Business owners and corporate executives often wonder why they suffer a loss at the end of the quarter or year- and then, after examining the details, notice that a majority of the loss arose from just a few activities. How can you effectively pinpoint these unwanted events, and mitigate the losses they generate while pursuing your business objectives?
This is where key risk indicators (KRIs) play a role.
Risks are unavoidable in any organization, and KRIs are an important tool to keep those risks in check. This article explores what KRIs are, how to identify and implement them, their relationship with the more popular key performance indicators (KPIs), and how those two concepts work together. Let’s dive in.
What Is a Key Risk Indicator? (KRI)
A KRI is a metric or predictor that provides information about an event (or series of events) that will have adverse effects on a company’s goals and objectives.
Used to assess and measure a possible risk, a KRI is like an early-warning sign that helps you identify your business’s risk exposure, assuring that you can take preventive steps to avoid negative outcomes – or, at least, mitigate those negative effects.
Whether used as independent measurements or in conjunction with other risk-related data such as loss events or assessment outcomes, KRIs are an important part of a company’s enterprise risk management system.
KRIs provide necessary insights and early warnings on your overall risk profile. They don’t necessarily cover every single risk, but they cover enough to help you avoid the most important risks to your organization.
Effective KRIs have four important characteristics:
- They are measurable metrics.
- They provide quantifiable information, either in the form of numbers or percentages, with which you can track trends in your risk profile over a given period.
- They are highly informational due to the importance or possible impact risks have on a company’s overall wellbeing.
- They are accurate, used to develop risk assessment and control plans to keep your business initiatives intact.
KRIs typically fall into three categories: financial metrics, human metrics, and operational metrics.
- Financial metrics help to quantify market risk, regulatory changes, competitive risk, or any other risks that might affect the financial wellbeing of your business or company.
- Human metrics give insights into employee satisfaction, customer churn, employee retention, or other human-related factors upon which a company’s goals are crucially dependent.
- Operational metrics provide information to a company about its level of exposure to certain operational risks, such as technical malfunction or security breaches.
Good Key Risk Indicators
KRIs help with monitoring and controlling risk. This means they are closely related to your operational risk management processes, including the implementation of risk appetite, risk management, and governance or control frameworks.
Ordinarily, KRIs can be any metric used to identify your risk exposure over time. That said, some KRIs have characteristics that make them better than others. So what are these important characteristics?
Good KRIs help you to identify, quantify, monitor, or manage risks that are directly relevant to your key business objectives. Wasting time on irrelevancies is something good KRIs help you avoid. A good KRI relates directly to your business initiatives and helps you keep track of your crucial operational risk management activities.
Good KRIs help to predict future problems. Any KRI that doesn’t help with early warnings about future risks, whether directly or indirectly, is not where you want to spend your risk management time and effort.
With good KRIs, your company identifies potential risks before those risks have an effect, and creates adequate risk assessment and management plans. This allows your business to respond quickly to emerging issues, keeping your risk exposure as minimal as possible.
It’s important to note that KRIs do not only signal threats to a company’s objectives, strategy, and overall existence. They also identify potential opportunities that abound from proper risk management plan implementations. Metrics provide information on where these opportunities are and the necessary actions required to exploit them.
Good KRIs should be fairly simple to collect, parse, and report – and you should be able to do so cost-effectively. They shouldn’t consume too many financial or operational resources, since they serve as metrics collected from both internal and external sources, providing risk-related information about a company’s regular day-to-day activities.
KRIs track a company’s risk exposure over some time, so they need to be consistent and to generate data that can be compared from one period to the next. Comparable data can reveal how your company’s risk exposure has evolved over time, and gives you clues about the effectiveness of your risk management operations.
Identifying Key Risk Indicators
Effective KRIs don’t just spring out of nowhere. To identify and develop them, your risk management team needs to follow a careful process in coordination with other parts of your enterprise.
Identify Your Company’s Goals And Vulnerabilities
As mentioned earlier, a good KRI is relevant to your business goals and objectives. Relevancy isn’t determinable until these business goals are established, because these are what KRIs seek to protect. Therefore, identifying KRIs first involves generating business goals so you avoid unnecessary complexities in your risk management process.
Once business objectives are determined, identifying the risks and barriers to achieving those goals becomes easier. Effective KRIs will address your most critical risks, so identifying these risks at the start of your risk management process is an important step.
