The third and final step in risk assessment is to compare and quantify risks, by
dealing with their consequences on a common basis, usually measured in cost. That
means converting schedule risk into cost risk, and this depends on both the details of
the project (e.g. penalty clauses) and the particular part of the project involved (e.g. if
it is on the critical path or not). Having carried this out, the mean value of the
consequence of each risk event can be calculated and, finally, multiplying this with
the probability of occurrence of the event yields a single monetary value for each
risk, which allows them to be listed in order of importance.
The main aim of risk analysis is to gain an understanding of the nature of the
risks; the parameters they are dependent upon, their sensitivity to parameter variations, the practical constraints they are subjected to, and so on. The results can be
presented in the form of upper and lower bounds, in the form of sensitivity matrices,
or in graphical form.
Another useful output of the risk analysis is to do a Monte Carlo analysis on the
data for a part or the whole project (in the sense of the matrix introduced above) and
present the result as cumulative probability distribution of completion cost.
Once the risk issues have been identified, analysed and assessed (see also para.
11.3.1), the efforts deployed to contain or reduce these risks form part of risk
management. Several strategies (para 12.1) are available including:
• Risk avoidance.
• Risk control.
• Risk assumption.
• Risk transfer.
16.2 Decision Theory
16.2.1 Steps in Decision Theory Approach
Most managers rarely take decisions with complete certainty concerning the inputs
or assumptions and about the outcome. Managers sanction significant financial
investments with more or less incomplete information about product marketability.
Decision theory provides a sensible strategy to deal with such problems when faced
with partial, imperfect or uncertain future conditions. The decision theory strategy
generally comprises four steps which will be introduced here through a manufacturing company that is considering several alternative ways to augment its production
to satisfy the increasing market demand.
Step 1. List all the feasible alternatives
The decision maker must first establish a list of all the feasible options that should
be considered in the decision. For example, the company mentioned earlier, may
have only the three alternatives as follows:
16.2 Decision Theory
445
dealing with their consequences on a common basis, usually measured in cost. That
means converting schedule risk into cost risk, and this depends on both the details of
the project (e.g. penalty clauses) and the particular part of the project involved (e.g. if
it is on the critical path or not). Having carried this out, the mean value of the
consequence of each risk event can be calculated and, finally, multiplying this with
the probability of occurrence of the event yields a single monetary value for each
risk, which allows them to be listed in order of importance.
The main aim of risk analysis is to gain an understanding of the nature of the
risks; the parameters they are dependent upon, their sensitivity to parameter variations, the practical constraints they are subjected to, and so on. The results can be
presented in the form of upper and lower bounds, in the form of sensitivity matrices,
or in graphical form.
Another useful output of the risk analysis is to do a Monte Carlo analysis on the
data for a part or the whole project (in the sense of the matrix introduced above) and
present the result as cumulative probability distribution of completion cost.
Once the risk issues have been identified, analysed and assessed (see also para.
11.3.1), the efforts deployed to contain or reduce these risks form part of risk
management. Several strategies (para 12.1) are available including:
• Risk avoidance.
• Risk control.
• Risk assumption.
• Risk transfer.
16.2 Decision Theory
16.2.1 Steps in Decision Theory Approach
Most managers rarely take decisions with complete certainty concerning the inputs
or assumptions and about the outcome. Managers sanction significant financial
investments with more or less incomplete information about product marketability.
Decision theory provides a sensible strategy to deal with such problems when faced
with partial, imperfect or uncertain future conditions. The decision theory strategy
generally comprises four steps which will be introduced here through a manufacturing company that is considering several alternative ways to augment its production
to satisfy the increasing market demand.
Step 1. List all the feasible alternatives
The decision maker must first establish a list of all the feasible options that should
be considered in the decision. For example, the company mentioned earlier, may
have only the three alternatives as follows:
16.2 Decision Theory
445