CHAPTER FIVE

SYSTEMATIC RISK MANAGEMENT

 INTRODUCTION

• Project is surrounded by people who wish to influence or will be influenced by the project.
 Stakeholders are important influential resources and as such should be
treated as potential sources of risk and opportunity within the project.

 A stakeholder risk analysis is essential so that each stakeholder – be it

an individual or organization – is aware of the risk perception.

 Stakeholder risk analysis means identifying the stakeholders, types of

risks, extent of risks, levels of stakeholder commitment, and degree of
influence.

 Risk management is informed by the objectives of the project and the

objectives of the participating stakeholder.

 Risk management system (RMS) identifies competing interests, and

employ techniques for weighing up inadequate information about the
project.
 RISK MANAGEMENT SYSTEMS (RMS)
 Systematic approach to risk management increases the capacity of an organization to
handle risks at all levels- it comprise processes to:
 Establish the appropriate risk context(s)
 Identify the project risks the stakeholder organization will face
 Analyze the identified risks,
 Develop responses to those risks,
 Monitor and control the risks during the project, and
 Permit post-project capture of risk knowledge.

 
 Establish the appropriate risk context(s)
Objectives and strategies in place to achieve objectives of the
organizations

The external and internal parameters to be taken into account

Identify stakeholders objectives, perceptions and values.

Define the scope (time, cost, roles and responsibilities..)

Determine evaluation risk criteria- Risk tolerance and appetites

of the organization for a specific activity or event.
 Identify the Project Risks

The aim of risk identification is to identify possible risks that may affect, either
negatively or positively, the objectives of the business.

Involves identifying retrospective and prospective risks.

Answering the following questions can help to identify risks.

 What can happen?
 How can it happen
 Why could it happen

Brainstorming is a useful approach of the many techniques available for

identifying risks, and this is best undertaken in a risk workshop environment.

Checklists are often advocated as a technique to stimulate brainstorming in risk

identification.
Risk Sources
Broad Categories of Risk
Market risk: Unable to promote the product to buyers as estimated
Financial risk: Development and ownership cost is higher than estimated
Technology risk: New technology brings unexpected compatibility problems
People risk: Leading developers resign from the company
Structure/process risk: New processes required to utilize the product are not
successful.
 
 Identified risks should be recorded as formal, precise statements of
likelihood, event, consequence and time.

Example
If the project goes beyond the current fiscal year, funding for the
project may decrease or dry up for the next fiscal year.

Exercise : write a risk identification statement for a road construction

project.

Hint: There is a P chance that W event will occur during X period,

with consequences Y1 to Yn Over the Z period.
 CHAPTER 6
RISK ANALYSIS
 Introduction

Risk analysis provide knowledge of the relative severity of risks on a

project.

Qualitative analysis is based on nominal or descriptive scales for describing

the likelihoods and consequences of risks.

Semi-quantitative analysis extends the qualitative analysis process by

allocating numerical values to the descriptive scales. The numbers are then
used to derive quantitative risk factors.

Quantitative analysis uses numerical ratio scales for likelihoods and

consequences, rather than descriptive scales.
 Likelihood of event occurrence and severity of consequence (S) have been
commonly used in risk assessment exercises.

 For qualities analysis likelihoods are rated in terms of occurrence on a five-

point descriptive scale (rare, unlikely, possible, likely, almost certain) showing
the likelihoods of specific risks arising and leading to the assessed levels of
consequences.

 Consequences are rated in terms of the potential impact on the criteria, often on
five-point descriptive scales ( insignificant, minor, moderate, major and
catastrophic) linked to the criteria identified.

 
Catastrophic - Extreme event, potential for large financial
costs or delays, or damage to the organization’s reputation
Major - Critical event, potential for major costs or delays, or
inappropriate products
Moderate - Large impact, but can be managed with effort using standard
procedures
Minor - Impact minor with routine management procedures
Insignificant - Impact may be safely ignored

A simple matrix is used to combine the likelihood and consequence ratings to

generate initial priorities for the risks.
 
