CHAPTER ONE

RISK AND RELATED CONCEPTS

Introduction
As supply chains become more complex and risk occurrence becomes potentially more costly,
the importance of risk management continues to increase. Increasingly, there are formal roles
devoted to risk management, or risk management is becoming a formal responsibility of existing
supply chains‟ material and operational management roles. This trend stems from the rising
visibility of supply chain risk. The natural disasters the world has seen in recent years, as well as
increasing information technology capability, has demonstrated to business management the
rewards available through the practice of improved risk management

Due to imperfect knowledge about the future, our activities are likely to result in outcomes,
which are different from our expectations. These deviations are not desirable. Risk is undesirable
outcome that exists due to imperfect foresight about the future. The future is always uncertain
and no one can be perfect about the future.

The more knowledgeable the person is, the more certain it will be concerning the future events.
However, the disappointing phenomenon is that perfect foresight about the future is something
impossible. Thus, risk becomes a fact that always remains side by side with human being
activities.

1.1.DEFINITION OF RISK
There is no one universal and comprehensive definition of risk that exists so far. It is defined in
different forms by several authors with some differences in the wordings used. The essence,
however, is very similar. Some of the definitions are shown below:
 Risk is a condition in which there is a possibility of an adverse deviation from a
desired outcome that is expected or hoped for.
 Risk is the objectified uncertainty as to the occurrence of an undesired event.
 Risk is the possibility of an unfavorable deviation from expectations; it is the
possibility that something we do not want to happen will happen or something that we
want to happen will fail to do so.

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  Risk is the variation in the outcomes that could occur over a specified period in a
given situation.
 Risk is the dispersion of actual from expected results.

From the above mentioned and other definitions of risk, we can infer that risk is undesired
outcome or it is the possibility of loss. The important point is there should be more than one
outcome for the risk to happen, i.e. there will be no risk if there is only one outcome. This is
because it is certain that only one outcome will take place. The absence of risk in this case
implies that the future is perfectly predictable. Variations in the possible outcomes, then, lead to
the existence of risk; and the greater the variability, the greater the risk will be.

1.2.SUPPLY CHAIN RISK DEFINED

Supply chain management is responsible for the movement of materials all the way from initial
suppliers through to final customers. Supply chain risk appears as any event that might affect this
movement and disrupt the planned flow of materials.

“There are risks in the supply chain when unexpected events might disrupt the flow of materials
on their journey from initial suppliers through to final customers”.

These risks might prevent deliveries, cause delays, damage goods or somehow affect smooth
operations. But these initial effects are only a beginning, and the consequences are generally
much broader. A late delivery of raw materials might halt production; it might raise costs by
forcing a move to alternative transport, materials or operations; it might raise stocks of work in
progress; it might make partners reconsider their trading relationships.

An interruption to the supply chain can have widespread effects, noting that shareholder return
typically falls by 7–8 per cent on the day that a disruption is announced, operating income falls
by 42 per cent and return on assets is down by 35 per cent. There are basically two kinds of risk
to a supply chain: 1) internal risks that appear in normal operations, such as late deliveries,
excess stock, poor forecasts, financial risks, minor accidents, human error, faults in information
technology systems, etc; and 2) external risks that come from outside the supply chain, such as

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earthquakes, hurricanes, industrial action, wars, terrorist attacks, outbreaks of disease, price rises,
problems with trading partners, shortage of raw materials, crime, financial irregularities, etc

Logistics managers are under continuing pressure to improve the efficiency of their supply
chains. For instance, they might remove stocks and use just-intime (JIT) operations. But JIT
illustrates the way that improving efficiency can also increase risks. In the past the effects of a
minor event, such as a late delivery, could be absorbed by stocks – but now it can stop operations
and bring an entire supply chain to a standstill. By removing slack from supply chains, managers
are also making them more vulnerable – sometimes described as „taut‟ or „brittle‟.

