A Starter’s Guide To Strategic Risk Management

James Lam Associates, a consulting firm for risk management that works closely with CISOs, CROs, CFOs, and CEOs, conducted a study on the principal reason organizations suffer financial distress.

The research found that 61% of incidents were due to strategic risks, 30% to operational risks, and 9% to financial risks.

In spite of such high numbers, a number of organizations still ignore strategic risk management which is key to business continuity. In this blog, we will understand the nuances of strategic risks and how it fits into the enterprise risk management strategy (ERM). 

TL;DR Strategic risk impacts an organization’s ability to achieve core business objectives. It is measured using the calculation of the economic capital (EC) and Risk-adjusted return on capital (RAROC). Strategic risk management is a five-step process that includes strategy planning, defining the risk appetite, quantifying the risk profile, analyzing multiple scenarios, and continuously monitoring risks.  Strategic risks can arise from internal factors such as employees, leadership, finance, etc., as well as external factors like regulatory changes, political standing, and industry trends.

What is strategic risk?

Strategic risk refers to risks that impact an organization’s ability to achieve its core business objectives, caused by poor strategic planning or implementation, mergers and acquisitions and subpar responses to market changes and economic factors.

Strategic risks can significantly impact the financial health and overall business value of the organization and are primarily guided by leadership.

What is strategic risk management?

Strategic risk management (SRM) is the process of identifying, analyzing, and mitigating or capitalizing on risks that could impact the organization’s ability to achieve its long-term objectives or mission. It ensures that the organization remains prepared to handle uncertain events and leverages opportunities that align with its goals.

Strategic risk management takes a proactive approach that integrates risk management within organizational strategy development. This way organizations are more aware of their risks and are able to develop strategies that alleviate them.

As suggested by MacLennan Roberts, SRM is an integral part of the company’s strategy focus wheel. Significant shifts in these risks may require revising strategic plans or implementing new strategies.

A strong strategic risk management framework sets clear business goals and defines KPIs (key performance indicators) and KRIs (key risk indicators) to predict and manage potential risks. It should involve your business’s board members and stakeholders, like senior management. 

Why is strategic risk management important?

Strategic risk management is essential for long-term business sustainability, enabling you to navigate challenges with confidence and make informed decisions through a proactive approach.

Following are the benefits of strategic risk management:

Protects Long-term objectives

Unlike operational risks that impact day-to-day activities, strategic risks can affect things like business survival, expansion, regulatory compliance management, and a risk-averse culture. These long-term objectives are protected when the organization anticipates potential threats from internal weaknesses and external threats and takes appropriate actions.

Enables well-informed decisions

Strategic risk management considers comprehensive risks before making each decision which helps minimize any blind spots and uncertainties. For example, if you are looking to enter a new market, the business will assess location-specific compliance requirements, geopolitical risks, and market conditions before launching the product to mitigate potential setbacks

Enhances adaptability and resilience

The business environment is volatile, and we see new technological enhancements, regulatory updates, emerging threats, and economic fluctuations every day. Organizations that successfully integrate strategic risk management into their overall planning and risk activities are able to adapt constantly to these changes and remain resilient.

Helps outperform competitors

The essence of strategic risk management is to anticipate risks and industry disruptions and leverage the right opportunities. Businesses that can do both minimize operational hurdles and take the first-mover advantage to stay ahead of the competition.

How do you measure strategic risk?

Measuring strategic risk involves defining success metrics like earnings, return on equity, and intrinsic value and evaluating critical risks like pricing strategies, market share, regulatory approvals, etc. This can be achieved with the help of two approaches:

1. Calculate economic capital

Economic capital (EC) quantifies the amount of capital needed to absorb unexpected losses from strategic risks. It provides a forward-looking assessment that contrasts with book capital, which reflects past financial performance. 

For strategic risk assessment, calculating EC involves:

• Generating distributions of changes in enterprise value due to each risk source.
• Combining these distributions, considering diversification effects.
• Calculating total economic capital required to maintain desired solvency standards.
• Allocating economic capital to specific risks based on their impact.

Economic Capital = Total Risk Amount – Expected Losses Total Risk Amount: Combined risk from different areas: – Credit Risk – Insurance Risk – Liquidity Risk – Operations Risk Expected Losses: Losses a firm expects to face, including: – Future losses from various risks – Contractual obligations – Debts

2. Assess risk-adjusted return on capital (RAROC)

RAROC assesses the return on strategic initiatives relative to the economic capital required to support them. It determines whether an initiative adds or destroys value by dividing the anticipated after-tax return by the economic capital. 

