Risk management 101: What you need to know for your business

This article includes tips, suggestions, and general information. We recommend that you always do your own research and consider getting independent tax, financial, and legal advice before making any important decision.

As a business owner, it may feel impossible to pinpoint the critical responsibilities on your to-do list. But risk management may deserve a spot at the top.

Knowing how to manage risk means that you can make decisions rooted in strategy and planning rather than relying on your gut. The result? A potentially more resilient business that can more easily make decisions in the face of uncertainty.

What is risk management in business?

Risk management is the process of identifying potential risks and developing strategies that address and reduce their effects.

In the business world, risk can refer to events that may have a negative impact on your organisation. This includes credit card fraud, reversals, chargeback fraud, phishing, and data breaches. Implementing the proper protections and measures can help businesses to reduce the likelihood and/or impact of fraud and other risks.

Why is risk management important?

Without mitigating risk, businesses of all sizes are in danger of suffering serious, far-reaching consequences. These can range from financial and data losses to decreased consumer trust and loyalty.

If you receive a fraudulent payment, you may also be held financially liable for the loss. Risk management can help you to anticipate and prepare for these potential setbacks.

Types of risk

Before you can mitigate risk, it’s important to understand the common risks that businesses face, such as credit card fraud, phishing, reversals, and chargeback fraud.

Credit card fraud

Credit card fraud involves using unauthorised credit card information to make a purchase. This can occur when a fraudster steals a physical credit card, or when they obtain the card information via phishing or data breach.

Strategies that help businesses to reduce the chances of credit card fraud can include requiring a signature, photo ID verification, and card verification value (CVV) at checkout.

Phishing

Phishing or spoofing is when a scammer impersonates a reputable brand or person. It’s an attempt to gain access to sensitive data via fake emails, websites, text messages, or voicemails.

Get more strategies that help you to avoid common e-commerce scams.

Reversals

A payment reversal (sometimes called an ACH return or bank reversal) arises when a merchant is requested to reverse a transaction and return the funds to the method of payment. The request may come from the customer or the bank, and it is usually filed because of suspected unauthorised use of a bank account.

Learn more about payment reversals and how to avoid them.

Chargeback fraud

Also known as friendly fraud, chargeback fraud occurs when a customer requests a payment reversal without legitimate reason. For example, a customer may claim that a received item was not delivered in order to secure a refund.

Risk management process

The risk management process typically involves 4 steps:

1. Identify
2. Analyse
3. Treat
4. Monitor and report

Keeping a well-established risk management system in place can provide a framework that supports proactive response to various risks.

Identify

Knowing what to look for can help you to mitigate risk and protect your business. The following are common signs of unusual or scammer activity that may suggest fraud and warrant further investigation:

• The shipping address is in a country known for having a high risk of fraud

• You receive an unusually large order or large number of orders during an unusual time of day or within a short period of time

• An order consists of multiple requests for the same item

• Several orders from different customers have the same shipping address

• The billing and shipping addresses don’t match

• You receive an order linked to a suspicious email address

• A customer asks you to change the shipping address after paying for the order

Analyse

Once you’ve identified the risk, it’s time to evaluate potential consequences. A useful approach is risk quantification: assigning a numerical value to the risk based on probability, severity, or financial impact. This helps you to prioritise the risks that require your attention, and allocate the appropriate resources to those that are critical.

You can use this data to begin identifying any emerging patterns or trends in your business’s overall risk picture.

Treat

The next step is to develop and implement strategies that address the risks you’ve identified and prioritised, as well as reduce your business’s overall risk exposure.

Some treatment examples for preventing fraudulent purchases include:

• Adding authentication protocols to the checkout process

• Leveraging secure payment gateways

• Training team members to recognise common fraud indicators

• Developing clear policies around customer protection

Advertising your fraud prevention measures can also help customers to feel safe shopping at your business.

Monitor and report

Risk management is an ongoing responsibility. Continuously monitor risk by tracking key indicators and implementing tools that detect emerging risks.

The nature of risk is constantly evolving. So reporting is another critical component of your business’s risk management strategy. This involves communicating risk-related information to stakeholders, such as your management team or investors. Reporting can facilitate informed decision making and help to create accountability around mitigating risk.

Risk management techniques

Here are some common risk management techniques:

• Avoidance. Avoiding situations that pose significant risks reduces potential harm. For example, to mitigate financial risk, you might decide not to enter an unpredictable market.

• Retention. If the cost of mitigating a risk outweighs the impact, you might decide to assume the potential risk and its consequences without implementing risk mitigation tactics.

• Sharing. To reduce risk’s potential impact, you could obtain financial support from a pool of investors, rather than just a single source.

• Transferring. Like sharing, transferring involves shifting potential risk to a third party, such as a vendor.

• Loss prevention and reduction. Rather than seeking to eliminate risk, this approach entails finding opportunities to reduce losses.

2 examples of risk management (for illustrative purposes only)

Jerry’s Hats is a small e-commerce business that sells artisanal hats straight off the runway. Unfortunately, the company has recently noticed an uptick in fraudulent credit card transactions.

To address this, Jerry’s Hats implements several risk management strategies. First, the company transfers the risk by implementing a third-party payment solution that assumes responsibility for ensuring the security of customer data and payments.

Next, Jerry’s Hats invests in a comprehensive fraud prevention and detection system. This system analyses transaction data and customer behaviour to identify and alert team members about suspicious orders. By leveraging these risk management strategies, Jerry’s Hats can successfully reduce the financial impact of fraudulent transactions, protecting its bottom line and reputation.

Healthy Eats is a small business that sells meal prep kits. Throughout the past few months, Healthy Eats has noticed an increase in chargebacks, with customers reporting unauthorised transactions or “item not received” incidents. Healthy Eats can work with its payment processor to address these issues and mitigate the risk of future chargebacks.

Instead of manually investigating each complaint, Healthy Eats can rely on its payment processor to authenticate each transaction and resolve each dispute. The payment processor may even flag questionable transactions as they occur so Healthy Eats can avoid potential chargeback fees and revenue loss.

With all of its payment data securely stored and managed in a single place, Healthy Eats can also gather valuable insights about customer payments and uncover purchase patterns to help the company to mitigate future risk.

Mitigating risk for businesses

Digital fraud has outpaced physical fraud, making up 52% of overall fraud losses.⁴ In this landscape, fighting fraud can feel overwhelming. But there are steps that you can take that can help you to reduce the risk to your business:

• Monitor your accounts, transactions, and orders for suspicious activity

• Regularly review financial statements

• Use the address verification system (AVS) in your payment processing solution

• Require CVV during checkout

• Keep all systems updated and use business-grade anti-malware software

• Record transactions that you suspect may be fraudulent or risky

• Contact customers before their orders ship to confirm order details and allow them to catch any errors

Weighing the costs of risk management

Mitigating risk is fundamental for growing businesses. But it can come at a cost. Common costs associated with risk management solutions include:

• Risk management systems. The cost of acquiring tools and platforms that mitigate and address security risks.

• Real-time risk monitoring. The cost of acquiring solutions that provide 24/7 fraud prevention and payment monitoring services, such as those powered by artificial intelligence and machine learning.

• Risk management training. The cost of training and educating new employees about the importance of risk management and how to use new systems that help to mitigate risk.

• Dispute resolution tools. The cost of acquiring tools that help to flag, manage, and resolve customer disputes.

It’s important to develop risk management solutions with benefits that outweigh the costs of unmitigated risk. For example, unchecked security risks can result in hefty fees, revenue loss, and decreased customer lifetime value. Security may not be where you want to compromise.