Some years ago Chartered Management Institute surveyed 440 firms to see how their attitudes to
risk had changed in the last six years and found that „concern is almost universally higher across
a broad range of threats‟. The percentage of firms worried about disruption of the supply chain is
clearly rising – even though the numbers that have actually experienced disruption is falling. A
dominant feature of supply chains is that all members are linked together, and a risk to one is
automatically transferred to all other members. For instance, when one key supplier goes out of
business, it is not just its immediate customers that are affected, but all other members of the
chain. When a manufacturer stops production, all the upstream tiers of suppliers are affected
back to the original suppliers. You can see the way that supply chain risks ripple around the
world with the 2003 outbreak of SARS, or bird flu. This was largely contained to southern China
and Hong Kong, but restrictions on travel disrupted business operations as far away as Toronto
and London. Similarly, in 2005 hurricanes Katrina and Rita both hit oil refineries in the Gulf of
Mexico, but the consequent fears of fuel shortages raised prices around the world.

Despite the obvious impact of supply chain risk, this is a new topic that has received very little
attention. In the past few years organizations have started making some progress in the area,
largely motivated by the terrorist attack on New York‟s World Trade Center – now universally
known as „9/11‟. All supply chains face risks of many different kinds, and the flow of materials
is much more likely to be disrupted by an unreliable supplier. Managers can control many of
these risks, and the key point is that they should not wait to see what damaging events occur and
then start thinking about their response. Instead, they should be proactive, identifying potential

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risks and planning their responses in advance. Then they are prepared and can take immediate
action when an unexpected event actually occurs.

1.3.RISK VS UNCERTAINTY
Many textbooks use the terms risk and uncertainty interchangeably. However, the distinction
between the two must be noted. The “risk versus uncertainty” debate is long-running and far
from resolved at present. Although the two are closely related, quite many authors make a
distinction between the two terms. Uncertainty refers to the doubt as to the occurrence of a
certain outcome. It is more of subjective belief. Subjective in a sense that it is based on the
knowledge and attitudes of the person viewing the situation and as the result different subjective
uncertainties are possible for different individuals under identical circumstances of the external
world.

Knight defined “risk” as a measurable uncertainty that can be determined by objective analysis
based on prior experience and “uncertainty” as un-measureable uncertainty that is of a more
subjective nature because it is without precedent. Risk is dealt with every day by weighing
probabilities and surveying options, but uncertainty can be debilitating, even paralyzing, because
so much is new and unknown. The practical difference between the two categories, risk and
uncertainty, is that in the risk the distribution of the outcome in a group of instances is known
either through calculation a priori or from statistics of past experience; while in the case of
uncertainty this is not true, the reason being in general that it is impossible to form a group of
instances, because the situation dealt with is in a high degree unique.

Preffer has noted the difference between risk and uncertainty as “Risk is a combination of
hazards and is measured by probability; uncertainty is measured by the degree of belief. Risk is a
state of the world; uncertainty is a state of the mind.”

In general, many authors indicated that risk is objective phenomenon that can be measured
mathematically or statistically. It is independent of the individuals belief. Whereas, uncertainty is
subjective that cannot be measured objectively. Of course, risk and uncertainty may have some
relationship. Uncertainty results from the imperfection of knowledge of mankind of predicting

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the future. The higher the lack of knowledge about the future the higher the uncertainty. But, it is
debatable to say that higher uncertainty leads to higher risk. The presence and absence of
uncertainty does not necessarily mean the presence and absence of risk respectively. The
following four situations underscore the difference between risk and uncertainty:

1. Both risk and uncertainty are present

eg. a person working in an assembly line may be exposed to risk of disability and may
experience uncertainty
2. Both risk and uncertainty are absent
eg. In old times people believed that earth is flat; at present it is proved to be round.
So now there is no risk of falling off the edge of the earth and no uncertainty.
3. Risk is present and uncertainty absent
eg. The possibility of loss due to interruption of operation by fire. There may be no
uncertainty because of failure to recognize the existence of such risk, understatement
of the situation or because of preoccupation with other problems.
4. Risk absent but uncertainty present
eg. An hour ago, a man heard that a plane departing from the airport crashed. The man
knows that his wife was scheduled to fly from the airport earlier today, but he does
not know whether she was on the plane crashed. Here there is no risk as risk refers to
future outcomes. However, there is uncertainty since it relates to past, present and
future situations. He is uncertain about: Is that the plane facing the crash? or Is she
alive or not? etc.

