Tuesday, March 1, 2011

Four Dimensions of Risk

As a science fiction reader and alternate history writer, I’ve always lived in the future to some extent. From our time-bound perspective, the future is a wave front of uncertainty. Many things are possible, but ultimately only some things will happen.

Today, we have to make decisions about the future, and those decisions necessarily have to be made under conditions uncertainty. That’s the domain of risk, the place where philosophy and statistics meet. Yesterday, I sent in the manuscript for my 24th book, Project Risk and Cost Analysis, for AMACOM’s self-study sourcebook line. It’s been a fascinating project.

Risk is future tense, as opposed to problem, which is present tense. Risks are events that have not yet happened. The events can be good for us, or bad for us. They can have great impact, or little impact. They are more likely or less likely.

The risk environment changes over time. For example, there’s a lot of noise on the issue of climate change. Opponents argue that the science cannot say with certainty that the feared effects of climate change will happen. From a risk management perspective, that’s true, but it’s also completely irrelevant. Hardly anything in the future is really 100 percent (or, for that matter, zero percent) sure to happen. The measurement of a risk today is our estimate of its probability times our estimate of its impact if it happens (usually written R = P x I).

As time moves forward, our knowledge will change. Our estimate of the probability will increase or decrease. Our estimate of the potential impact will be refined. (Estimates of impact, by the way, tend to be more precise and have more agreement than estimates of probability. In the case of climate change, both sides agree on the claimed impact; what they disagree on is the likelihood of that impact occurring.)

And, by somewhere around the year 2050, the argument will eventually go away completely. By then, it will be incontrovertibly clear what has happened. One or both sides will be proved wrong. Uncertainty will collapse; Schrödinger’s cat will be out of the box, alive or dead.

As we move through the life cycle of a project, our vision changes. All risks on a project eventually go away, either by becoming true (problem or good fortune), or by becoming false (no harm, no foul). At the same time, new risks swim into view as we navigate forward through the rocky stream of time.

The uncertainty of the future inevitably becomes the fact of the present.

Risk can be thought of in four dimensions:

  1. Goodness/Badness. In practice, risk is often used a synonym of threat. But events can be beneficial or harmful, or a mixture. Sometimes you can choose.
  2. Impact. You can find a dollar bill on the sidewalk, or you can find a hundred dollar bill. Both qualify as opportunity. You can lose a dollar, or you can lose a hundred dollars. Both qualify as threats. The difference, in both cases, is impact.
  3. Probability. Most people carry a lot more ones than hundreds, and are more likely to miss and search for a lost hundred. There’s a greater chance of finding (or losing) the smaller amount.
  4. Time. What we knew yesterday is different from what we know today or will know tomorrow. The risks that should concern us, and the choices we can make, do not remain static.
  5. Remediation. What, if anything, can you do about it? What will it cost? The value of a risk all by itself doesn’t tell us much. Only when you compare the value of the risk with the cost of the risk response do you know the shape of the decision space

In thinking about risk, put the risk into context — what’s it’s effect on you and others, and what’s the relative cost of the solution compared to the (risk-based) cost of the problem?

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