Part III - Decisions and Management under Uncertainty Chapter 8: Value Added Risk Management

1. Part III - Decisions and Management under Uncertainty Chapter 8: Value Added Risk Management Most of the chapter’s figures are included in the file. Instructor must decide how many and which examples to use.

2. Part III - Uncertainty • Introduction to risk and uncertainty • Risk Management Process • Identify • Quantify • Eliminate, mitigate, cope • Frame decisions with significant uncertainty • Influence Diagram • Decision Tree (schematic)- multiple alternatives • Analyze uncertain decisions • Solve a decision tree – Maximize (or Minimize) the expected value • Risk Profile • Structured risk management and the value of information • Risk attitude and utility theory

3. Risk Management Theme • You cannot manage risk if you do not admit there is uncertainty • Managing uncertainty also includes unrealized upside potential and not just downside losses • You cannot allocate appropriate resources if you do not quantify the risk or uncertainty

4. Risk (and Uncertainty) Management Definitions • Risk: Exposure to the chance of injury or loss; a hazard or dangerous chance (Webster) • Risk is NOT just bad things happening, but also good things NOT happening • Risk Measures • Consequences: Impact • Likelihood: Probability or frequency • Risk Management: A systematic process of identifying, analyzing and responding to risk

6. Random Elements in Decision Environment • Resources Required • Sales - Market Demand • Unanticipated competitive actions • Revenue • Globalization • Currency fluctuations • National and regional politics and economies • Team dynamics in cross-culture paradigm • Is task doable? • Will something specific happen? (election)

7. Random Elements (variables) in Decision Environment • Time: to complete task or reach goal • How long each task takes to complete? • Can the project deadline be met? • Cost • Variable costs of production for a totally new product • Uncertainty in learning curves impact long term cost variability • Breakdowns, personnel training • Performance • Unfixed bugs in a new software • NVH, fuel economy, warranty claims for a car • Effectiveness and toxicity of a drug

8. Table 8.1: Sources of randomness in a manufacturing company

9. Table 8.2: Sources of randomness in health care system decision

10. Table 8.3: Sources of randomness in personal health decision

11. Activity: Randomness in your environment • Current company or organization • Future career • Your community • Personal life including family

12. Risk management process Risk Identification FMEA, fishbone diagram, brainstorm Risk Quantification Experts assess probability and impact of individual events System Risk Analysis Simulation, decision trees, FMEA Reduce, eliminate, transfer, avoid, absorb or share risk Institute early warning and tracking of unmitigated risk Risk Mitigation and Contingency Plan Communicate and Track Risk Explain and track risk Documentation of Risk Analysis Document all aspects of risk

13. Risk Identification • Identify all significant sources of risk and uncertainty associated with • each of the objectives and • key parameters relating to these objectives • Determine the causes of each risk • Assess risks relationship to other risks • Classify and group risks for evaluation • Fishbone diagram organizes risks

14. Manufacturing Company

15. Risk Quantification • Identify the consequence and likelihood of each risk event • Consequences: Impact of risk event • Example: Delay, dollars,…. • Likelihood of a risk event • Point estimate of probability • Range of probability • Probability distribution for the uncertain probability parameter

16. Figure 8.2: Fishbone diagram of storage tank risk

17. Table 8.5: Likelihood-impact map (3 x 3)

18. Table 8.6: Rating for severity of equipment failure

19. Table 8.7: Rating for likelihood of occurrence of equipment failure

20. Figure 8.4: Likelihood-impact: financial organization risk (What about personal?)

21. Career risk Assume that you are assessing your career risk. Identify risk factors that are specific to your career and their potential impact on your career. Risk factors Impact _________________ _________________________ Describe risk management strategies that you could use to reduce your career risk.

22. Organizationrisk Assume that you are assessing the risks your organization faces in the near term. Identify risk factors that are specific to your organization and its potential impact on it. Risk factors Impact _____________________ ________________________ • Describe risk management strategies that your organization could use to reduce your organization risk. • What risk messages does your organization routinely communicate, and how does it do so?

23. After identification and quantification  Take action • Manage risk • Control sources of risk: occurrence: likelihood • Control impact of risk: magnitude • Focus on different environmental elements of risk • Internal management controls • External supervision • Where does risk go? • Eliminate • Transfer • Share • Live with

24. Systems Risk Analysis  Action • Calculate overall project risk using • Decision tree • Simulation • FMEA • Conduct sensitivity analysis • Prioritize risk events in terms of magnitude and frequency of impact

25. Risk management actions and process • Define risk management alternatives • Evaluate risk management alternatives in terms of • Cost Effectiveness • Design and select the optimum risk management plan • Select and commit the resources required for specific risk management plan • Implement risk management plan • Early warning indicators • Communication and organizational awareness • Rapid and effective response strategy

26. Risk mitigation or elimination strategies • Reduce or eliminate risk: Develop a risk reduction plan and then track to the plan • Example: Inventory Reduces production disruption risk • Transfer (e.g. to a contractor or an insurance company): An attempt to pass the risk to another program element • Example: Supplier is responsible for warranty cost • Avoid risk: Use an alternate approach that does not have the risk • Example: Use well-established supplier for sourcing complex components though it offers higher piece price • Absorb or pool risk : e.g. Dual sourcing • Accept risk: Develop contingency plan or live with it.

27. Example:Managing Risk to Avoid Supply-Chain BreakdownRisk Identification - Risk Drivers – Detail: Table 8.4 • Disruptions • Natural disaster • Labor dispute • Supplier bankruptcy • War and terrorism or disease • Single sourcing and availabilities of alternative suppliers • Delays • High capacity utilization at supply source • Inflexibility of supply source • Poor quality and or yield at supply source • Excessive handling due to border crossing or to change in transportation modes

28. Supply-Chain BreakdownRisk Identification - Risk Drivers – Detail cont. • System problems • Information infrastructure breakdown • System integration or extensive systems networking • E-commerce • Forecast errors • Inaccurate forecasts due to long lead times, seasonality, product variety, short life cycles, small customer base • Ownership and protection of intellectual property • Vertical integration of supply chain • Global outsourcing and markets

29. Supply-Chain BreakdownRisk Identification - Risk Drivers – Detail cont. • Procurement challenges • Exchange rate risk • Percentage of a key component or raw material procured from a single source • Industry-wide capacity utilization • Long-term versus short-term contracts • Receivables • Number of customers; financial strength of customers • Inventory • Rate of product obsolescence; inventory holding cost • Product value; demand and supply uncertainty • Capacity • Cost of capacity • Capacity flexibility

30. Which Categories of Supply Chain Risk are the most significant to your company? • Disruptions • Delays • Systems risk • Forecast risk • Intellectual property risk • Procurement risk • Receivables risk • Inventory risk • Capacity risk

31. Figure 8.6: Risk mitigation for supply chain risks

32. Table 8.8 FMEA – Sourcing to Emerging Markets: Specific quantification of probability and not just likelihood scale  Calculate expected values

33. Table 8.9: Case studies for sourcing to emerging markets

34. Table 8.11: Product Development Risk and Risk Mitigation

35. Table 8.11: Product Development Risk and Risk Mitigation

36. Other risk management frameworks • Focus on environment • Contrast internal vs. external sources and controls

37. Figure 8.5: Controlling risk – change environment

38. Table 8.10: Four categories of risk abatement strategies

39. Table 8.12: Management actions reduce riskInternal Management of Firm

40. Table 8.12: Management actions reduce riskExternal Arrangements