Hence, from the discussions above it is clear that risk is primarily objective while uncertainty
relates to the subjective sate of mind. Moreover, there may not be any necessary relationship
between risk and uncertainty. Risk exists whether or not a person is aware of it. It is a state of the
world. Uncertainty, however, exists only with awareness; it is a state of mind. For example, the
risk of cancer from cigarette smoking existed the moment cigarettes are produced. However, the
uncertainty did not arise until the relationship between cigarette smoking and cancer is
established through scientific and empirical research.

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Generally, it is possible to conclude that although there is relationship between risk and
uncertainty, they are different practically.

1.4.SOURCES OF SUPPLY CHAIN RISK

In the simplest form, supply chain risks refer to the possibility and effect of a mismatch between
supply and demand as well as its associated characteristics. The observed „Risk sources‟ are the
environmental, organizational or supply chain-related variables which cannot be predicted with
certainty and which impact on the supply chain outcome variables. The predictable Risk
consequences are the focused supply chain outcome variables like e.g. costs or quality, i.e. the
different forms in which the variance becomes manifest.

The supply chain risks could be in the form of delays of materials from suppliers, large forecast
errors, system breakdowns, capacity issues, inventory problems, and disruptions. The
classification provided by some authorities categorized supply chain risks into operations and
disruptions risks. In the case of operations risks, uncertainties inherent in a supply chain plays
more critical role, which include demand, supply, and cost uncertainties while disruption risks
are those caused by major natural and man-made disasters such as flood, earthquake, tsunami,
and major economic crisis.

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Risks external to the corporation can be summarized as follows:
 Demand risk relates to potential or actual disturbances to the flow of product,
information and cash, emanating from within the network, between the focal firm and its
market. It is interesting to note that during the current downturn disruptions in the cash
resource within the supply chain has had a major impact on the operating capability of
organizations.
 Supply risk is the upstream equivalent of demand risk; it relates to potential or actual
disturbances to the flow of product or information emanating within the network,
upstream of the focal firm. In a similar way to demand risk the disruption of key
resources coming into the organization can have a significant impact on the
organization‟s ability to perform.
 Environmental risk is the risk associated with external and, from the firm‟s perspective,
uncontrollable events. The risks can impact the firm directly or through its suppliers and
customers. Environmental risk is broader than just natural events like earthquakes or
storms. It also includes, for example, changes created by governing bodies such as
changes in legislation or customs procedures.

Risks internal to the corporation relate both to how the firm addresses the external risks and its
competences to plan and execute its own business:
 Processes are the sequences of value-adding and managerial activities undertaken by the
firm. Process risk relates to disruptions to key business processes that enable the
organization to operate. Some processes are key to maintaining the organization‟s
competitive advantage while others may underpin the organization‟s activities. It is
important to recognize and classify the importance of the various processes to enable
effective risk management strategies to be implemented.
 Controls are the assumptions, rules, systems and procedures that govern how an
organization exerts control over the processes and resources. In terms of the supply chain
they may be order quantities, batch sizes, safety stock policies, etc., plus the policies and
procedures that govern asset and transportation management. Control risk is therefore the
risk arising from the application or misapplication of these rules.

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  Mitigation is a hedge against risk built into the operations themselves and, therefore, the
lack of mitigating tactics is a risk in itself. Mitigation needs to be considered during the
supply chain design process – if this is not undertaken the risk profile can be increased.
 Contingency is the existence of a prepared plan and the identification of resources that
can be mobilized in the event of a risk being identified. This requires all stakeholders
within the supply chain to understand what resources can be mobilized and the
procedures to do this.

