Innovation risks: types, factors, methods of reduction, management

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

New goods and services are created so that people can solve many tasks better than before, or do and create what they could not before. However, innovation also carries certain dangers. How risky an innovation turns out to be depends almost entirely on people's choices.

And it turns out that the more informed their choice, the lower the risk in innovation.

The more complex the system in which the innovation enters, the more likely and more serious the consequences of risks will be. Almost all the dangers and risks that are associated with innovations do not come from the innovations themselves, but from the infrastructure facilities in which they are introduced.

The bottom line is that all innovation is the result of a compromise between innovation risk and efficiency. To minimize risk, unexpected results and consequences, users, companies and policy makers need to be aware of how to make rational choices when it comes to new products and services.

Innovation risk is a tricky doctrine. The relevance of the study is justified by the need to identify andmanaging such risk, creating a suitable financial and industrial environment.

Concept and doctrine

Risk is a universal concept. Each step of social development implied certain difficulties and problems in innovative work. Financial productivity depends on the high quality characteristics of the product. Innovative problems as a complex concept are studied alongside such disciplines as innovation management, risk management in innovation, psychology, etc. The difficulty of identifying risks is studied in almost all research papers.

Innovation risk is a complex multidimensional doctrine. To work successfully in the field of risk, specialists must have expert knowledge in the field of economics. Effective risk management contributes to the competitiveness of the company in the domestic and international markets and increases the financial and industrial capacity needed to fulfill the government's innovation development tactics in general. Innovation productivity indices are the ability to manage operational risks, as well as the ability to predict the dangers of innovation. Businessmen play an organizing role in risk management. As a result, they help to establish a hierarchy of innovative links in the existing economy and the financial system as a whole.

Factors

Innovation is constantly associated with certain risks for the organization. An organization must consider five key innovation risk drivers:

• It is possible that the new business model will not create a competitive advantage. It must be tested first.
• Economically powerful competitor copies innovation and turns it into an industry standard. Therefore, innovation becomes a common solution for every company in the industry and loses its own innovative status. This destroys the competitive advantage for the innovator.
• A follower can learn faster (for example, correct errors at startup) and achieve results more accurately than the innovator.
• The innovator overestimates their innovative and organizational capabilities (e.g. change management, cash management).
• Misunderstanding the market. The new product is excellent in terms of belief and technical specifications. Regardless of these features, no customer is willing to pay for them because their price is higher than the expected benefit (for example, in relation to an already developed product). Another option is that customers do not behave as expected (for example, they do not accept the pricing policy regarding innovation).

All of these hazards represent resource risks for the innovator and can be detrimental.

Classification and types

Depending on the reasons that cause them, the risks of innovative development are classified as follows.

Pure risks

Management decision-making is constantly influenced by a number of reasons that cannot be changed or limited. To such factorsinclude tax and regulatory acts, natural and geographical conditions, social morality, social principles, etc.

These reasons create the net risks of innovation processes. However, it must be emphasized that the same risks can be classified as pure or not included in this group. For example, when illustrating the nature of the manifestation of pure risks, it is most often proposed to take into account natural and geographical hazards.

Political dangers are connected with the political situation in the state. They appear when the conditions of the industrial and commercial process are violated for reasons not directly dependent on the economic entity.

Natural and climatic hazards are hazards that are associated with the manifestations of natural forces: earthquake, flood, storm, fire, epidemic, etc.

Speculative risks

Speculative innovative risks of enterprises are entirely determined by the decision of the company's management. Often speculative dangers are uncertain, their analytical estimates change over time.

Financial risk is the risk that a borrower will not pay principal and interest. It can also become a problem in which the issuer of debt securities fails to pay interest on them or on the principal amount of the debt.

This uncertainty increases not only the risk, but also the beneficial effect. Speculative dangers are more pronounced in areas of work that depend on market conditions. Therefore, often speculativedangers are called dynamic risks.

