Business Risk

Business risk can be defined as uncertainties or unexpected events, which are beyond control. In
simple words, we can say business risk means a chance of incurring losses or less profit than
expected. These factors cannot be controlled by the businessmen and these can result in a decline in
profit or can also lead to a loss.

Nature of Business Risk

Business risk is the possibilities a company will have lower than anticipated profits or experience a
loss rather than taking a profit. Business risk is influenced by numerous factors, including sales
volume, per-unit price, input costs, competition, and the overall economic climate and government
regulations.

1. Arises due to Uncertainties

Uncertainties mean when you are not sure of what is going to happen in future. Common examples
of uncertainties are: change in demand, government policy, technology etc. Business risk is due to
these uncertainties.

2. Essential part of any Business

A risk is an important characteristic of business. No business can avoid risk although the degree of
risk may vary Risk can be reduced but cannot be eliminated.

3. Degree of Risk Depends upon the Nature and Size of Business

The degree of risk depends upon the type of business; for example, a business involved in fashion
items bears more risk as compared to the business involved in standardized goods. Similarly, a
business operating at large scale bears more risk as compared to small-scale business houses.

4. Profit is the Reward for bearing the Risk:

The business earns a profit because they are bearing risk.”No risk no gain” larger the risk more is
the profit. An entrepreneur bears risk with the expectations of earning a profit.

Causes of Business Risk

Natural Causes

Nature is an independent phenomenon and human beings have no control over it. Natural calamities
like earthquake, flood, drought, famine etc. Affect a business a lot and can result in heavy losses.
The natural causes are such type of uncertain factors that human beings cannot make any
preparation against.
Human Causes

Human causes are related to a chance of loss due to human being or employees of the organization.
The dishonesty of employees can bring heavy losses for business e.g., the employees may leak a
business secret to a competitor and may commit fraud also bring heavy losses by wastage of
resources.

The employees may hamper the production by going on strikes, riots etc. This can also lead to
heavy loss of business condition. There can be price fluctuations in the market, there can be a
change in fashion, taste, preferences, and demands of customers

Economic Causes

Economic causes are related to a chance of loss due to change in the market. There can be a change
in the degree of competition. All these have a direct impact on the earnings of the business.

Even change in Government policy affects the business a lot. For example, in 1971 when Janata
government came to power the Coca-Cola Company and many other foreign companies were sent
back to India

Physical Causes

All the causes which result in damage of assets are considered as a physical cause, for example,
change in technology may result in machinery being outdated, use of old technology, mechanical
defects may also result in damage of assets such as the bursting of a boiler, accident to employee
etc.

Types of Business Risk

In order to identify business risk, it is crucial to understand the different types of business risk
and their implications for the company. Let’s take a look at a list of business risks:

 Strategic Risk: Out of all the kinds of business risk, strategic risk has the most implication
it’s on reaching your desired goals. If a company strategy becomes less affective,
objectives or not as easily met. This could be down to shifts in customer demand, new
competitors, rising interest rates and other changes.
 Compliance Risk: Compliance risk refers to whether or not a company is complying with
the laws and regulations that are applicable to the business and the country in which it
operates.
 Financial Risk: All types of business risk tend to come with some sort of financial risk.
This type of risk refers to the flow of money in and out of your company and the potential
for financial loss.
 Reputational Risk: Reputational risk can also be called client business risk and it refers to
the potential for a damaged reputation. A damaged reputation Will result in loss of revenue
and have other effects on the company.
  Operational Risk: Any failure and your businesses day-to-day operations is known as the
operational risk. This could be seen in a technical failure, for example.

RISK MANAGEMENT

Risk management is the process of identifying, assessing and controlling threats to an

organization's capital and earnings. These threats, or risks, could stem from a wide variety of
sources, including financial uncertainty, legal liabilities, strategic management errors, accidents
and natural disasters. IT security threats and data-related risks, and the risk management
strategies to alleviate them, have become a top priority for digitized companies. As a result, a
risk management plan increasingly includes companies' processes for identifying and controlling
threats to its digital assets, including proprietary corporate data, a customer's personally
identifiable information and intellectual property. Risk management strategies and processes

All risk management plans follow the same steps that combine to make up the overall risk
management process:

 Risk identification. The company identifies and defines potential risks that may negatively
influence a specific company process or project.