1.5.IMPORTANCE OF SUPPLY CHAIN RISK MANAGEMENT

Any supply chain that invests in a risk management system stands to benefit in a multitude of
ways. Beyond the ability to recognize threats, create plans to deal with them, and establish steps
to resolve conflict, a supply chain risk management system offers the company multiple ancillary
benefits.

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Creates a System of Best Practices
Best practices in any industry are created to establish a series of controls or procedures for
ensuring quality, reducing errors, or maintaining compliance with regulations. At its core, this is
the primary objective of a good risk management system. When a professional 3PL begins
the risk management audit, they discover areas of strength, weakness, waste, and organizational
structure. Once the risks are discovered, they‟re able to create best practices for supply chain
management to mitigate these hurdles.

Improves Communication
Multiple risks can be resolved through improvements in communication. Supply chain
management depends on seamless communication, to ensure all parties are aware of changes,
delays, or unforeseen service disruptions. The supply chain risk management system gives
stakeholders the right communication tools – whether it‟s cloud-based, SMS text, email, or
desktop alerts – or updated tracking solutions for improved visibility, transparency and supply
chain management.

Respond Quicker & Maintain Operations

When a natural disaster strikes, those with a plan in place to deal with the unexpected are those
who respond quickly and maintain business operation. Your customers, vendors, distributors,
and retailers depend on your commodities delivered quickly and without delay. While most
people understand that accidents or natural disasters can happen, those who are ahead of the
game are those likely to succeed when others fail. A company that understands their threats and
has a plan to eclipse those risks are the ones who succeed in business. The supply chain is filled
with hurdles, from weather to self-inflicted problems.

Having a professional 3PL oversee the risk management process can greatly benefit a company
in multiple ways including:
 Verifying that product development, production, fulfillment, and final delivery is
functioning at peak efficiency
 Reducing the potential of profit loss by discovering risks early
 Responding quickly to unexpected situations or events based on planning and execution

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  Providing safeguards to protect your brand‟s reputation
 Improving customer support and satisfaction
 Staying ahead of regulatory issues
 Ensuring your supply chain company is investing in technology solutions that make sense
 Creating a blueprint for dealing with unexpected challenges with reduced delays or
expenses

1.6.TYPES OF SUPPLY CHAIN RISK

Risks to the supply chain consist of anything that might interrupt the smooth flow of materials.
You can see an immediate problem here, as there are a huge number of possible risks that can
appear in almost endless variety. Most things can appear as a risk to the supply chain, and
managers comment that when you put „risk‟ after any other business word you find something
else to worry about.

So a more detailed view of supply chain risk can describe risks as internal risks, which either are
inherent or arise more directly from management decisions, risks within the supply chain, or
risks in the external environment:
 Internal risks arise from operations within an organization. They might be: – inherent
risks in operations (such as accidents, the reliability of equipment, loss of an information
technology system, human errors and quality issues); – risks that arise more directly
from managers‟ decisions (such as the choice of batch sizes, safety stock levels, financial
problems and delivery schedules).
 Supply chain risks are external to the organizations, but within the supply chain. These
occur from the interactions between members of the supply chain, and are principally: –
 risks from suppliers: reliability, availability of materials, lead times, delivery
problems, industrial action, etc
 risks from customers: variable demand, payments, problems with order
processing, customized requirements, etc.
The main causes of these risks are inadequate cooperation between members and
lack of visibility.

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  External risks are external to the supply chain and arise from interactions with its
environment – including accidents, extreme weather, legislation, pressure groups, crime,
natural disasters, wars, etc.

