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  James Cole December 21, 2010 18:01

  I suspect the answer to your question is often going to be "both".

  1. A company with a problematic IT operation. The Board decides to eliminate that known source of risk to its business by outsourcing IT - in doing so it eliminates one risk but substitutes a new risk (and one that may prove to be a very different animal indeed!)
  2. A company with a problematic line of business may wish to eliminate the risk to its business by ceasing that line of business, removing all the business and operational risks relating to it. Of course, in doing so it also may be removing its opportunity for profit, so no doubt it will substitute a new line of business with the attendant risks that this will bring.

  Does that help? Do you have specific examples in mind? 

   

  regards

   

  James
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  Ken Sherman December 21, 2010 17:57

  Starting from my Economics 101 base that there is no free lunch, to my mind, elimination does not include introducing a new thing but would be the complete withdrawal from an activity.  Even then, there is a risk to the portfolio due to unknown impact of withdrawal such as market reaction, portfolio rebalancing, complimentary products, etc.   Introduction of of thing perceived to have less or no risk is substitution to my mind,

   

  Ken
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  David L Russell, PE December 21, 2010 17:53

  I'll offer a bit of an explanation.  I'm sure others may disagree.

  The concept of risk relates to the concept of vulnerability. If there is no vulnerability, the risk is non-existent. I'll talk in terms of vulnerability reduction and substitution because the definition of risk is anthromorphic

  You can eliminate vulnerability by moving a facility or massively over designing the facility to withstand both external and internal vulnerabilities.  Consider:  Relocate the refinery inland to eliminate the risk from hurricane damage and the vulnerability from the same.  But you may introduce a vulnerability to damage from earthquake or prairie fire or forest fire or airplane crash.

  In that regard, there is no such thing as a facility with "no risk" or no vulnerability. When we attempt to make things foolproof, nature invents a better class of fool.

  Vulnerability by substitution can occur through use of such things as intrinsic safe design or chemical substitution which eliminates certain classes of vulnerability from explosion or toxic formations because the chemistry is different.  (Consider what might have happened at Bophal if Union Carbide had not been using MIC for the reactions.

  So: To summarize:  Vulnerability elimination occurs with specific actions and reduces certain types of vulnerabilities - through relocation or redesign.  Vulnerability substitution occurs when one makes changes in the type of operation to change the basic process to eliminate one or more types of vulnerabilities from specifi sources while producing the same products.

  Hope that helps.

   
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  jacob szafranski December 21, 2010 17:52

  Substitution is the simpler of the two. Instead of taking the risk of your direct counterpart you ask them to post a Letter of Credit, provide parent or corporate guarantee. The result would be substituting and accepting the risk profile of a third party. Eliminating may be tantamount to taking a lender out of a subordinated position. There are instances that other lenders are in a senior position to you (perfecting UCC filings, collateral etc...). Eliminating this risk would require entering into an intercreditor agreement which puts all the lenders in the same position. Thereby sharing the collateral, proceeds etc..
  Would like to hear your ideas/thoughts as well.
  Thanks