interruptions due to natural disasters.