Other classifications
This classification of internal and external risks is only one option, and we can look at them in
several different ways. An alternative is to consider risks to the three related flows of materials,
money and information in a supply chain, and then add a fourth type of risk based on the ways
that these flows are organized:
1. Physical risks are associated with the movement and storage of materials – and include
risk to transport, storage, delivery, material movement, inventory systems, etc. These
risks typically appear as late deliveries, interrupted transport, damage to goods, shortage
of stock, missing products, accidents and so on.
2. Financial risks are associated with the flows of money – and include risks to payments,
cash flows, debt, investments, accounting systems, etc. These risks appear as poor returns
on investment, excessive costs, unpaid bills, shortage of cash, missing accounts and so
on.
3. Information risks are associated with the systems and flows of information – and include
data capture and transfer, integrity, information processing, market intelligence, system
failure, etc. These risks appear as missing data, errors in information, and breaches of
data security, systems failure, and incorrect transactions and so on.
4. Organizational risks arise from the links between members of the supply chain – and
include relationships between suppliers and customers, alliances, shared benefits, etc.
These risks appear as poor communications, lost customers, problems with supplies,
disagreements over contracts, legal disputes, et
5. Strategic – arising from strategic decisions made within organizations that directly
increase the risk ;
6. Natural – arising from unforeseen natural events such as extreme weather, lightning,
earthquakes, flood, landslides or outbreaks of diseases;
7. Political – such as government instability, new legislation, regulations, policies, permits,
treaties, customs barriers, conflicts or wars;

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8. Economic – from the broad economic environment, including interest rates, inflation,
currency exchange rates, taxes and growth;
9. Physical – risks to buildings and facilities, such as traffic accidents, equipment failure,
congestion or limited capacity;
10. Supply – all issues with the movement of materials into an organization, including
sources, supply market conditions, constraints, limited availability, supplier reliability,
lead times, material costs, delays, etc;
11. Market – all aspects of customer demand, such as level of demand, variability, alternative
products, competition and patterns of change;
12. Transport – for all movements of materials, including risks to the infrastructure, vehicles,
facilities and loads;
13. Products – risks arising from product features, including technology used, innovation,
product mix, range, volumes, materials used and standardization;
14. Operations – arising from the nature of activities in the organization, type of process,
complexity, technology, special conditions, after-sales service, etc;
15. Financial – all money transactions, including payments, prices, costs, sourcing of funds,
profit and general financial performance;
16. Information – including the availability of data, data transfer, accuracy, reliability,
security of systems, etc;
17. Organization – arising from the way the organization works, including its structure,
disputes, types of interactions, subcontractors, communication flows, culture, etc;
18. Management – and risks arising from their knowledge, skills, experience, decisions, real
aims, etc;
19. Planning – risks from the design and execution of plans for operations, including
mismatch between supply and demand, inadequate detail, missed constraints, poor
forecasting, lack of synchronization, etc;
20. human – from all the complex interactions between people, including working
requirements, aims, culture, human errors and industrial action;
21. technical – and new technology in processes, communications, new products, process
designs and reliability;

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 22. criminal – arising from all illegal activities, such as theft, fraud, bribery, vandalism and
terrorism;
23. safety – to people and facilities, including accidents, hazardous substances and fire;
24. environment – eg pollution, use of resources, traffic and regulations;
25. local permits – usually administered by local government and including planning
permissions, land use, local policies, grants, etc

1.7.RISK VS PROBABILITY
It is necessary to distinguish carefully between risk and probability. Probability refers to the
long-run chance of occurrence, or relative frequency of some event. Risk, as differentiated from
probability, is a concept in relative variation. We are referring here particularly to objective risk.

The probability associated with a certain outcome is the relative likelihood that outcome will
occur. And probability varies between 0 and 1. If the probability is 0, that outcome will not
occur, if the probability is 1, that outcome will occur.

Probabilities are generally assigned to events that are expected to happen in the future. There
may be a number of possible events that will take place under given set of conditions; and these
events may occur in equal or different chance of occurrence. The weights given to each possible
event may depend on prior knowledge, past experience, statistical or mathematical estimation of
relevant data or psychological belief. Thus, to each possible event is assigned a corresponding
probability of occurrence that leads to probability distribution. This means that probability
relates to a single possible event.

