Kiss Approach To Risk Based Decision Making
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Who doesn't have to make decisions? Private decisions? Job related/business decisions? No matter your age, position, job, we all have to make decisions almost on a day to day basis. Decisions alternatives, even the straight forward ones, often have hidden/secondary effects, and most of the time are made more difficult by our perception, sentimental values etc. Large corporations sometimes use highly sophisticated procedures to support their decisions on capital expenditure, investments, processes, and yet, oftentimes, they realize afterwards that the best option was not selected. Not to dig the dagger in the wound or work on the obvious, but if the world went into the global economic recession and crisis we have endured, it was precisely because decision making was based on improper parameters. The reason for these problems afflicting decision making is that risks (positive= winning aspects, negative=failure aspects) are not properly accounted for each alternative, and alternatives are not properly compared among each other. What you will find in here is a KISS (Keep it Simple) approach to decision making, applicable to any type of decision. In order to make it really simple, we had to simplify some areas to the bone (hence the remarks about a mathematician most likely fainting when reading our explanations). More sophisticated and rigorous methods do exist, especially if you want to compare in detail long term alternatives and produce/evaluate their financial results. We have books, blogs, courses and web site talking about them, but the purpose here was to really bring a somewhat impervious subject to the point it make sense for everyone to use it on a day to day basis, with a minimum of remote supervision/coaching. Welcome to the world of transparent, justifiable, decision making!
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Kiss Approach To Risk Based Decision Making
- 1. KISS* Approach to Risk Based Alternative Selection: A Guide to Improvement and Success By F.+C. Oboni * KISS=Keep it Simple Riskope International SA © 2009 www.riskope.com 1 ISBN: 978-0-9784462-3-9
- 2. Hi, my name is Stake, Mat Stake and I .... Riskope International SA © 2009 www.riskope.com 2 ISBN: 978-0-9784462-3-9
- 3. ...need to decide among these alternatives: Alternative # 1 # 2 # 3 Description of each Alternative Introduce a Modify your your have to Maintain new procedures select from Status Quo process... with.... Alternative 1 Alternative 2 Alternative 3 Bla bla Bla Bla Bla Bla Of course you can write the description of the three (or more) alternatives you have to select from to “customize” or “own” the example. It will be clearer to you. A lawyer could use this scheme to select, for example, among negotiating, going through a simplified procedure, or a full pledged litigation. An IT specialist could use this to decide changes to a network, a Manager of an operation could use this to decide process changes etc. Riskope International SA © 2009 www.riskope.com 3 ISBN: 978-0-9784462-3-9
- 4. Of course it's very important for me to select the best alternative. In the past I have trusted my intuition, asked people.... I know I could have made better, but I did not know how... One thing I have learned, however.... Riskope International SA © 2009 www.riskope.com 4 ISBN: 978-0-9784462-3-9
- 5. Good decisions have mortal Enemies. Here are a few examples: Pit Fall Rozy Scenario Riskope International SA © 2009 www.riskope.com 5 ISBN: 978-0-9784462-3-9
- 6. ...and of course I could not forget to mention these two... Perryl Shield Dr. Noel Tall Riskope International SA © 2009 www.riskope.com 6 ISBN: 978-0-9784462-3-9
- 7. By quantifying upside and downside risks I could probably make a better decision, but I did not know how... ...until I met these two guys... Riskope International SA © 2009 www.riskope.com 7 ISBN: 978-0-9784462-3-9
- 8. They said I could do it, without being an expert/ mathematician, with their facilitation/supervision. They said I should use a Quantitative Approach (i.e. based on numbers, money) to obtain concrete support to my selection. They said not to worry and start immediately, coached remotely by them via email or Skype, or to follow one of their Seminars, read their Book, BLOG .... Riskope International SA © 2009 www.riskope.com 8 ISBN: 978-0-9784462-3-9
