Planning for Risk

Risk is all about planning for what might happen, rather than what is most likely to happen, or even what is likely to happen on average. These can be very different – consider a parachute jump where the most likely outcome is a safe landing, the worst case is fatal and the average of these is meaningless. Traditional business planning uses a single scenario, usually the most likely. If there is a second, it is often a worst case scenario. The most likely scenario largely ignores risk and the worst case is difficult to use for strategic purposes without knowing how likely it is to occur. Statistics and probabilities are critical to understanding this variability and certainty. 

Knowing that we can’t know what will happen with certainty, how can we estimate a spectrum of what might happen? At the broadest level, we need to attach probabilities to what might happen, and then combine these probabilities statistically to understand the overall effect of the possibilities and the likelihood of these possibilities occurring.

Individual uncertainties can be combined - not everything will be best case but not everything will be worst case.

Simulation is a tool to assist with this (although not the only one) and there are a raft of software packages to help do this, but combining the probabilities of different events occurring at different times, and their relationships to each other, usually requires statistical understanding of both the information sources and the structure of the probabilities.

But for real insights, there is more to it than this. There can be very different consequences of some situations arising than others, and the costs or benefits of each must be considered when making decisions. This is often achieved by assigning penalty functions to the analysis, converting the probabilities of outcomes to dollar values, enabling decisions to be made and consequences considered in the context of bigger decisions. Ignoring this can be very costly to business.

Risk reduction is not the only way in which planning for risk can be beneficial for a business. Understanding the distributions of what might happen opens up strategic opportunities, placing an organisation in a position to take opportunities when they arise, since it had been recognised that they might arise. For example, in planning a hotel development, understanding the range of possible demand can guide the design to ensure that additional rooms could be added as the demand increases, using an approach of building for what is likely but planning for what is possible.

Opportunity is not luck, but being able to take advantage of luck when it presents.

Risk based planning is essential so that risks are understood before projects commence and so that managers are prepared to act across a range of conditions. It is not a luxury but a necessity in modern agile management.

For further information on how Data Analysis Australia can assist you in business and risk analysis, please contact daa(at)daa.com.au or phone 08 9468 2533.

June 2016