How to Estimate Risk Consequences
5 of 9 in Series: The Essentials of Managing Risk in Your Project
After you identify the likelihood that a particular risk will affect the project you're managing, be sure to determine the magnitude of the consequences or effects that may result. That magnitude directly influences how you choose to deal with the risk. Determine the specific effect that each risk may have on your project’s product, schedule, and resource performance. When evaluating these effects, do the following:
Consider the effect of a risk on the total project rather than on just part of it. Taking one week longer than you planned to complete an activity may cause you to miss intermediate milestones (and cause the personnel waiting for the results of that activity to sit idle). However, the effect on the project is even greater if the delayed activity is on your project’s critical path, which means the weeklong delay on that one activity also causes a weeklong delay for your entire project.
Consider the combined effect of related risks. The likelihood that your schedule will slip is greater if three activities on the same critical path have a significant risk of delay rather than just one.
Be sure to describe risks and their associated consequences as specifically as possible. For example, suppose a key piece of equipment you ordered for your project may arrive later than expected. You can describe that risk as the delivery may be late, or as the delivery may be delayed by two weeks. Just stating that the delivery may be late doesn’t give you enough information to assess the likely effect of that delay on the overall project. It also makes estimating the probability of that risk’s occurrence more difficult. Are you talking about a delay of one day? One month? Stating that the delivery may be delayed by two weeks allows you to determine more precisely the likely effect the delay will have on the overall schedule and resources. It also allows you to decide how much you’re willing to spend to avoid that delay.
You can use a variety of formal techniques to support your risk estimation and assessment, including the following:
Decision trees: These diagrams illustrate different situations that may occur as your project unfolds, the likelihood of each situation’s occurrence, and the consequences of that occurrence to your project.
This simple decision tree helps determine from which of two vendors to buy a piece of equipment. Both vendors have proposed a price of $50,000 if the equipment is delivered on the agreed-on date. Both vendors have also proposed they receive an incentive for delivering early and absorb a penalty for delivering late, but the amounts of the incentives and penalties differThis decision tree depicts the probabilities that each vendor will deliver the equipment early, on time, and late, respectively, and the resulting price you pay in each case.
Multiplying the base price plus the performance incentive for early delivery by the probability of early delivery yields the expected value of the price you pay if delivery is early. You can calculate the total expected prices for Vendors A and B by totaling the expected prices if each is early, on time, and late, respectively.
This analysis suggests that you can expect to pay Vendor A $45,000 and have a 70 percent chance he’ll deliver on time or early. You can expect to pay Vendor B $56,000 and have a 70 percent chance he’ll deliver on time or early. So you can see that Vendor A is the better choice!
Risk-assessment questionnaires: These formal data-collection instruments elicit expert opinion about the likelihood of different situations occurring and their associated effects.
Automated impact assessments: These computerized spreadsheets consider — in combination — the likelihood that different situations will occur and the consequences if they do.