 Risk analysis. Once specific types of risk are identified, the company then determines the
odds of it occurring, as well as its consequences. The goal of the analysis is to further
understand each specific instance of risk, and how it could influence the company's projects
and objectives.

 Risk assessment and evaluation. The risk is then further evaluated after determining the
risk's overall likelihood of occurrence combined with its overall consequence. The company
can then make decisions on whether the risk is acceptable and whether the company is willing
to take it on based on its risk appetite.

 Risk mitigation. During this step, companies assess their highest-ranked risks and develop a
plan to alleviate them using specific risk controls. These plans include risk mitigation
processes, risk prevention tactics and contingency plans in the event the risk comes to
fruition.

 Risk monitoring. Part of the mitigation plan includes following up on both the risks and the
overall plan to continuously monitor and track new and existing risks. The overall risk
management process should also be reviewed and updated accordingly.
Risk management approaches

After the company's specific risks are identified and the risk management process has been
implemented, there are several different strategies companies can take in regard to different types
of risk:

 Risk avoidance. While the complete elimination of all risk is rarely possible, a risk
avoidance strategy is designed to deflect as many threats as possible in order to avoid the
costly and disruptive consequences of a damaging event.

 Risk reduction. Companies are sometimes able to reduce the amount of effect certain risks
can have on company processes. This is achieved by adjusting certain aspects of an overall
project plan or company process, or by reducing its scope.

 Risk sharing. Sometimes, the consequences of a risk is shared, or distributed among

several of the project's participants or business departments. The risk could also be shared
with a third party, such as a vendor or business partner.

 Risk retaining. Sometimes, companies decide a risk is worth it from a business standpoint,
and decide to retain the risk and deal with any potential fallout. Companies will often retain a
certain level of risk a project's anticipated profit is greater than the costs of its potential risk.

Business Combination: Concept, Causes, types and Forms

Business combinations may be defined as follows:

Business combinations are combinations formed by two or more business units, with a view to
achieving certain common objective (specially elimination of competition); such combinations
ranging from loosest combination through associations to fastest combinations through complete
consolidations.
L.H. Haney defines a combination as follows:
“To combine is simply to become one of the parts of a whole; and a combination is merely a
union of persons, to make a whole or group for the prosecution of some common purposes.”

Causes of Business Combinations:

(i) Wasteful Competition:
Competition, which is said to be the ‘salt of trade’, by going too far, becomes a very powerful
instrument for the inception and growth of business combinations. In fact, competition,
according to Haney, is the major driving force, leading to the emergence of combinations, in
industry.

(ii) Economies of Large-Scale Organization:

Organisation of production on a large scale brings a large number of well-known advantages in
its wake – like technical economies, managerial economies, financial economies, marketing
economies and economies vis-a-vis greater resistance to risks and fluctuations in economic
activities. Economies of large scale operations, thus become, a powerful force causing increased
race for combinations.

(iii) Desire for Monopoly Power:

Monopoly, a natural outcome of combination, leads to the control of market and generally means
larger profits for business concerns. The desire to secure monopolistic position certainly prompts
producers to join together less than one banner.

(iv) Business Cycles:

Trade cycles, the alternate periods of boom and depression, lead to business combinations. Boom
period i.e. prosperity period leading to an unusual growth of firms to reap rich harvest of profits
results in intense competition; and becomes a ground for forming combinations.Depression, the
times of economic crisis-with many firms having to only option to close down-prompts business
units to combine to ensure their survival.

(v) Joint Stock Companies:

The corporate form of business organization is a facilitating force leading to emergence of
business combinations. In joint stock companies, control and management of various corporate
enterprises can be concentrated, in a ‘small group of powerful persons through acquiring a
controlling amount of shares of different companies.

(vi) Influence of Tariffs:

Tariffs have been referred to as “the mother of all trusts”. (A trust is a form of business
combinations). Tariffs do not directly result in combinations; they prepare the necessary ground
for it. In fact, imposition of tariffs restricts foreign competition; but increases competition among
domestic producers. Home producers resort to combinations, to protect their survival.
(vii) Cult of the Colossal (or Respect for Bigness):
In the present-day-world, business units of bigger size are more respected than units of small
size. Those who believe in the philosophy of power and ambition, compel small units to
combine; and are instrumental in forming powerful business combinations, in a craze for
achieving bigness.

