Risk Appetite and Risk Tolerance are two terms that are vital to any Enterprise Risk Management (ERM) Program. They are defined as the amount and type of risk an organization is willing to accept (Risk Appetite) and the specific maximum risk that any organization will take to pursue any one business objective (Risk Tolerance). The reason that ERM is defined by these two terms is that every company must take on some risk to reach its profit margins, but the ultimate question is, “How much risk are you going to take on and how are you identifying your key risks?”
A recent article in Rough Notes magazine by Michael J. Moody titled “It Always Comes Back to Risk Appetite,” touches on both of these facts. In the article, Moody focuses on Risk Appetite; he believes that identifying a company’s Risk Appetite is the key to a successful ERM program. Moody admits that while identifying and defining an organization’s Risk Appetite can be difficult and is more of a “work in progress,” it is something that must be done. It has also become apparent that identifying the Risk Appetite is the responsibility of the board and is not necessarily a single identifiable number. One number that was identifiable in his article is more than 60% of the shareholder value was lost as a result of a company failing to identify Strategic Risk. This was based on a Booz & Company study of 1,200 large companies.
At The ALS Group (ALS), we support Moody’s notion that Risk Appetite is a vital part of any successful ERM program and believe strongly in identifying our clients’ Risk Appetite as it relates to their Strategic Risk. The identification process, while difficult, must take a three-dimensional approach to risk identification. This means that when ALS is engaged we look to speak with not only senior management, but with business unit leaders from the logistics to the sales department. This allows us to clearly identify the most material risks and to provide senior management with the transparency that would, in turn, enable them to report a clear definition of the company’s risk to the board.
If you would like to discuss the ERM and your company’s Risk Appetite further please feel free to contact The ALS Group for more information.