In short, determining your business goals is the foundation for creating your risk management framework. Strategic objectives provide you important business context to prioritize your risks. They help you place your risks on a scale of preference and, consequently, keep your KRIs relevant at all times.
Understanding Potential Risk Exposure
Risk exposure is the measure of potential future loss resulting from your identified risks. An analysis of the risk exposure for your business will rank risks according to their probability of occurring and their potential harm. Your risk exposure, in turn, helps you determine your organization’s risk appetite and the strategies to keep your losses below the set threshold.
You can use this equation to calculate risk exposure:
(probability of a risk occurring) X (total loss of risk occurrence) = risk exposure.
Having prioritized your risks based on your business goals, and how each risk contributes to your overall risk exposure, it’s time to establish the indicators.
Start by focusing on your priority risks. Work with internal experts in your operating units to determine what a good KRI would be for each risk. For example, if a major security risk is loss of customer data, the privacy or IT security teams might recommend tracking failed user log-ins or password reset requests as KRIs to measure possible cyber attacks.
As mentioned earlier, good KRIs are metrics that are highly relevant to your business goals, quantifiable, comparable, and predictive. Any KRI developed can be compared against these attributes, assuring they are actionable enough for effective risk management.
You’ll also need to consider how often indicator data is updated. This is where data feeds through software tools become handy, as they help you automate an integral part of your risk assessment workflow.
Incorporate a Monitoring Process for your KRIs
Once your KRI data gathering processes have been established, create a system or framework to monitor the data gathering process; fine-tune the type and quality of metrics collected. Making good use of the initial data gathering or risk assessment periods can help solve this.
Compare the KRI data that arrives against your risk appetite or threshold. When you see a KRI that breaches existing risk limits repeatedly, that is a warning sign not to be ignored: either your business practices are too risky, or your KRI itself was designed poorly. Either way, you at least know to investigate further.
You should also incorporate indicators into ongoing risk management and reporting processes. This includes a protocol to alert appropriate risk managers, business unit managers, and leading team members when your risk appetite levels are exceeded or close to being exceeded.
Constant monitoring, complemented by respective changes in business operational processes is where the heart of risk management truly is. Your fine-tuned KRIs help you make the most informed and reliable strategic decisions in accomplishing business goals while limiting risks.
Examples of Key Risk Indicators
KRIs take on different forms based on the type of risks they aim at mitigating. Risks, either pure or speculative, are split across different areas and elements involved in running and managing your business. Below are some examples.
The various technology risks involved in running your business, which range from hardware malfunctions to software failures to cyber security issues, among others, are measured by certain KRIs.
These KRIs are known as technology-based KRIs or technological KRIs and help you determine how to manage various risks involved in running the technological aspects of your business. Technological KRIs remain very significant to companies in the tech space. Some examples include software crashes and hardware failures or inadequacies.
Examples of technological KRIs include Mean Time to Repair (MTTR), Mean Time Between Failure (MTBF), and Percent Difference in MTTR.
Financial KRIs are metrics that give information about the different events that affect the financial health of a firm. These could include metrics monitoring liquidity, exchange rate volatility, variance reports measuring actual spending compared to budget, and so forth.
Human Resource KRIs
Human resource KRIs measure risks such as low staff satisfaction, labor shortages, or high staff turnover, among others. They are particularly important for service-based companies and human resource departments within companies.
Operational KRIs measure the impact of risks ranging from failed internal strategy execution processes to ineffective internal management controls.
Examples of Operational KRIs include System Availability, Percentage of Projects Delayed, and Assets Currently Not in Use.
How Key Risk Indicators Work
When talking about the risks that KRIs help to monitor and manage, two categories exist: pure risks and speculative risks.
- Pure risks are unavoidable occurrences like death or natural disasters which are out of your control.
- Speculative risks, on the other hand, are voluntary risks that a company undertakes with uncertain outcomes – investments and mergers, for example; or risks arising from the introduction of new products.
When the KRI trends upward, in a positive direction, that indicates an increased chance of the risk happening or at least exceeding the company’s risk appetite. To push the KRI back down, you would typically reduce the activities related to that risk. Conversely, when a KRI moves in a downward direction or holds steady, that means your risk appetite remains healthy and you can take more risks in pursuit of your strategic goals.
Understanding Key Performance Indicators
Key performance indicators (KPIs) are metrics used to measure the performance of various employees, business processes within a company, or performance of the company as a whole over a period of time, compared against specific set objectives.
