Academic journal article Journal of Management Information and Decision Sciences

Managing Risk in Operations

Academic journal article Journal of Management Information and Decision Sciences

Managing Risk in Operations

Article excerpt

ABSTRACT

Risk is an intrinsic part of business in a market economy. The ability to control risk in operations is essential to productivity and profitability. Typically, actions to control operational risk and its effects are the result of an ad hoc process, adopted without a comprehensive analysis of alternatives. Risk mitigation in supply chains requires closer analysis since coordination across multiple organizations is required. Effective risk management requires an assessment of both the locus of control and the range of alternative control actions. We describe the nature of operational risk, its locus, and present a taxonomy of mitigation tactics. We observe that operations adopt a mix of control actions and that this mix must evolve in response to changes in the environment. Finally, we present a discussion of the issues and processes required to revise the mix of risk mitigation tactics.

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Risk is defined in a variety of ways, depending on context and the presumed interest of the reader. Amram & Kulatilaka (1999) assert, "The adverse consequence of a firm's exposure is risk." Mandel (1996) employs two broad categories for risk: idiosyncratic and structural. Idiosyncratic risks affect a single company while structural risks affect economies, sectors or industries. Usual treatments of risk (Weston & Copeland, 1998) address market risk, financial risk, and business risk. Business risk is the combination of revenue risk and operating leverage, that is, the variability of EBIT (earnings before interest and taxes) and the ratio of fixed costs to total costs.

Notions about the inevitability of, and appropriate response to, risk vary around the world. In economies that practice Strategic Trade (as contrasted to Free Trade), risk is viewed as inherently bad and economic policy and governmental action are devoted to reducing risk and variability in markets, (Fallows, 1994). State capitalism (Bremmer, 2010) exhibits similar characteristics. Significant inefficiencies typically result. At the firm level, excessive attention to risk can result in overspending on risk reduction with corresponding reductions in operating margins. Excessive inventories are a common and visible manifestation of this phenomenon.

As our interest centers on operations in the organization, we apply the treatment suggested by Weston & Copeland (1998), and recognize operational risk as a major source of variability in EBIT. Risk in Operations arises from internal variation and from the environment.

Further, risk may be due to either common or special causes (Deming, 1982). In the following, we provide a structure for categorizing the ways in which operations can mitigate risk or its effects on the organization.

OPERATIONS

We define Operations as revenue-producing activities carried out by the firm, specifically, those activities that 'deliver' the value proposition of the enterprise. The measure of the performance of an operation is its productivity. Economic theory defines productivity as (McConnell, 2008):

Productivity = output/ inputs (1)

In this form, the equation is may be applied to a firm, an industry, a sector of an economy, or an entire economy. As defined, output and inputs are flow rates stated in physical terms. Converting the equation to "per period" terms moves towards a construct useful to the manager and establishes consistency with accounting convention. Converting inputs and output to their monetary equivalents illustrates the relationship between Productivity and EBIT. Output monetized is revenue and current inputs become COGS (Cost of Goods Sold). Variability in productivity relates directly to variability in EBIT.

Typically, discussions of productivity proceed with a focus on the partial factor productivity of labor (output stated in terms of labor input). Eschewing this direction, we pursue a path that acknowledges the variety of inputs and has the objective of developing the relation between productivity and the managerial decisions that affect it. …

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