The key steps in assessing RAROC include:

• Comparing RAROC to the company’s cost of capital. Initiatives with RAROC exceeding the cost of capital are considered value-adding.
• Conducting scenario analysis to understand potential outcomes under different conditions.
• Evaluating risk-return trade-offs across various strategic decisions, including organic growth, acquisitions, or capital management strategies.

RAROC = {Expected revenue – (Operating cost + Interest charges) + Return on capital – Expected losses}/Economic capital.

Other Quantitative Measures

Beyond economic capital and RAROC, organizations can also use:

• Net Present Value (NPV) calculations adjusted for risk using discount rates.

• Economic Value Added (EVA) models, which integrate risk adjustments into assessments of value creation.

5 key steps for strategic risk management 

Managing strategic risk helps optimize the company’s long-term balance between risk and return. It defines the risk appetite of a company while keeping in mind the company’s products and services. 

Effective strategic risk management helps companies predict and prepare for potential obstacles. It allows flexibility to develop mitigation strategies or tactics to minimize risks or capitalize on unexpected opportunities. 

Here are five essential steps for strategic risk management:

Step 1: Integrate risk management and strategy planning

Strategy planning usually begins with methods like SWOT analysis, balanced scorecards for risks (Kaplan and Norton), or Michael Porter’s Five Forces. However, it’s commonly noticed that these frameworks do not integrate strategic risks into them. 

Hence, when planning a business strategy, one should utilize common risk assessment tools like a risk matrix, decision trees, FMEA modes, bowtie models, etc. These provide a structured approach for the risk analysis from both internal and external threats and competitive dynamics.

Step 2: Define the risk appetite

Develop a clear risk appetite statement that aligns with the company’s business strategy. It should articulate how much risk the entire organization is willing to accept in pursuit of its strategic objectives.

To define risk appetite:

1. Identify principal risk categories (financial, operational, strategic, etc.).

2. Set clear lower & upper limits for each risk category. [Using a risk matrix or KRIs (key risk indicators)]

3. Design approaches for managing and mitigating risks using company policies. 

4. Draft concise risk appetite statements aligned with strategic goals.

5. Implement a practical risk appetite checklist for decision-making and monitoring.

Learn more about risk appetite.

Step 3: Quantify your risk profile

Use tools such as economic capital and RAROC (as discussed above) to quantify your organization’s risks for strategic initiatives. 

Economic capital helps you assess the capital required to support risks, while RAROC evaluates the expected return on capital relative to the associated risks. Such a quantitative analysis provides insights into each initiative’s potential upside and downside, enabling you to make informed strategy decisions.

Step 4: Analyze multiple risk scenarios

Your company’s risks should be analyzed against various scenarios like expected loss, unexpected outcomes, best-case results, or work-case scenarios. This is directly related writing better risk statements. 

According to ISACA, the basic format of a risk statement is:

[Event that has an effect on objectives] caused by [cause/s] resulting in [consequence/s].

Alternatively, scenarios can be evaluated using risk matrices, as suggested in the N. Komendantova—International Journal of Disaster Risk Reduction 8 (2014). 

Step 5: Continuously monitor risks

Conduct periodic assessments and ensure that there is a proper monitoring and reporting system to track the performance of strategic initiatives against predefined risk metrics. Review these metrics regularly to detect emerging risks or deviations from expected outcomes early. 

The best way to monitor risks is to use a risk register with assigned risk owners. 

Risk registers are usually a part of (Governance, risk, compliance) GRC tools where risks are mapped to specific controls. Here’s an example of Sprinto’s risk register:

Risks are categorized into low, medium, and high levels, with various scenarios, their mapped controls, treatment plans, status, and risk owners. Furthermore, each risk has an individual profile with its asset group, source, monetary value, and potential threats and vulnerabilities. 

Two types of strategic risk factors: Internal & External

Strategic risks, whether internal or external, can disrupt an organization’s path to achieving its goals. This holds true for both business and compliance goals. According to Lead Auditor at Sprinto, Varenya Penna, 

Recommended read: Compliance vs Risk Management: Differences and Tools

Here’s an overview of the six internal and external factors that affect strategic risks, along with examples:

Internal factors	External factors
Leadership and management: Poor decisions, lack of vision, or ineffective communication from leaders	Economic condition: Recessions, inflation, or interest rate hikes
Organizational structure & culture: Rigid hierarchy, siloed departments	Shift in industry trends: Shifts in consumer preferences, new technologies, or emerging competitors
Human capital/employees: shortage of skilled employees, low morale, or high turnover	Political environment: Changes in government policies, political conflicts, instability in the country
Technology used: Outdated or inadequate technology	Regulatory changes: Changes in regulatory policies, updates, new laws introduced
Financial capabilities: Poor financial planning, cash flow problems, or high debt	Natural disasters and crisis: Pandemics, wide-scale cyberattacks, flood

9 examples or types of strategic risk

The types of strategic risks pertinent to your business depend on factors like consumer demand, demographics, industry, product, etc. However, all types of risks for a business are interdependent on each other. The nine broad categories of strategic risks that all businesses should consider are: 

1. Reputational risk

Data breaches or cyber attacks can cause major damage to a company’s reputation. Customers lose trust in a business if their data is exposed due to a cyber incident. 

