RISK ANALYSIS - THE PURSUIT OF MANAGEMENT BEST PRACTICE
Organizations today operate in an environment of increased competitiveness and change. Successful organizations are those that are effective at change, either through creating new markets or meeting new goals for existing products. Yet many companies are ineffective at change and hampered by poor control of their product development operations.
How do Companies Manage?
Many companies are unable to accurately estimate, control and improve specific product or contract profit margins, product ship dates, or product quality. Companies know that they need to improve, but with inadequate data they often find themselves unable to prioritize problems, leading to excessive improvement initiatives performed in an unfocused manner.
What is Performance Improvement?
Companies are left either spending very little money on improvement because they're unsure how to best allocate the money, or are spending a lot of money very ineffectively on numerous improvement efforts going in 20 different directions.
What is Best Practice?
Best practices can be defined as "those practices that have been shown to produce superior results; selected by a systematic process; and judged as exemplary, good, or successfully demonstrated", these practices are then adapted to fit a particular organisation (American Productivity and Quality Centre, 1997). The use of best practices, when incorporated within all areas of an organisation, including its stakeholder relationships, can lead to an organisation attaining world class performance.
WHAT IS RISK MANAGEMENT?
Everyone knows that "risk" affects the gambler about to roll the dice, the wildcatter about to drill an oil well, or the tightrope walker taking that first big step. But these simple illustrations aside, the concept of risk comes about due to our recognition of future uncertainty -- our inability to know what the future will bring in response to a given action today. Risk implies that a given action has more than one possible outcome. In this simple sense, every action is "risky", from crossing the street to building a dam.
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The term is usually reserved, however, for situations where the range of possible outcomes to a given action is in some way significant. Common actions like crossing the street usually aren't risky while building a dam can involve significant risk. Somewhere in between, actions pass from being nonrisky to risky. This distinction, although vague, is important -- if you judge that a situation is risky, risk becomes one criterion for deciding what course of action you should pursue. At that point, some form of Risk Analysis becomes viable.
Why Introduce Uncertainty To A Project?
Say you're planning a big job that could span a year or more. Things can and will go wrong but, with @RISK for Project, you can make informed decisions by accounting for high risk elements such as learning curves, inflation, weather, etc.
Characteristics of Risk
Risk derives from our inability to see into the future, and indicates a degree of uncertainty that is significant enough to make us notice it. This somewhat vague definition takes more shape by mentioning several important characteristics of risk.
First, risk can be either objective or subjective. Flipping a coin is an objective risk because the odds are well known. Even though the outcome is uncertain, an objective risk can be described precisely based on theory, experiment, or common sense. Everyone agrees with the description of an objective risk. Describing the odds for rain next Thursday is not so clear cut, and represents a subjective risk.
Given the same information, theory, computers, etc., weatherman A may think the odds of rain are 30% while weatherman B may think the odds are 65%. Neither is wrong. Describing a subjective risk is open-ended in the sense that you could always refine your assessment with new information, further study, or by giving weight to the opinion of others. Most risks are subjective, and this has important implications for anyone analyzing risk or making decisions based on a Risk Analysis.
Second, deciding that something is risky requires personal judgment, even for objective risks. For example, imagine flipping a coin where you win £1 for a heads and lose £1 for a tails. The range between £1 and -£1 would not be overly significant to most people. If the stakes were £100,000 and -£100,000 respectively, most people would find the situation to be quite risky.
There would be a wealthy few, however, who would not find this range of outcomes to be significant. Third, risky actions and therefore risk are things that we often can choose or avoid. Individuals differ in the amount of risk they willingly accept. For example, two individuals of equal net worth may react quite differently to the £100,000 coin flip bet described above -- one may accept it while the other refuses it. Their personal preference for risk differs.
Who uses Risk Management Tools
Companies who wish to achieve all their objectives, must be able to effectively manage the risk to resources, finance, markets and projects.
Assessing and Quantifying Risk
Realizing that you have a risky situation is only the first step. How do you quantify the risk you have identified for a given uncertain situation? "Quantifying risk" means determining all the possible values a risky variable could take and determining the relative likelihood of each value. Suppose your uncertain situation is the outcome from the flip of a coin. You could repeat the flip a large number of times until you had established the fact that half of the times it comes up tails and half of the times heads. Alternatively, you could mathematically calculate this result from a basic understanding of probability and statistics.
In most real life situations, you can't perform an "experiment" to calculate your risk the way you can for the flip of a coin. How could you calculate the probable learning curve associated with introducing new equipment? You may be able to reflect on past experiences, but once you have introduced the equipment, the uncertainty is gone. There is no mathematical formula that you can solve to get the risk associated with the possible outcomes. You have to estimate the risk using the best information you have available.
How can @RISK Help?
@RISK uses a technique called "simulation" to combine all the uncertainties you identify in your modeling situation. You no longer are forced to reduce what you know about a variable to a single number. Instead, you include all you know about the variable, including its full range of possible values and some measure of likelihood of occurrence for each possible value. @RISK uses all the information, along with your Project model, to analyze every possible outcome.
It's just as if you ran hundreds or thousands of "what-if" scenarios all at once! In effect, @RISK lets you see the full range of what could happen in your situation over and over again, each time under a different set of conditions, with a different set of results occurring.
You can calculate not only the most likely project end date, but also dates for the best and worse case scenario. How about viewing the uncertainty in cost, project duration or critical indices? No problem! Choose any task or resource field in Project as an output from your @RISK simulation. The result is improved decision making backed up by a complete statistical analysis and presentation quality reports and graphics.
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