What is the purpose of effective risk management? You might assume that the main objective is to reduce exposure to damaging downside risks, thus preventing bankruptcy or reputation loss, for instance. You would probably also agree that effective risk management should be used to support risk taking, where the rewards are sufficient to justify this – after all, no organisation can achieve its objectives without taking some degree of risk. However there is another key purpose of effective risk management that must not be forgotten – ensuring that an organisation can conduct its operations in an efficient manner.

Economists talk about two types of efficiency: ‘allocative efficiency’, where the resources required for production are used in the most efficient combination, and x-efficiency, where a given resource should work at maximum capacity to ensure full productivity. For example, an organisation may have the right combination of workers and machinery, but if the machinery breaks down or the workers go off sick, then it will not be getting the most from these ‘inputs’.

The bottom line is that risk events, even very small ones, can have a significant effect on x-efficiency and may well mean that organisations require more resources or redundancy than they really need to ensure the smooth running of their operations. Equally the over-zealous control of risk can also reduce x-efficiency – by adding to the complexity and reducing the speed of operational processes and systems.

For example, by maintaining the stability of an important IT system, an organisation can ensure that its staff are not wasting time waiting for a failed system to come back on line. Equally if too much security is built into the system then it may become overly slow.

Even in the absence of big risks, risk management can have a key operational role – helping fulfil an organisation’s objectives in the most efficient way possible. By highlighting this purpose to management you may find that it is possible to deliver short run benefits from effective risk management and win round even the most obstinate risk management sceptic.

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