How to Calculate the Impact and Probability of Business Risk

I was recently asked to explain the “Impact Score” in a Strategic Risk evaluation process. This is easy to do with a tool called the Strategic Risk Severity Matrix.

In this post, I’ll walk you through each step of using this tool, along with a practical example to demonstrate how it works.

Why Does Severity Matter?

There are many reasons for evaluating the degree of vulnerability (or potential vulnerability) in a business:

  1. Maybe you are wondering whether you should simply monitor a problem, conduct an investigation, or stop all activity in order to manage a critical problem.
  2. You may have an intuitive feeling that something is not right, but you want to prove this with data that corroborates your gut feeling.
  3. You might need to convince others to take action (by your business partners or Board of Directors), so you’re looking for evidence that the problem is bad enough to allocate significant funding and resources.

Whatever the reason, the Strategic Risk Severity Matrix is a fantastic tool to help you make a data-driven determination.

strategic risk, strategic planning, strategic risk severity, severity index, severity matrix, risk planning, catastrophic risk, risk probability, risk likelihood, risk impact
Grace LaConte’s Strategic Risk Severity Matrix

What Is the Severity Matrix?

The Strategic Risk Severity Matrix is a square containing 25 colored boxes in a 5×5 pattern.

On the left side, we see Impact factors, or severity if the event occurs.

Impact

Impact goes from Low (at the bottom left) to High (at the top left):

  1. Negligible — Risks have minimal damage or long-term effect (the lowest Impact)
  2. Marginal — Risks may cause minor loss but little overall effect
  3. Serious — Risks may cause considerable loss, injury, or damage
  4. Major — Risks will cause significant loss, injury, or damage
  5. Catastrophic — Risks will cause extensive damage and long-term effect (the highest Impact)
Strategic Risk, Strategic Severity, Risk Matrix, Risk Severity, Strategic Impact, Strategic Probability, impact and probability
Strategic Risk Severity Matrix (Impact circled)

On the bottom are the Probability factors, which is how we rate the likelihood that the event will happen.

Probability

Probability goes from Low (at the bottom left) to High (bottom right):

  1. Unlikely — Not expected to occur (the lowest Probability)
  2. Remote — Not expected, but possible
  3. Occasional — May occur intermittently
  4. Certain — Expected to occur eventually
  5. Frequent — Likely to occur soon and often (the highest Probability)
Strategic Risk, Strategic Severity, Risk Matrix, Risk Severity, Strategic Impact, Strategic Probability, impact and probability
Strategic Risk Severity Matrix (Probability circled)

How to Use the Strategic Risk Severity Matrix

We can use this tool to calculate whether negative outcomes will happen, and if so how destructive the effects could be.

This is done using a numbered scoring method and color-coded indicators.

Scoring

Our scoring is done when we select a level of Impact (1 to 5), and a level of probability (1 to 5).

A score is determined by the product (multiplication) of the two numbers. This number is associated with a 5-level scoring result (Controlled, Serious, Disruptive, Severe, or Critical).

Here are all the possible results:

Controlled (a score of 1 to 2) — Limited monitoring only
Serious (a score of 3 to 6) — Active monitoring
Disruptive (a score of 8 to 9) — Investigation needed
Severe (a score of 10 to 16) — Rapid action is required
Critical (a score of 20 to 25) — Immediate, crucial priority

There are 6 steps I recommend when using this tool.

Step 1: Step Back and Use Logic

First, consider your problem from a big-picture perspective.

Take a few steps back, and pretend that you’re an observer who is not emotionally tied to the situation.

Isolate the main problem.

State it as simply as possible.

Here’s an example. Let’s say you own a healthcare service business, and you notice a sudden drop in the number of customers. Upon reviewing your numbers, it is clear that several customers have decided to stop using your services.

You want to know whether this is a significant problem or one that can just be monitored.

Rather than pointing blame or trying to solve the problem right away, a better approach is to state the problem logically.

Here is what you can see objectively:

  • The overall rate of customers has dropped by 10% in the past month, from 120 active customers to 108.
  • Of the 12 customers who left, 5 were new and 7 were repeat.
  • 3 of the 12 were significantly profitable, with a high cost-to-profit ratio (they generated more sales than the cost of doing business).
  • The loss of these 3 customers is equivalent to a profit loss of 4%.
  • 5 of the 12 departing customers were difficult to work with:
    • complained frequently and loudly
    • needed a lot of reassurance
    • expected frequent phone calls and updates,
    • changed their minds a lot
    • demanded returns for services rendered
    • paid late or refused to pay
    • were rude to staff, etc.