Commercial risk is associated with industrial, commercial or monetary work, the main task of which is to generate income. It is the result of a complex action of all causes that determine different types of risks: monetary, political, commercial, financial, etc. The assessment of commercial risk is carried out on the basis of the principles of absorption and risk addition: if the hazards do not depend on each other, the assessments are pessimistic, if the hazards generate other risks, then their estimates are formed according to the laws of probability theory and mathematical statistics. Commercial risks are associated with a stable operation of production, financial or monetary work.

Currency risk is studied as the risk of financial losses associated with a change in the exchange rate of a foreign currency against the state currency in the process of foreign trade, credit, money transactions, operations on stock or money exchanges. For exporters and importers of innovations, monetary risk arises when the cost of innovation is expressed in foreign currency. The exporter loses income in relation to his own national currency in the period between the conclusion of the contract and payment for it. For the importer, losses appear when the exchange rate changes.

Portfolio risk is linked to the investment portfolio. Strategic Asset Allocation describes a method of allocating a portfolio with long-term forecasts that are based on indicators such asefficiency, variance, covariance. Tactical asset allocation is based on short-term projections of how funds should be allocated at a given moment.

If a financier is interested in increasing income from his own monetary investments and seeks to increase the cost of borrowed capital in order to implement innovation, then the innovator, on the contrary, tries to reduce the cost of attracting investments and thereby increase his profit. As it should, the risk of one is the chance of another.

Business risk (commercial) appears in entrepreneurial work and is associated with the likelihood of profits falling to a level that does not cover business costs. It appears as a result of the impact of adverse changes in the market situation (market risks) or incorrect market policy (marketing risks), which is associated with the need to reduce prices under the influence of competition or the impossibility of the process of selling products (goods, services) in the planned volume.

Uncertainty is a prerequisite for management. Innovative activity is more risky than other areas of commercial activity. In the conditions of the volatile situation in the economy, the problem of the risk of losses when a company invests in innovation becomes burning and relevant. Innovation risk assessment is carried out according to the same rules as commercial risk assessment. Unlike commercial ones, innovation hazards are associated with the commercialization of new types of products and services.

Modern classification

There are several typesinnovative risks that are more consistent with modern criteria. Among them are:

• Dangers of wrong choice of innovative projects. A prerequisite for this type of risk may be an insufficiently reasoned choice of the values of the company's financial and market tactics. For example, in the case of the dominance of short-term interests in decision-making over long-term ones (the desire to quickly distribute profits between owners reduces the possibility of increasing the share of the company's innovative products on the market in a couple of years). The possibilities of the company's position in the market in the future can be misjudged. At the same time, its financial stability (the desire to increase profits by increasing sales of a profitable product) can lead to additional spending on the development of resource-saving technologies.
• The risk of inability to provide an innovative project with a sufficient level of funds. It contains the risk of a lack of finance for the development of the project (the company was unable to attract investors due to an incorrectly drawn up business plan) or the risk of choosing the wrong sources of funding (inability to implement the project from its financial reserves, lack of available sources of borrowed funds, etc.).).
• Risk of non-performance of business contracts. This is the risk of the counterparty refusing to sign the contract after negotiations (in the event of a sharp change in the financial situation) or the risk of signing the contract on extremely unprofitable terms. This also includes the risk of concluding contracts with incompetent partners, the risk of non-fulfillment of contractual obligations by partners interm (subject to sharp fluctuations in financial conditions).
• Marketing risks of current supplies and sales. Almost always, these risks are determined by the lack of skill of the company's marketing services, or their absence at all.
• The risk associated with the protection of intellectual property rights. The likelihood of this kind of risk is especially relevant for companies producing innovative products. The main prerequisite for its appearance in enterprises is the imperfection of patent legislation.

The productivity of innovative work directly depends on how accurately the assessment and examination of risk was carried out, as well as on how correctly the methods of managing it were determined.

Analysis Basics

When conducting an analysis of innovation risk, special methods are used. They are subdivided into:

• qualitative (description of all project risks);
• quantitative (determining changes in project performance under the influence of risks).

Among the qualitative methods are the expert method, the cost-benefit analysis method, the analogy method.

