Tradeoffs between risk and expected performance

Closely linked with the concept of risk efficiency is the possibility of making trade-offs between alternative risk efficient project plans.

Return for the moment to the assumption that expected cost and associated cost risk are adequate measures of performance. For most-risk efficient plans, the level of cost risk can be decreased given an increase in expected cost, and the level of expected cost can be decreased given an increase in cost risk. In relation to Figure 3.1, point G represents the minimum expected cost project plan, with a high level of cost risk despite its risk efficiency. Point C represents the minimum cost risk project plan, with a high level of expected cost despite its risk efficiency. If an organization can afford to take the risk, G is the preferred solution. If the risk associated with G is too great, it must be reduced by moving toward C. In general, successive movements will prove less and less cost-effective, larger increases in expected cost being required to achieve the same reduction in absolute or relative risk. In practice, an intermediate point like E usually needs to be sought, providing a cost-effective balance between risk and expected cost, the exact point depending on the organization's ability to take risk.

The scale of the project relative to the organization in question is a key issue in terms of the relevance of plans D, E, F, or G. If the project is one of hundreds, none of which could threaten the organization, plan G may be a sensible choice. If the organization is a one-project organization and failure of the project means failure of the organization, a more prudent stance may seem to be appropriate, closer to C than G.

Traditional portfolio theory discussions of alternative choices on the risk efficient boundary (e.g., Markowitz, 1959) usually treat these decisions as a simple matter of preference: how much risk does the decision maker want to take? The Synergistic Contingency Planning and Review Technique (SCERT) (Chapman, 1979) followed this lead, using the term 'risk balance' to discuss the balance between expected cost and cost risk. Later work with IBM UK made it clear that in the context of an ongoing portfolio of projects, choosing between D, E, F, and G is better viewed as a matter of corporate level risk efficiency, as distinct from the project level of risk efficiency involved in defining these plans. That is, corporate risk efficiency means never reducing risk for a project by increasing expected cost when the risk involved does not threaten the organization as a whole more than a proportionate increase in the expected cost of all projects. In these terms an aggressive approach to risk taking at a project level is part of a risk efficient approach to corporate level risk management. IBM UK developed project risk management in the early 1990s to facilitate taking more risk, not less, to exploit this perception of corporate risk management, and both authors of this book were involved in a linked culture change programme. Chapman and Ward (2002) develop this extended risk efficiency notion in more detail, in the context of both projects and security portfolios. It can be viewed as a matter of project versus corporate risk efficiency, or as a matter of dynamic versus static risk efficiency, or as both. It implies decisions about 'risk balance' which involve a higher level form of risk efficient choice, not a simple preference statement.

If an organization can afford to minimize expected project cost and not worry about cost risk at the individual project level, this has the very great merit of simplicity. This in turn implies it is very worthwhile defining a level of potential cost overrun below which the organization can accept cost risk, above which cost risk needs to be considered in terms of risk efficient trade-offs at a corporate level. Similar arguments apply to risk in terms of other measures of performance.

Risk analysis can serve three separate roles in relation to trade-offs between risk and expected performance: two almost (but not quite) directly analogous to those associated with risk efficiency and the third somewhat different (but complementary):

1. diagnose possibly desirable changes in plans;

2. demonstrate the implications of such changes in plans;

3. facilitate, demonstrate, and encourage 'enlightened gambles'.

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