 Risk priority rating

Consequence
Likelihood
Insignificant Minor Moderate Major Catastrophic

Almost certain Medium Medium High High Extreme

Likely Medium Medium Medium High Extreme
Possible Low Medium Medium High High
Unlikely Low Low Medium Medium High
Rare Low Low Medium Medium Medium
Semi-quantitative Scales for Risk Analysis

Likelihood Scale Consequence Scale Rating Scale

Almost certain Catastrophic 5

Likely Major 4

Possible Moderate 3

Unlikely Minor 2

Rare Insignificant 1
Likelihood ratings
Level Frequency
Very high (5) ≥1 in 2
High ( 4) 1 in 2
Medium (3) 1 in 5
Low (2) 1 in 10
Low (1) 1 in 100

Risk score = Likelihood X Consequence

Risks are sequenced in decreasing order of risk factors, and cut-off levels are set to provide
an initial indication of priorities based on absolute criteria.

Example
Extreme ≥ 15
High ≥ 10 10 to 14
Medium: ≥ 5 5 to 9
Low: ≤4
A three dimensional risk magnitude perspective includes a third dimension duration
( short term(1), medium-short term (2), medium term (3), medium-long term(4) and
long term(5))

Risk factor/ Severity score= likelihood X Consequence X Duration

A three dimensional risk severity model is not commonly used in most risk analysis
except for discounted cash-flow investment projects.
Quantitative Risk Analysis

The aim of quantitative risk analysis is to analyze numerically the probability of

each risk occurring and its consequence on project objectives

Expected Monetary Value (EMV) considers an event’s probability of

occurrence and the loss or gain that will result. It is calculated by multiplying each
possible outcome by its probability of occurring and then adding the result.

Decision Tree Analysis. A diagramming and calculation technique for

evaluating the implications of a chain of multiple options in the presence of
uncertainty.
Example 1

Project Risks 1 – Weather: There is a 25 percent chance of excessive rain fall

that’ll delay the construction for two weeks which will, in turn, cost the project
Birr 80,000.
Project Risks 2 – Cost of Construction Material: There is a 10 percent
probability of the price of construction material dropping, which will save the
project Birr100,000.
Project Risks 3 – Labor Turmoil: There is a 5 percent probability of construction
coming to a halt if the workers go on strike. The impact would lead to a loss of
Birr 150,000. Compute the expected value.
 Decision Tree Analysis
Decision Decision Chance Net Path
Definition Node Node Value

Strong
65%
Demand $80
$200
EMV of New Bldg
New Node = $41.5!
Plant 35%
Weak -$30
-$120 Demand
$90
Build or
Upgrade
Plant 65%
Upgrade Strong $70
Demand
Plant $120
-$50 EMV of Upgrade
Node = $49!

Weak
35%
$10
Demand
$60
Example 2

A manager of a furniture company has been quite successful the past three years.
She is thinking whether or not it is a good idea to expand her company this year.
The cost to expand her company is Birr 1.5M. If she does nothing and the economy
stays good and people continue to buy lots of furniture she expects Birr 3M in
revenue; while only Birr 1M if the economy is bad. If she expands the factory, she
expects to receive Birr 6M if economy is good and Birr 2M if economy is bad.
She also assumes that there is a 40% chance of a good economy and a 60% chance
of a bad economy.

Draw a Decision Tree showing these choices and advice the manager what she
should do
Exercise : suppose a farmer must decide what to do with his land for the next
growing season. He can choose to plant corn or soybeans or to not plant anything at
all. If he plants nothing at all, the government farm subsidy will pay him $30 per
acre.
If the farmer decides to plant corn or soybeans on his land, there is some risk
involved. The yield per acre depends on the amount of rainfall. Too much rain or too
little rain will give poorer results than the right amount of rainfall. There is a 40
percent probability that the rainfall will be low; there is a 40 percent probability that
the rainfall will be medium; and there is a 20 percent chance that the rainfall will be
high.
If the farmer decides to plant corn, the yield per acre will be $0, $90, and $50,
respectively, if the rainfall is low, medium, or high. If the farmer decides to plant
soybeans, the yield per acre will be $40, $70, and $20, respectively, for low,
medium, and high amounts of rainfall.