For example, Volkswagen experienced a data leak in 2021, causing loss of customer information like license numbers, loan numbers, and social insurance information ranging from 2019 to 2021. This led to negative publicity and a decline in customer loyalty for the brand in the US and Canadian markets. 

2. Financial risk

Financial risks are the worst-case scenario for strategic risks. It comes in the form of costs for data recovery, forensics investigations, legal fees, regulatory fines, and customer compensation. Additionally, this risk is linked with operational disruptions, which can lead to lost revenue. A financial services company, for example, experiencing a denial-of-service attack could lose millions in potential transactions.

3. Governance risk

Weak cybersecurity governance can increase the likelihood and impact of cyberattacks. This includes having inadequate security policies, failing to provide proper training for employees, and lacking a clear incident response plan.  

For example, an organization without a multi-factor authentication policy might be more vulnerable to phishing attacks targeting employee login credentials.

4. Regulatory risk

Many industries have regulations governing data privacy and security, such as ISO 27001, SOC 2, GDPR, etc. Non-compliance with these guidelines carries serious penalties and can sometimes even lead to imprisonment. 

For example, if you want to conduct your business in the European Union, you must comply with GDPR to protect consumers’ data, or else face fines up to 4% of your annual income. 

5. Operational risk

Operational risks are part of everyday business operations and procedures. These risks include challenges like supply chain interruptions, which disrupt daily operations, resulting in productivity losses, service outages, and delays.

Additionally, various types of risks, such as financial, governance, and regulatory risks, can also give rise to operational risks by impacting the efficiency and reliability of business processes.

6. Competitor risk

In industries where competition is very high, such as marketing, finance, SaaS, etc., there is always the risk of a rival developing a product or service with higher functionality and lower costs. This is an important strategic risk as it could cause you to lose customers. 

Furthermore, these risks can also come in the form of industrial espionage, where competitors steal valuable intellectual property to gain an unfair advantage. 

7. Economic risk

Economic risks for businesses can emerge from factors like inflation, recessions, trade disputes, exchange rate fluctuations, political instability, and natural disasters. To mitigate these, companies should diversify their customer base across different regions, and maintain flexible pricing models.

8. Political risk

Political risks arise from the possibility that political events or instability in a country can negatively impact a business’s operations and profitability. It’s a complex issue encompassing various factors like geopolitical tensions, corruption, or evolving government policies. 

For example, recently, in the political tensions between Russia and Ukraine, Russia was involved in distributed denial of service (DDoS) attacks in Ukraine. The National Cyber Security Centre (NCSC) is almost certain that the GRU was behind the DDoS incidents.

9. Change risk

Change risk leads to a potential negative impact on a business due to internal or external changes. These include shifting customer expectations, mergers and acquisitions, changes in internal policies, etc. 

What does the future of strategic risk management hold?

The future of strategic risk management lies with the advancement of technology and automation. The increasing use of automation powered by Artificial Intelligence (AI) and Machine Learning (ML) libraries, along with data analytics in risk management software, paves the way toward more accurate risk predictions, real-time monitoring, and proactive mitigation strategies.

Your enterprise risk management strategy (ERM), coupled with strategic risks, highly benefits from data analytics software that can compute large amounts of data in minimal time. It makes the work of risk managers easier by identifying trends, patterns, and potential risk factors. This enables them to make better decisions regarding ERM.  

A shift towards automation in strategic risk management practices holds further benefits such as:

• Increasing ROI: More accurate risk predictions and proactive mitigation lead to better financial outcomes.
• Reducing cost: Automation and efficient data processing lower operational and risk management costs.
• Saving time: Real-time monitoring and quick data computation reduce the time needed for risk assessment.
• Improving decision-making: Identifying trends and patterns enhances strategic planning and risk management along with better decision-making.
• Allocating resources better: Focus on high-priority risks enables the effective use of resources.