Risk on the other hand refers to the variation in the possible outcomes. This means that risk
depends on the entire probability distribution. It indicates the concept of variability. Therefore,
the concepts of risk and probability are two different things.

The following example illustrates the distinction between risk and probability. Suppose the
occurrence of a particular event is to be considered. One extreme is that this event is certainly to
take place. Thus, the probability that this event will take place is 1. There is certainty as to the

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occurrence of this event with prefect foresight in this regard. Accordingly, there is no risk. The
other extreme is that the event will not take place at all. Hence, the probability of occurrence is
zero. Here, too, there is certainty and therefore, there is nor risk. In between these two extremes
there could be several occurrences of the events with the corresponding probabilities of
occurrence. It is therefore; risk and probability are different but related concepts.
Probability The concept of risk is based on the probability of an event – where probability is a
measure of likelihood, relative frequency or proportion of times an event occurs. When you toss
a coin it comes down heads half the time and tails half the time, so you can say, „The probability
that a fair coin comes down heads is 0.5.‟ A pack of playing cards has 52 cards, 13 of which are
hearts, so the probability that a card chosen at random is a heart (or any other suit) is 13/52 =
0.25. As the probability of an event is the proportion of times that it occurs, it can only take a
value in the range 0 to 1.

 Probability = 0 means the event will never occur.

 Probability = 1 means the event will always occur.
 Probability between 0 and 1 gives the relative frequency or likelihood.
 Probabilities outside the range 0 to 1 have no meaning.

An event with a probability of 0.9 is quite likely (it happens 9 times out of 10); an event with a
probability of 0.5 is equally likely to happen as not; an event with a probability of 0.1 is quite
unlikely (it happens once in 10 times). There are three ways of finding probabilities for events:

 Calculation. You can use your knowledge of a situation to calculate theoretical or a

priori probabilities

The probability that two people share the same birthday is 1/365 (ignoring leap years). This
is an a priori probability calculated by saying there are 365 days on which the second person
can have a birthday and only one of these corresponds to the birthday of the first person.

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  Observation. You can use historical data to see how often an event actually happened in
the past, and use this information to give an experimental or empirical probability

 Subjective estimates. This third approach is not really recommended, as it asks for
people‟s opinions about the likelihood of an event. For instance, you might ask a finance
department for a probability that a currency exchange rate will fall by more than 10 per
cent next year. These personal estimates may be good enough to help with decisions, and
they are the only option when there are no relevant data. Unfortunately, they are
notoriously unreliable as they rely on people‟s judgment and opinions – as well as their
ignorance, bias, lack of skills, prejudice and so on. You should always treat subjective
estimates with caution.

1.8.DISTINCTION OF RISK, PERIL AND HAZARD

The concepts of risk have already been defined above. Two concepts, peril and hazard must be
distinguished from risk. Although, the three concepts have one common feature in transmitting
bad taste or feeling, they are differentiated as follows:
Peril: - refers to the specific cause of a loss. For example, fire, windstorm, theft, explosion, flood
etc. therefore, the source or cause of a loss is called a peril.
Hazard: - refers to the condition that may create or increase the chance of a loss arising from a
given peril. Hazard affects the magnitude and frequency of a loss. The more hazardous
conditions are, the higher the chance of loss. There are three categories of hazards:

1. Physical Hazard: - This is associated with the physical properties of the item exposed to risk.
Examples of physical hazard include the following:
 Type of construction material such as wood, bricks, etc

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  Location of property such as near to fuel station, near to flood area, near to earthquake
area, etc.
 Occupancy of building such as dry cleaning, chemicals, supermarket etc.
 Working condition such as machines for personal accidents.etc.
2. Moral Hazard: - This originates from evil tendencies in the character of the insured person. It
is associated with human nature, qualities, reputation, attitude, etc. examples include the
following:
- dishonesty, fraudulent intention, exaggeration of claims, etc …
3. Morale Hazard: - This originates from acts of carelessness leading to the occurrence of a
loss. It occurs due to lack of concern for events. Examples are:
 Poor housekeeping in stores
 Cigarette smoking around petrol stations. etc.