- 9. Here is the story of how it is done...some details are missing to keep the story short. It is quite simple to get started.. Just realize: for each Alternative, each thing that can go wrong or turn out positive has a certain likelihood of doing so, and if that happens I can make or lose some money. Let's look at some examples of Likelihood: A coin has approximately ½ chances of coming out on une side: Likelihood 1/2=0.5 A dice has approximately 1/6 chances of coming out with one specific number: Likelihood 1/6= 0.1667 The weather forecast tells you the probability of precipitation (POP) tomorrow is 0.9, Likelihood =0.9= 9/10. Riskope International SA © 2009 www.riskope.com 9 ISBN: 978-0-9784462-3-9
- 11. These guys constitute a Hazard...with a likelihood of dropping on Rozy a given volume. The Consequence is: a ruined day, the swimming suit to be washed etc. Riskope International SA © 2009 www.riskope.com 11 ISBN: 978-0-9784462-3-9
- 12. The next step? Any event can bring in positive or negative Examples of tolerability curves. consequences (very rarely it can be neutral, meaning its consequence is basically nil) To make it simple.. let's consider consequences as money (but could be anything else). If your are betting in a game of dice or coins, then the consequence will be what you may win or lose from your bet. If you are considering the Alternative of opening a cafè business downtown vs. bad weather, then you may be looking at an additional profit (because people will spend all day at your cozy café), or a loss, if no one shows up. For any event a consequence can be evaluated, or estimated. It is always safe to make an optimistc and a pessimistic evaluation and say that the consequence will be between so much and that much. Again, techniques exist to solve complex consequence evaluations with nonmonetary stuff. Riskope International SA © 2009 www.riskope.com 12 ISBN: 978-0-9784462-3-9
- 13. Let's put this concept on paper: just remember, a mathematician would probably die of an heart attack right here, because I am making it too simple for you! Likelihood 1.00 Max Likelihood Min Likelihood Max Consequence Min Consequence 0.00 Consequence Riskope International SA © 2009 www.riskope.com 13 ISBN: 978-0-9784462-3-9
- 14. Let's use this information to evaluate the risks of a car accident. Let's start with a “fender bender” scenario Likelihood 1.00 1/10 per year 1/30 per year 1,000$ 200$ 0.00 Consequence Riskope International SA © 2009 www.riskope.com 14 ISBN: 978-0-9784462-3-9
- 15. Let's use the same plot to evaluate the risks of “totalling your car” scenario Likelihood 1.00 25,000$ 35,000$ 1/80 per year 1/100 per year 0.00 Consequence Riskope International SA © 2009 www.riskope.com 15 ISBN: 978-0-9784462-3-9
- 16. Let's now build a single plot to display the risks of a car accident scenario from “fender bender” to “totalling your car” Likelihood 1.00 1/10 per year 35,000$ 25,000$ 1/30 per year 1/80 per year 1,000$ 200$ 1/100 per year 0.00 Consequence Riskope International SA © 2009 www.riskope.com 16 ISBN: 978-0-9784462-3-9
- 17. In real studies a single plot displaying the risks of a complete scenario encompassing small to catastrophic subscenarios is often shown as a “Risk Bubble” Likelihood 1.00 1/10 per year Just remember, a 35,000$ mathematician would probably die of an heart attack right here, because I am making it too simple! 200$ 1/100 per year 0.00 Consequence Riskope International SA © 2009 www.riskope.com 17 ISBN: 978-0-9784462-3-9
- 18. It's easy to add Reputational Damages to the Risk Bubble if they are converted into monetary value (you lose your job because of drunk driving, for example...)...see the red line. Likelihood 1.00 1/10 per year 35,000$ 200$ 1/100 per year 0.00 Consequence Riskope International SA © 2009 www.riskope.com 18 ISBN: 978-0-9784462-3-9
- 19. Those two guys told me they call that red line the “Pinocchio Nose” of the scenario. If you are caught lying after an accident (hence the Pinocchio reference), your reputation will be more damaged: the more you lie, the longer the nose...easy! By the way, small accidents (risks) can have a huge Pinocchio nose... if you are unprepared to deal with the crisis that may come in the aftermath of the accident; when journalist will ask you difficult questions in a moment of stress. Thus: evaluate your risks and prepare for crises! Riskope International SA © 2009 www.riskope.com 19 ISBN: 978-0-9784462-3-9
- 20. At the end of the day I had a plot similar to the one below for the first alternative (I have omitted the reputational damages, i.e. the Pinocchio Nose for each bubble.) Likelihood For each thing that 1.00 can go wrong or make money you will have a bubble in the plot. The mathematician is already dead, so we will not mention him/ her again... 0.00 Consequence Riskope International SA © 2009 www.riskope.com 20 ISBN: 978-0-9784462-3-9