(viii) Individual Organising Ability:

The scarcity of organizing talent has also induced the formation of combinations, in the business
world. Many-a-times, therefore, combinations are formed due to the ambition of individuals who
are gifted with organising ability. The number of business units is far larger than the skilled
business magnates; and many units have to combine to take advantage of the organising ability
of these business brains.

Types of Business Combinations:

Business combinations are of the following types:
(i) Horizontal Combinations.

(ii) Vertical Combinations.

(iii) Lateral or Allied Combinations:

Lateral combination refers to the combination of those firms which manufacture different kinds
of products; though they are allied in some way.

Lateral combination may be:

(a) Convergent lateral combination:
In convergent lateral combination, different industrial units which supply raw-materials to a
major firm, combine together with the major firm. The best illustration is found in a printing
press, which may combine with units engaged in supply of paper, ink, types, cardboard, printing
machinery etc.

(b) Divergent lateral combination:

Divergent lateral integration takes place when a major firm supplies its product to other combing
firms, which use it as their raw material. The best example of such combination may be found in
a steel mill which supplies steel to a number of allied concerns for the manufacture of a variety
of products like tubing, wires, nails, machinery, locomotives etc.

(iv) Diagonal (or Service) Combinations:

This type of combination takes place when a unit providing essential auxiliary goods / services to
an industry is combined with a unit operating in the main line of production. Thus, if an
industrial enterprise combines with a repairs workshop for maintaining tools and machines in
good order; it will be effecting diagonal combination.

(v) Circular (or Mixed) Combinations:

When firms engaged in the manufacture of different types of products join together; it is known
as circular or mixed combination. For example, if a sugar mill combines with a steel works and a
cement factory; the result is a mixed combination.

Forms of Business Combinations:

By the phrase ‘forms of combinations’, we mean the degree of combination, among the
combining business units.

According to Haney, combinations may take the following forms, depending on the degree
or fusion among combining firms:
(I) Associations:
(i) Trade associations

(ii) Chambers of commerce

(iii) Informal agreements

(II) Federations:
(i) Pools

(ii) Cartels

(III) Consolidations – Partial and Complete:

(а) Partial Consolidations:
(i) Combination trusts

(ii) Community of interest

(iii) Holding company

(b) Complete Consolidations:

(i) Merger

(ii) Amalgamation

The following chart depicts the above forms of business combinations:

Following a brief account of the above forms of business combinations:
(I) Associations:
Forms of Combinations, in this Category are:
(i) Trade Associations:
A trade association comes into being when business units engaged in a particular trade or
industry or in closely related trades come together for the promotion of their economic and
business interests. Such an association is organized on a non-profit basis and its meetings are
used largely for a discussion of matters affecting the common interests of members such as
problems of raw- materials, labour, tax-laws etc.

Most of the trade associations are organised on a local or territorial basis. A trade association is
the loosest form of combination and it does not interfere with the internal management of a
member unit.

(ii) Chambers of Commerce:

Chambers of commerce is voluntary associations of persons connected with commerce and
industry. Their membership consists of merchants, brokers, bankers, industrialists, financiers etc.

Chambers of commerce is formed in the same way as associations, with the ultimate objective of
promoting and protecting the interests of business community. But they differ from trade
associations in that they do not confine their interests only to a particular trade or industry; but
stand for the business community in a particular region, country, or even the world, as a whole.

Chambers of commerce act as spokesmen of business community and make suggestions to the
government regarding legislations that will foster trade and industry. The constitution and
composition of chambers of commerce vary from country to country. In most of the countries,
they are voluntarily organised by businessmen; though the government maintains close contacts
with them.

(iii) Informal Agreements:

Informal agreements are types of business combinations which may be formed for the purpose of
regulating production or for dividing the markets or for fixation of prices etc. Such agreements
require the surrender of some freedom by the combining business units; though ownership and
control of combining units is not affected.
Informal agreements among business magnates are often concluded secretly at social functions
like dinners or at meetings of trade associations etc. These agreements are merely understanding
among the parties and no written documents are prepared. As they depend mainly on the honour
and sincerity of members; they are referred to as Gentlemen’s agreements.
(II) Federations:
Forms of Business Combinations in this Category are:
(i) Pools:
Under the pool form of business combination, the members of a pooling agreement join together
to regulate the demand or supply of a product without surrendering their separate entities, in
order to control price.

