What is a Systematic Business Risk? Definition and How Can A Business Mitigate It?

Introduction

Business risks tend to be an increasingly important factor in determining the overall ability of the business to sustain and survive in the VUCA (Volatile, Uncertain, Complex, and Ambiguous) world.

There are several risks that businesses need to equip themselves against. However, in this regard, a couple of risks are more relevant to the business than others.

This is predominantly because of the reason that these risks are capable of inducing higher damage to the business as compared to other inherent risks.

These risk categories can broadly be categorized into systematic and unsystematic risks.

Systematic Risks – Definition

Systematic Risk can be defined as the risk that is inherent to the entire market, or the particular market segment. It is also referred to as undiversifiable risks.

This is the kind of risk that the company cannot avoid, because of the nature of this particular risk, because of the fact that it is highly unpredictable.

Even though systematic risk can be mitigated through diversification, it cannot be completely avoided.

Therefore, it can be seen that systematic risk is mainly inherent to the market as a whole, which reflects the overall impact of the economic, ego-political as well as financial factors.

The reason that it is highly difficult to avoid is because of the reason that it is beyond the control of the company, and hence, it is also unpredictable.

It is mainly contingent on market dynamics, and macroeconomic factors, because of which companies find it increasingly hard to fully hedge against this particular risk.

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Sources of Systematic Risks

Given the fact that systematic risks mainly occur because of reasons that are beyond the companies control, it can be seen that the sources of these risks need to be identified in order to get proper clarity regarding things that can be done in order to mitigate this impact.

Therefore, it can be seen that systematic risks can only be partially hedged against.

The main sources of systematic risks can be seen as industry specific external factors which highly impact company’s ability to perform at par with the market dynamics.

For example, macroeconomic factors like inflation, changes in interest rates, and fluctuations in the international exchange rate market, highly make the business portfolio volatile.

These sources of uncertainty greatly cause the company to face severe uncertainty because they cannot control these factors. Hence, they result in the company being exposed to this risk.

How Can Businesses Mitigate Against Systematic Risk?

Given that businesses can only hedge against systematic risks to a given point, there is a need to understand how businesses can create an effective hedging strategy.

These strategies to mitigate against the given level of risk mainly lie in ensuring that businesses plan ahead, so that the underlying systematic risks do not deeply impact them.

For example, in the case of exchange rates, they can try to set up forward contracts, to reduce the underlying volatility.

In the same manner, they can also predict certain macroeconomic indicators, like inflation, with reasonable accuracy, in order to extrapolate the best results.

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The inherent risk that lies within the markets cannot be predicted, and therefore, businesses cannot prepare well in advance for these particular incidents.

However, businesses can create a strategy that can help them deal with such a risk, when it occurs.

This can be achieved by creating an adaptive workforce that can help businesses to inculcate agility within their workforce.

By ensuring that they are receptive to changes in the external environment, they can try to induce a higher degree of flexibility within the workforce.

Conclusion

Therefore, it can be seen that systematic risk can be defined as the risk that is inherent in the market or the industry dynamic the business is operating in.

This risk is true of almost all businesses, and therefore all businesses, regardless of their size or structure need to deal with this particular risk at hand.

The factor that separates businesses from each other, when it comes to systematic risk, is to effectively hedge against it.

Regardless of the fact that this particular risk cannot be completely hedged, yet it can be controlled to a certain extent, based on the approach that the companies adopt.

This can be achieved by inducing a flexible and adaptive approach towards cyclical movements in the economy, in addition to awareness about the existing macroeconomic environment the company is operating in.