Defining a Policy for Uncertainty

The consideration of risk is a normal component of the portfolio-planning process. But we have to be careful about how the risk is factored in. For instance, some of the formulas call for modifying the expected benefits by the risk percentage. This can be misleading. Let's use the Titanic for an example. We'll say that the net present value (NPV) of the investment is calculated as $50 million. There is a 10 percent chance that the ship will hit an iceberg during the first year and sink. Is it reasonable to modify the NPV to $45 million?

No! What we have here is a case where the risk event would totally eliminate any return on the investment. The issue is not how much to modify the benefit. It is whether the governance council is willing to consider a project that might fail entirely.

This is an issue that has to be addressed by those responsible for implementing the tactical plans in support of the strategic plan. If we recognize that uncertainty is part of the game and that in some cases the degree of uncertainty can seriously negate the expected benefits, then surely a risk policy is needed.

At the executive level, guidance should be provided relative to how much risk is acceptable. The guidelines might spell out a risk balance, with a mix of high-risk and low-risk projects within a portfolio or a limit to one (or a specified number) of high-risk projects.

Getting back to the Titanic illustration, what if we mitigate the risk? We insure the ship. Certainly that is an option. But now we have to consider the effect of the mitigation on the income model. First, there is the cost of the insurance. If it is $2 million, we have to factor that cost into the NPV for the base case. We still have to have a figure for the effect of destruction of the ship from collision with an iceberg. The insurance is not likely to cover the income that would be lost, only the loss of the property. So we would still have a risk-based income model that is substantially below the $50 million.

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Project Management Made Easy

Project Management Made Easy

What you need to know about… Project Management Made Easy! Project management consists of more than just a large building project and can encompass small projects as well. No matter what the size of your project, you need to have some sort of project management. How you manage your project has everything to do with its outcome.

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