Among the quantitative methods are: discount rate adjustment method, sensitivity analysis, scenario method, Monte Carlo method (simulation).

One of the most popular methods is simulation. It is a set of procedures in which a special mathematical model of the probability of future situations is created. Next, this modelis subjected to different types of simulation forecasts for different indicators and values. Each option is evaluated and compared in terms of effectiveness.

Evaluation basics

There is the following option for calculating the innovation risk assessment indicator:

R=ƩWiPi, where Wi is the risk weight;

Pi is the average probability of the i-th risk.

The results of calculations using this method allow us to identify the most significant of the possible hazards.

Risk assessment of innovative projects is used to calculate the likely indicators of dangers, neutralize them and create such industrial and financial criteria under which the occurrence of this risk will be minimal.

Risk assessment is based on the ratio of costs that were caused by innovative risks and the duration of the situation.

This method allows you to use all the data that is associated with losses over a certain period of time.

When planning the company's budget, the amount of situation management associated with the occurrence of risk is calculated.

In general, the causes of innovation risks can be taken into account when calculating the amount needed for situations that involve the threat of unexpected losses in innovation or shortfall in income.

This method is used to calculate resources for the elimination of administrative, labor, monetary, infrastructural, industrial and financial risks that arise during the implementation of an innovative project. Moreover, this method reduces the timeat the stage of risk management of an innovative project and minimizes risks.

Given that the main resource of innovative companies is their internal funds, and given the risky nature of such projects, a new way of managing these types of risks is required.

Control Options

Innovation risk management is understood as a set of practical measures that reduce the uncertainty of innovation outcomes, increase the usefulness of their implementation, and reduce the cost of achieving the goal.

Among the main tasks of risk management in innovation are:

• predicting the manifestation of negative causes that affect the dynamics of the innovation process;
• assessment of the impact of negative causes on innovation and the outcome of innovation;
• development of ways to reduce the risks of innovative projects;
• create a risk management system.

The implementation of tasks and goals rests with the managers of innovative projects.

Reducing the ambiguity of innovation results is achieved by creating information bases on similar projects and accumulating information about the degree and quality of their implementation. But a surplus of information about innovations does not reduce uncertainty. In order to manage risks in innovation activities, it is necessary to ensure the relevance (sufficiency) of information for decision-making.

If the company's management decides to develop a new market sector for their own organization,then no perfect information base about the state of the original market sector will reduce the uncertainty of working in the new area. All accumulated information will be irrelevant and unsuitable for risk management.

The growth of the benefits of innovation is directly related to the change in innovation. The development of options for the implementation of innovative projects is the main goal of the theory of innovation management. And since the number of options for implementing innovations is limited to a finite set, the methods for choosing alternatives provide completely satisfactory performance. On this basis, the method of competitive selection of projects is used.

The cost of achieving an innovation goal is determined by the characteristics of the economic situation in which the innovator ventured to implement his project.

Let's consider the main difficulties of the innovation risk management process:

1. Difficulty in accessing raw materials: If a company develops an innovation that requires the use of scarce raw materials, then this will make procurement difficult, and any disruption in supply will be very seriously affected.
2. The structure and values of society: people matter. Some will benefit from innovations, others are responsible for their design and development. The producers and users of innovations can be the same individuals.
3. Excellence at work: this is part of the innovative inventory. It should be used as leverage to create a high price.
4. Innovation Capabilities Transfer: If innovation competition performance among competitors is positive inshort term, their impact in the long term will be difficult to assess.
5. Effect on the ecology of nature: an example is genetically modified organisms (GMOs). They were initially regarded as a great technical breakthrough. However, some companies have tried to make short-term profits while ignoring the need for detailed risk mitigation planning. They skimped on research and ignored the impact of seed purchases on millions of traditional farmers. The result is a temporary ban on GMOs in Europe, h alting their distribution.
6. The ability to predict changes in the ecological system: accurate forecasting is profitable and effective for innovation. For example, global warming projections are driving innovation in cleantech. This has created several opportunities for commerce in response to the call for carbon footprint management. The companies involved improved their industrial processes and achieved competitive advantages.
7. Organizational agility: It is very important for companies to be environmentally agile. The stronger and more aggressive the competition, the more flexibility is required to take the measures necessary to meet this competition. We need to rethink how we do business.
8. Collective innovation network: Innovative success is achieved primarily through interactions involving networks and identified partners. This is especially suitable for small and medium-sized companies whoseresources are limited. Relying on a productive collective innovation network reduces hazards and accelerates return on investment and the innovation process. At the same time, it must be ensured that all partners receive an appropriate share of the profits in the innovation chain. In addition, it is fundamental to attract and choose the right partners, who must be reliable.