In some situations, however, it is difficult to distinguish between a peril and a hazard. Fore
example, a fire in general may be regarded as a peril concerning the loss of physical property. It
may also be regarded as a hazard concerning auto collisions created by the confusion in the
vicinity of the fire (around the fire).

1.9.CLASSIFICATION OF RISK

Risk can be classified in several ways according to the cause, their economic effect, or some
other dimensions. The following summarizes the different ways of classifying risks.
1. Financial Vs Non-financial risks
This way of classification is self explanatory. Financial risks result in losses that can be
expressed in financial terms. Non-financial risk does not have financial implication. For
example, loss of cars (property) is a financial risk, and death of relatives is a non-financial risk.
2. Static Vs Dynamic risks
Dynamic risks originate from changes in the over all economy which are associated with such as
human wants, improvements in technology and organization (price changes, consumer taste

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changes, income distribution, political changes, etc.). They are less predictable and hence beyond
the control of risk managers some times.
Static risks, on the other hand, refer to those losses that can take place even though there were no
changes in the over all economy. They are losses arising from causes other than changes in the
overall economy. Unlike dynamic risks, they are predictable and could be controlled to some
extent by taking loss prevention measures.
3. Fundamental Vs Particular risks
Fundamental risks are essentially group risks; the conditions, which cause them, have no relation
to any particular individual. Most fundamental risks are economic, political or social.
Particular risks are those due to particular and specific conditions, which obtain in particular
cases. They affect each individual separately. They are usually personal in cause, almost always
personal in their application. Because they are so largely personal in their nature, the individual
has certain degree of control over their causes.
Thus, fundamental risks affect the entire society or a large group of the population. They are
usually beyond the control of individuals. Therefore, the responsibility for controlling these risks
is left for the society it self. Examples include: unemployment, famine, flood, inflation, war, etc.
Particular risks are the responsibility of individuals. They can be controlled by purchasing
insurance policies and other risk handling tools. Examples include: property losses, death,
disability, etc.
4. Objective Vs Subjective risks
Some authors classify risk in to objective and subjective. These two types of risk are also
mentioned as measurable and Non-measurable risk. Objective risk has been defined as “the
variation that exists in nature and is the same for all persons facing the same situation”. it is the
state of nature (world). However, each individual‟s estimate of the objective risk varies due to a
number of factors. Thus, the estimate of the objective risk which depends on the person‟s
psychological belief is the subjective risk. The problem, however, is that it is difficult to obtain
the true objective risk in most business situation.
The characteristics of objective risk are that it is measurable. In other words, it can be quantified
using statistical or mathematical techniques.
5. Pure Vs Speculative risks

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The distinction between pure and speculative risks rest primarily on profit/loss structure of the
underlying situation in which the event occurs. Pure risks refer to the situation in which only a
loss or no loss would occur. There are only two distinct outcomes: loss or no loss. They are
always undesirable and hence people take steps to avoid such risks. Most pure risks are
insurable. Pure risks are further classified in to three categories: personal risk, property risk, and
liability risk.
i. Property risk
This refers to losses associated with ownership of property such as destruction of property by
fire. Ownership of property puts a person or a firm to property exposure, i.e. the property will be
exposed to a wide range of perils.

ii. Personal risk

This refers to the possibility of loss to a person such as death, disability, loss of earning power,
etc. There are losses to a firm regarding its employees and their families. Personal risks may
arise due to accidents while off duty, industrial accident, occupational disease, retirement,
sickness, etc. Generally, financial losses caused by the death, poor health, retirement, or
unemployment of people are considered as personal losses. Either the workers and their families
or their employers may suffer such losses.

iii. Liability risk

The term liability is used in various ways in our present language. In general usage, the term has
become synonymous with “responsibility” and involves the concept of penalty when a
responsibility may not have been met. A person may be generally obligated to another, because
of moral or other reasons, to do or not to do something; the law, however, does not recognize
moral responsibility alone as legally enforceable. One would be legally obliged to pay for the
damage he/she inflicted upon other persons or their property.