KPIs reflect important business goals set for employees, departments, or companies. They help management to gauge progress towards achieving these goals, and offer insights to help employees, departments, or companies make better-informed decisions.
KPIs are important tools to help any company move forward. While some are used to measure short-term progress against an objective, others measure progress over a longer time horizon. Either way, KPIs’ relationship with the achievement of business goals is their defining factor.
KPIs come in two forms; leading and lagging. Leading KPIs help to gauge the outcome of certain actions and processes about achieving business goals. Examples include % Growth in Sales Pipeline, % Growth in New Markets, and Number of New Clients.
Lagging KPIs, in contrast, gauge the progress of past events or activities. Examples of Lagging KPIs include Growth in Annual Sales, Gross Margin, and Annual Net Income.
Astute management teams will use both leading and lagging KPIs together to create and manage a comprehensive KPI structure.
What's the Difference Between a KRI and a KPI?
KRIs and KPIs are not the same.
KRIs measure the chance of certain risk events and the effect those events would have on key objectives. They help companies understand the possible losses they might face, and help management teams make better decisions about whether to keep pursuing certain activities or to change course and reduce risk.
KPIs, on the other hand, only measure the progress the company makes toward business objectives. They present managers and employees with milestones of achievements as well as insights on how better to reach these milestones and to achieve strategic business goals.
KRIs and KPIs both relate to business objectives, but in different ways. KRIs help to limit potential losses while pursuing those goals; KPIs aim to improve productivity so you can pursue those goals more efficiently.
For example, you might have the business objective of growing market share. KPIs such as return on investment and sales by region could help management measure the progress toward this goal.
Meanwhile, KRIs such as competitor growth, customer shift, or general economic downturn could all help management understand the risks to the goal of growing market share.
So in the above example, the KPIs and KRIs work together to assure that the company can make steady progress towards its market share goal while avoiding possible losses through proper risk management processes.
In cybersecurity, a company might use a KPI of average system uptime, to measure performance of its IT systems; and a KRI of number of cybersecurity attacks, to monitor the risks associated with those IT systems.
KPIs typically focus on past events, gauging how business activities contribute to achieving goals. KRIs are mainly predictive, looking at how future risk events might harm the achievement of business goals.
Both KPIs and KRIs can be used independently of the other, and some companies don’t use any at all. But the best way to advance on strategic objectives is to use both KRIs and KPIs together.
KRIs for Startups
Established companies might have hundreds of KRIs available to assess risk exposure and generate an effective risk management framework. Startups often do not, and not all KRIs will be relevant for startups. Still, startups need to track relevant risk events so they can develop the right risk management strategy or framework to reduce loss. Some of these relevant KRIs include measuring risk events relating to:
Startups need to understand their market and the number of opportunities available to them. Having a comprehensive understanding of your total addressable market (TAM) helps you to set strategic goals; accompanying KRIs warn against risk events.
Your TAM includes your target market and potential customers, how sizable the market is to make sales, what portion of the available market you get to capture (your market share), and how the available market share shifts among competitors.
Income is another crucial metric a startup should track. Your income determines cash flow and, ultimately, how well you stay afloat and competitive in the market. You need to identify key risk events affecting your recurring revenue and customer lifetime value.
A sometimes overlooked risk is customer concentration: Having a majority of income coming from too few customers leaves you more financially vulnerable than having a larger pool of customers and clients.
Customers remain the most important factor affecting the success of any business, especially startups looking for means to scale up business activities. Identifying KRIs affecting your customer acquisition strategy, such as your customer acquisition costs (CAC), risks to customer growth numbers, and risks to lead conversion rates, among others is crucial.
Stagnant cash flow is one major reason startups go out of business. That’s why metrics that track your “funding health” are so important. One crucial metric affecting your company’s funding health is your burn rate: the rate at which you service expenses and the cost of servicing these expenses.
A high burn rate is a risk to your funding health, and KRIs to measure and monitor against this risk event are critical.
Better Risk Management With ZenRisk
Reciprocity ZenRisk can assist you in establishing, managing, and tracking your risk management framework and corrective tasks. The risk assessment modules in ZenRisk give significant insight into where your measures are lacking, enabling you to take immediate action.
The platform provides an intuitive user experience mixed with extensive automation and analytics to further simplify the majority of the process.
Schedule a demo and get started on the path to worry-free risk management.