Unsystematic Business Risk: Definition, Factories, How to Hedges it?

Introduction:

Business Risk can be defined as the risks that can adversely impact the business by lowering profitability, or impacting their market share. Therefore, this is something that needs to be taken seriously by the business, in order to ensure that they survive in the already competitive business landscape.

In this regard, it is quite rudimentary for businesses to identify the relevant business risks, so that they are able to create a viable strategy against these risks, in order to direct their strategy accordingly.

There are numerous types of risks that businesses are exposed towards, and they can broadly be categorized into systematic and unsystematic risks.

Systematic Risks can be defined as risks that are not contingent on the business model that the business follows. On the other hand, it can be seen that unsystematic risk can be defined as the risk that occurs because of the business itself.

Definition:

Unsystematic Business Risk can be defined as the risk that is inherent to a specific company or industry. This is also referred to as diversifiable risk, or specific risk.

This is predominantly called so because it is specifically related to the company, in terms of their operations, or other inherent factors that make them susceptible to the underlying business risk.

As the name suggests, this risk can be predicted well in advance, and therefore, companies can craft strategies in order to hedge against this particular risk.

In this regard, it can further be seen that this risk can be diversified using numerous different strategies that can reduce the business exposure.

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Factors of Unsystematic Risk

It can be seen that there are two main factors because of which unsystematic risk occurs.

Firstly, the major cause of unsystematic risk is the inherent business risk. Business Risks refer to the risks that are underlying with the current business model or practices.

These factors can either be internal or external. Speaking of internal reasons of business risks, it can be seen that they are mainly attributed to the inability of company to induce operational efficiency within their business model.

This means that the business model has certain features which hampers its ability to meet targets, or reach respective heights.

On the contrary, external business risks refer to the risks that businesses are exposed to, because of industry-related factors. For example, a new entrant in the market, which threatens the company’s financial standing.

The second major factor of unsystematic risk is financial risk. Financial Risk mainly lies in the existing capital structure of the company. As a matter of fact, financial risk is mainly reflected as a result of a mismatch between company’s debt and equity.

Alternatively, financial risk exposure also occurs when the company is exposed to high-risk debts, which have a significant probability of defaulting on their loans.

How Can Companies Hedge Against Unsystematic Risk?

Regardless of the fact that companies cannot completely hedge against business risks, yet it can be seen that companies can adopt a number of policies that can ensure that they are able to create a cushion that can reduce their exposure.

When it comes to unsystematic risk, this can mainly be achieved through policies of diversification and ensuring that companies are able to diversify their portfolio. This can greatly help them to create an effective strategy to eliminate a significant risk, i.e. market risk.

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In the same manner, businesses can also try to make changes in their business model in order to make it more robust, as per the new changes in business strategies.

Alternatively, this can help businesses to prepare against unprecedented circumstances, by being more adaptive and receptive to the changes that take place within the business, or outside the business.

Conclusion

Unsystematic Risk is the risk that a business faces because of its business model, or it’s operational. Given the intrinsic nature of this particular risk, it can be regarded that this is something that can be controlled by the business by analyzing the inherent risks so that they can formulate a strategy at the earliest.

This is an important consideration for the business since it has the potential to greatly impact profitability and sustainability of the business model.

However, not all unsystematic risks can be accurately predicted. In this regard, it is imperative that business stay prepared for all types of risks, in order to strengthen their position in the industry.

It is perhaps a useful strategy to conduct a risk analysis after every short interval to assess the position and strategize again, depending on the situation at hand. 

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