5 key tools & techniques for strategic risk management

Using powerful tools for risk management is important for the growing threat landscape and for keeping up with the competitive market. With these tools, organizations can better anticipate, assess, and mitigate potential risks. 

Here are five key tools and techniques for effective strategic risk management:

1. SWOT analysis

SWOT stands for Strengths, Weaknesses, Opportunities, and Threats. It’s a foundational tool used to assess an organization’s overall strategic position. 

In risk management, a SWOT analysis helps identify internal strengths and weaknesses that may influence how your organization handles risks. It also helps you identify external opportunities and threats that could pose potential risks for you or create opportunities for risk mitigation.

2. Risk registers

A risk register is a central repository for documenting all the identified risks within your organization. It usually includes details such as description of the risk, likelihood of occurrence, potential impact, mitigation strategies, and assigned owners responsible for risk management. 

Maintaining a risk register allows your organization to track your risks better while enabling communication of risks across different departments.

3. Risk heat map

A risk heat map is a visual representation of identified risks. It is typically represented in a matrix format. One of the axes of the matrix usually points to the likelihood of a risk occurring, and the other points to the potential impact (financial, reputational, operational, etc.) of that risk. 

The risk heat map is usually color-coded by its matrix cell and hence provides a quick visual overview of which risks require your immediate attention. This is predefined according to the severity of the risk. It helps prioritize risk mitigation efforts and allocate resources respectively.

4. Enterprise Risk Management (ERM) software

An ERM software combines a suite of tools to streamline and automate various aspects of the risk management process. Its features include risk identification, assessment, mitigation planning, scenario analysis, reporting, and data analytics. 

ERM software helps companies that handle large amounts of data. It manages huge volumes of risk data efficiently while facilitating collaboration across departments. The most important feature is the real-time insights for efficient monitoring and decision-making. 

As compared to manual methods, ERM solutions offer improved efficiency, consistency, and data-driven risk management. Examples of ERM software include SpiraPlan, MetricStream, Archer, Auditboard, IBM, and LogicGate. 

Beyond risk management: GRC tools

GRC tools are software systems to help organizations manage and integrate their governance, risk management, and compliance processes. They streamline business-critical functions and integrate policy management, risk assessment, legal compliance, and operational efficiency. 

Using a GRC tool for strategic risk management is an excellent option as it covers almost all types of risks as discussed above. Plus, GRC tools like Sprinto are packed with automated features for breach notification alerts, reports, dashboards, control monitoring, and much more.

Sprinto integrates into your existing cloud environment and maps security controls to compliance requirements. Its dedicated risk dashboard is packed with a risk register and inherent and residual risk heat map. It gives you a live status of all the risks categorized in multiple scenarios with assigned risk owners. 

Furthermore, constant risk monitoring allows for better corporate governance, which is essential for risk management. Sprinto provides a high-level governance framework from a compliance point of view with its compliance gap reports, health reports, risk reports, and third-party/vendor insights reports. 

Frequently Asked Questions (FAQs)

1. Why is a risk management strategy important?

A risk management strategy is important because it helps organizations identify, assess, and prioritize risks, allowing them to implement measures to minimize or control the impact of potential threats. This ensures business continuity, protects assets, and enhances decision-making, ultimately contributing to the organization’s long-term success and stability.

2. What is the concept of strategic risk management?

The key concept of strategic risk management is to proactively manage risks that can impact business growth and identify opportunities that can help the organization maintain a competitive edge. It goes beyond traditional risk management and also focuses on uncertainties that arise from business decisions, regulatory changes, market dynamics and other conditions.

3. How to calculate strategic risk?

Calculating strategic risks involves calculating the business’s economic capital using the formula EC = Total Risk Amount—Expected Losses or the RAROC (risk-adjusted return on capital) method. 

4. What is the difference between strategic and operational risk?

Strategic risks are those that impact an organization’s long-term goals and strategic objectives. Operational risks arise from daily business operations and internal processes. Strategic risks include market changes, competitive pressures, and economic downturns. In contrast, operational risk includes system failures, human errors, fraud, and supply chain disruptions.

5. What are the four strategies to manage risks?

1. Avoidance: Eliminating the risk by discontinuing the activities that generate it.
2. Reduction: Implementing measures to reduce the likelihood or impact of the risk.
3. Transfer: Shifting the risk to another party, such as through insurance or outsourcing.
4. Acceptance: Acknowledging the risk and deciding to accept its potential impact without taking specific actions to mitigate it.

6. What are some strategic risk management examples?

Strategic risk management examples include:

• Diversifying investments
• Implementing strong cybersecurity measures
• Developing contingency plans
• Conducting regular risk assessments
• Establishing a crisis management team