Important Types of Pools are:

(a) Output Pools:
Under these pools, the current demand for the product of the industry is estimated; and quotas of
output for various member units are fixed. Member units are expected to produce only up-to the
quota, and sell their products at a price determined by the pooling association.

(b) Traffic Pools:

Such pools are formed by shipping companies, airlines, railway companies and road transport
agencies; with the basic objective to limit competition through a division of the area of operation.

(c) Market Pools:

These pools are formed with the objective of ensuring a certain demand to each member. For this
purpose, the entire market is divided among the members in any of these three ways by
customers, or by products or by territories.

(d) Income and Profit Pools:

In these pools, members of the pooling association are required to deposit a very high percentage
(say 80%) of the gross receipts in the common pool for re-distribution among members on an
agreed basis.

(ii) Cartels (Kartells):

Basically cartel is the European name for the American pools. According to Von Beckereth,“A
cartel is a voluntary agreement of capitalistic enterprises of the same branch for a
regulation of the sales market with a view to improving the profitableness of its members’
business.”
Von Beckereth mentions the following broad types of cartels:

(a) Price-Fixing Cartels:

In this type, prices are fixed for goods and members cannot sell below those prices.

(b) Term-Fixing Cartels:

In this type, terms regarding sales e.g. rate of discount, period of credit; terms of payment etc. are
prescribed.

(c) Customer Assigning Cartels:

In this type, each member unit is allotted certain customers.

(d) Zonal Cartels:

In this type, division of market among units takes place; but generally these cartels are formed
for dividing the world market.

(e) Quota-Fixing Cartels:

In this type, production quotas are fixed for each member; and no member would produce more
than the allotted quota.

(f) Syndicates (or Cartels Proper):

This type of cartel is brought into existence, through an agreement among a number of
competing producers to establish a joint selling agency (called syndicate) for the exclusive sales
of their products. Member units sell their products to the syndicate at a price called the
accounting price.

The syndicate sells to consumers at a price higher than the accounting price; and the profits
earned are distributed among members on an agreed basis.

(III) Consolidations:
As a Form of Business Combinations, Consolidations may be:
(a) Partial Consolidations:
Under partial consolidations, the combining units surrender their freedom for all practical
purposes to the combination organisation; but retain respective individual entities nominally.

Popular Types of Partial Consolidation are the following:

(i) Combination Trusts:
A combination trusts is an arrangement by which the business control is entrusted to the care of
trustees, by a number of business concerns. It consists in the transfer to trustees of the voting
rights arising from the possession of shares.

The trust has a separate legal existence. The control and administration of the combining units
are consolidated; and they have to forgo a large measure of their independence and autonomy in
directing their affairs. The shareholders of combining companies get trust certificates from the
Board of Trustees; which show their equitable interest in the income of the combination.

(ii) Community of Interest:

When trusts were declared illegal in the U.S.A.; the business leaders devised a new form of
combination ‘Community of interest’, for keeping a number of companies under some kind of
common control.

A community of interest may be defined as form of business combination in which, without any
central administration, the business policy of several companies is controlled, by a group of
common shareholders or directors.

(iii) Holding Company:

A holding company is a concept recognized by law in India and most other countries. A holding
company is any company which holds more than half of the equity share capital of other
companies or controls the composition of the board of directors of other companies (called the
subsidiary companies).

Further, a company which is a subsidiary of another subsidiary company will be the subsidiary of
that other holding company too. If e.g. C is a subsidiary of B; and B is a subsidiary of A; then C
will be deemed to be a subsidiary of A through the medium of B.

(b) Complete Consolidations:

Complete consolidation is that form of business combination under which there is a complete
fusion of the combining units and the separate entities of these units are surrendered in favour of
the consolidated unit.

There are Two Forms of Complete Consolidation:

(i) Merger:
In merger, one or more companies merge with another existing company. The absorbing
company retains its entity and enlarges its size through merger. The company which is absorbed,
on the other hand, loses its entity in the absorbing company.

(ii) Amalgamation:
An amalgamation implies the creation of a new company by a complete consolidation of two or
more combining units. Under amalgamation none of the existing companies retains its entity.
There is a complete fusion of various existing companies, leading to the formation of an
altogether new company.