Speculative risks, on the other hand, provide favorable or unfavorable consequences. The
situation is characterized by a possibility of either a loss or a gain. People are more adverse to
pure risks as compared to speculative risks. In speculative risk situation, people may deliberately
create the risk when they realize that the favorable outcome is so promising. Speculative risks are

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generally uninsurable. For example, expansion of plant, introduction of new product to the
market, lottery, and gambling.

Both pure and speculative risks commonly exist at the same time. For instance, accidental
damage to a building (pure risk) and rise or fall in property values caused by general economic
conditions (speculative risk). Risk managers are concerned with most but not all pure risks.

RISKS RELATED TO BUSINESS ACTIVITIES

Most risks in business environment are speculative in nature. The finance literature considers
five types of risks that business organizations face in the course of their normal operation:
business risk, financial risk, interest rate risk, purchasing power risk, and market risk.

1. Business Risk: - This the risk associated with the physical operation of the firm. Variations in
the level of sales, costs, profits, are likely to occur due to a number of factors inherent in the
economic environment. Business risk is independent of the company‟s financial structure.
2. Financial Risk: - This is associated with debt financing. Borrowing results in the payment of
periodic interest charge and the payment of the principal upon maturity. There is a risk of default
by the company if operations are not profitable. Other financial risks include: bankruptcy, stock
price decline, insolvency, etc. Bond holders are less exposed to financial risk than common stock
holders because they have a priority claim against the assets of an insolvent firm.
3. Interest Rate Risk: - This is a risk resulting from changes in interest rates. Changes in interest
rates affect the price of financial securities such as the price of bonds, stock, etc---
4. Purchasing power Risk: - This risk arises under inflationary situations (general price rise of
goods and services) leading to a decline in the purchasing power of the asset held. Financial
assets lose purchasing power if increased inflationary tendencies prevail in the economy.
5. Market Risk: - Market risk is related to stock market. It refers to stock price variability caused
by market forces. It is the result of investor‟s reactions to real or psychological expectations. The
market in many cases, is also affected by such events like presidential election, trade balances,
wars, new inventories, etc. market risk is also called systematic or non diversifiable risk. All
investors are subject to this risk. It is the result of the workings of the economy; and cannot be
eliminated through portfolio diversification.

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Summary
Risk is generally viewed as the chance that an unexpected event can harm an organization. In
practice, there are many types of risk to the supply chain, ranging from minor inconveniences of,
say, a late payment through to the complete destruction of the chain in a natural disaster. The
basic process of risk management The idea of positively managing these risks is new, even
though logistics managers have traditionally used standard methods to mitigate the most obvious
effects (such as high stocks and spare capacity).

More usually, managers tend to ignore risks to the supply chain and make a reactive response
when an unforeseen event actually occurs. The problem is that this reactive approach is too slow,
and a lot of harm can be done before it begins to have an effect. A better approach to risk
management is proactive, analyzing likely events before they occur and planning steps to
mitigate their effects. In principle, managers should take a balanced view of risk, but they tend to
be pessimistic and focus on the negative impact. As we do not know exactly what will happen in
the future, there is always risk to operations.

We can develop analyses for this based on the standard features of decisions. In particular, we
can categorize the doubts about future events as certainty, uncertainty, risk and ignorance. With
certainty we know exactly which event will occur; with uncertainty we can list possible events
but not give them probabilities; with risk we can add probabilities; with ignorance we cannot
even list the possible events. Different analyses deal with each level of uncertainty, but the most
common use expected values to deal with risk.

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