Directions of minimization

Reducing innovation risk is to develop a process that spans three dimensions:

• threats: correctly identify the dangers and barriers that are associated with innovative implementation;
• action: develop appropriate tactics;
• opportunity: leveraging knowledge to gain competitive advantage over competitors least able to ride the wave of risk.

Ways to reduce

The main ways to reduce risk are: distribution, diversification, capping, insurance, hedging, risk avoidance, etc.

The distribution of risks is usually carried out among the project participants in order to evenly distribute the hazards that, under these conditions, must be calculated. Hazards must be kept under control, and the necessary measures must be taken to overcome the consequences of risks.

Diversification reduces risks by working in different directions in sales and distribution, accounts payable, etc.

A simple example of multidirectional investments is a portfolio that consists of two or more securities. As a result, a decreasethe exchange price of some securities is actually fully offset by the growth of others, i.e., regardless of the state of affairs in the market, the price of the portfolio remains unchanged, and investments are only subject to periodic risk.

A portfolio created in this way usually carries less risk than any of its monetary assets.

Limitation of risks is ensured by setting the maximum amount of costs, sales, loans. This method is used by banks to reduce the degree of risk when issuing loans to business entities, when selling products on credit, determining the amount of capital investment, etc.

Insurance as a system of financial relations includes the formation of a special fund of funds (insurance) and its implementation by paying insurance compensation for various types of losses that were caused by adverse events (insured events).

Depending on the system of insurance relations, different types of insurance are distinguished: coinsurance, double insurance, reinsurance, self-insurance.

In group insurance, two or more insurers take part in certain insurance interests of the same risk, concluding solidarity agreements in which each of them is responsible for the sum insured in their own share of the investment.

Double insurance involves the presence of several insurers with the same interests against similar risks, when the total sum insured exceeds the sum insured for each insurance contract.

In case of reinsurance, the riskpayment of insurance compensation or the sum insured, which was accepted by the insurer under the insurance agreement, may be insured either in full or in parts. In the event of an insured event, the reinsurer is liable in the amount of the reinsurance obligations assumed.

Self-insurance - the creation of monetary and in-kind insurance funds for specific business entities. The main goal of self-insurance is to promptly overcome temporary difficulties in the financial sector of the business.

Hedging is an effective method of reducing the risk of adverse changes in the price environment by concluding futures contracts (futures and options). The method makes it possible to fix the cost of purchase or sale at a certain level and, thus, make up for losses in the main market at the expense of income in the futures market. By buying and selling fixed-term contracts, a businessman protects himself from price fluctuations in the market, thereby increasing the certainty of the results of his own production and economic work.

In management practice, from time to time there are cases when it is necessary to withdraw from risky innovative projects or complete collective activities with colleagues. There are risk avoidance methods for this:

• rejection of unreliable partners;
• avoiding risky projects;
• search for guarantors, etc.

Conclusion

Thus, innovation activity is characterized by a high level of uncertainty in dynamicsthe main reasons on which its performance depends. Innovation can end in complete failure. Yet, a significant number of businessmen who embark on innovations prefer to calculate their dangers and opportunities, create bottlenecks and try to reduce the likely negative trends. These tasks are solved when developing a risk management system.

It should be noted that there is no single methodology for assessing the impact of innovation risk. Any company uses independent developed methods for calculating risk. This approach leads to errors in assessing the costs of identified risks, negative results and a decrease in management productivity.