- 21. The two guys CONGRATULATED me!!! You have just compeleted your first Quantitative Risk Assessment (QRA), for one of the alternatives you have to chose from! They also said: You are on a good way to make sensible and transparent decisions. Please complete the same procedure for each alternative, and look at the three risk assessment plots (QRAs) once you are done. So, I went home and set up for a long night of work... Riskope International SA © 2009 www.riskope.com 21 ISBN: 978-0-9784462-3-9
- 22. This is what I got next morning. As I was sipping my coffee I could not understad why they had asked me to do all this work...but I was sure they would tell me soon Likelihood Alternative 1 Risks 1.00 Alternative 2 Risks Alternative 3 Risks 0.00 Consequence Riskope International SA © 2009 www.riskope.com 22 ISBN: 978-0-9784462-3-9
- 23. Instead of telling me right away, they started asking me questions: Mat, are there risks that you can afford (tolerate)? Mat, which one of the Alternatives is the riskier? Mat, which alternative would you select, now? I realized I was not able to reply any of these questions and so, before I committed ritual suicide out of shear despair they said I needed to do one more thing: determine my tolerability to risks! Riskope International SA © 2009 www.riskope.com 23 ISBN: 978-0-9784462-3-9
- 24. I had never heard talking about Risk Tolerability before. Basically, they said, tolerabiity criteria are different for each person, organization, corporation: With three questions it is possible to determine the parameters of the tolerabiity criteria of anyone. The questions may be answered in five minutes by an individual, or take a couple days of a facilitated workshop for a corporation, with its FCO and Board present. Once it's done, it's a great tool, as it is the key to serious, concrete Entreprise Risk Management and to Risk Based Decision Making/Alternative Selection Riskope International SA © 2009 www.riskope.com 24 ISBN: 978-0-9784462-3-9
- 25. I am sure your're diying to see one, right? So here it is: from a real QRA! NB: Risk Bubbles are reduced to dots (centre) or vertical lines (to highight min, max Likelihood) 1 1/10 Likelihood 1/100 1/1000 ..... 1 in a Million Consequence in MUS$ Riskope International SA © 2009 www.riskope.com 25 ISBN: 978-0-9784462-3-9
- 26. See the difference below? On the left you've 14 risk scenarios. On the right you have the same together with the Tolerability. The left plot shows me the risks, but the right one tells me that only seven are critical for this company. Actually it can be shown that only three are really bad! Riskope International SA © 2009 www.riskope.com 26 ISBN: 978-0-9784462-3-9
- 27. By determining my Tolerability curve and plotting it on top of the Risk Bubbles of each Alternative I can now reply the three questions the guys asked me. Mat, are there risks that you can afford (tolerate)? Mat, which one of the Alternatives is the riskier (including of course upside and downside risks)? Mat, which alternative would you select, now? Riskope International SA © 2009 www.riskope.com 27 ISBN: 978-0-9784462-3-9
- 28. I felt great! Now I was able to select the best alternative for me, including postives and negatives of each, my appetite for risk, economic solidity. People like Geo Pardy will not scare me away from business or life opportunities! I will not end up “bombed” like Rozy Scenario either! But, may be more importantly... Riskope International SA © 2009 www.riskope.com 28 ISBN: 978-0-9784462-3-9
- 29. I will not miss good opportunities like Perryl Shield, or Pitt Fall...I would enjoy my success! From NOW ON! Riskope International SA © 2009 www.riskope.com 29 ISBN: 978-0-9784462-3-9
- 30. What can I accomplish now? By using a transparent and sound quantitative approach I can: Scientifically select the most significant risks, Draw attention to the objective highest exposures (filtering emotional perceptions), and Prioritize them to allow reasonable mitigation in a very focused way. I can clearly enhance the ability to prioritize risks for a rational and sustainable development. Riskope International SA © 2009 www.riskope.com 30 ISBN: 978-0-9784462-3-9
- 31. BUT, more importantly Create the basis to avoid a slide into a crisis, by proactively controlling the situation. NB: Long term comparison of Alternatives requires the use of more sohisticated tools, such as CDA (Comparative Decision Analysis in replacement to classic NPV Riskope International SA © 2009 www.riskope.com 31 ISBN: 978-0-9784462-3-9