(These are all, by the way, indicators of non-Ideal Customers.)

Step 2: Select an Impact Score

Next, we want to set a numeric equivalent for the amount of impact — the degree of negative change that will (or could) happen due to this problem.

We might consider that 5 of the 12 customers were “difficult,” and probably not our Ideal Customers.

[Read more: What to Do When You Realize Your Customer Is Not a Good Fit]customer fit, customer service, customer experience, business fit, ideal customer, ideal patient, business planning, strategic risk, risk analysis

Another consideration is what effect this shift is having on other customers, on staff, or on projected sales targets.

In our example, 3 of the 12 departing customers are highly profitable. This loss could affect future sales, especially if those were repeat customers and loyal buyers.

Note: I always suggest that you conduct a Post-Mortem Evaluation for any change in customers to find out what went wrong and why. You can also find some gems of wisdom by having an Offboarding process, where departing customers can express their complaints or reasons for leaving — this is an invaluable source of information that can be applied to decision-making.

[Read more: How to Do a Year In Review]Year in review, review of year, year-end review, end-of-year review, yearly review, yearly evaluation, year-end evaluation, retrospective evaluation, risk intelligence

A financial analysis at this point to determine the profit margins could reveal whether this problem will continue to affect sales. If you know for certain that this change will not cause tremendous long-term problems, then you could comfortably pick the 3rd level of Impact:

  1. Negligible — Risks have minimal damage or long-term effect (the lowest Impact)
  2. Marginal — Risks may cause minor loss but little overall effect
  3. Serious — Risks may cause considerable loss, injury, or damage
  4. Major — Risks will cause significant loss, injury, or damage
  5. Catastrophic — Risks will cause extensive damage and long-term effect (the highest Impact)

Step 3: Select a Probability Score

We then need to look at the chance of this happening again.

Since we haven’t fully determined the cause of 10% of our customers leaving, it is quite likely that more customers could leave as well. Without further data, we need to assume that this risk is fairly high.

Thus, we need to pick the 5th level—the highest degree of Probability:

  1. Unlikely — Not expected to occur (the lowest Probability)
  2. Remote — Not expected, but possible
  3. Occasional — May occur intermittently
  4. Certain — Expected to occur eventually
  5. Frequent — Likely to occur soon and often (the highest Probability)

Step 4: Multiply the Scores

Now we take the Impact Score of 3 and the Probability Score of 5 and multiply them:

3 x 5 = 15

Step 5: Evaluate the Results

On the graph, we can see that this square is in the orange zone (Severe).

Strategic Risk, Strategic Severity, Risk Matrix, Risk Severity, Strategic Impact, Strategic Probability, impact and probability

So our finding for this particular situation is that it has a very high probability (Frequent) and moderate impact (Serious).

A score of 15 puts this in the Severe range (a score between 10 and 16), which means rapid action is required.

Step 6: Draw Conclusions and Develop a Plan

Based on this score, we know that this problem (10% of customers departing) is having quite an effect on the health of the business.

[Read more: Analyzing Profit Margins]profit margin, profit margins, analyzing profit, profitability, business profit, net profit, financial profit, Facebook Live, FB Live, strategic risk

We also know the same thing could continue to happen unless we conduct a Root Cause Analysis (aka Post-Mortem Review) and investigate the reasons for customers who already departed.

Depending on our findings, we might decide to:

  • adjust our policies,
  • enhance communication with existing customers so they are fully aware of the circumstances,
  • educate staff, or
  • change the services and products currently being provided.

Final Thoughts

As you can see, this risk management tool is a really easy way to visualize the impact of risk. You can use it to evaluate current problems, potential future problems, or as part of a Post-Mortem to evaluate what happened in the past and how to correct it.

What do you think of this tool? Have you used strategy tools like this in your business?

If you feel frustrated with running your company and want to talk about ways to think strategically, schedule a free 30-minute consult with me today.


Grace LaConte is a Strategic Risk Expert who helps service business owners find and fix organizational vulnerabilities. Using her experience as a Risk Officer in the healthcare and technology fields, Grace shares a refreshingly honest approach to uncovering hidden risks and opportunities. Learn more at http://laconteconsulting.com, or connect with her on Twitter @lacontestrategy.

Tell us what you think!

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s