The concept of risk is essentially a modern one. In ancient and mediaeval societies the idea of risk management would never have arisen and fortune was attributed to luck, fate or ‘acts of God’. Giddens has demonstrated that the concept of risk is now central to our society and he defines risk as being different to danger or hazard in that it is related to our impact on our environment and stems directly from the consequences of our actions on the world.
The term risk was introduced by Portuguese explorers who identified uncharted areas of sea as ‘risky’. The term has gone from having a spatial meaning to its current temporal meaning whereby risk relates to future events.
Such a concept could only have arisen in a society bent on controlling the future. Giddens also stresses that the notion of risk is positive as well as negative and cites the example that the whole rationale behind western capitalism is based on the calculation of future risk.
We will look at some simple mathematical concepts that can help you introduce a certain amount of objectivity into the risk management process but first it is important to think about how we perceive risk as individuals and organisations. Risk management is about taking decisions and, however much we may formalise the process, decision-making is a very emotional business.
Our approach always stresses that projects are about people and nowhere is this more evident than in approaches to risk. Whenever someone is required to take a decision their evaluation of the options open to them is coloured in terms of:
- Personal/corporate wealth
- Attitude toward risk taking (risk taker/risk averse)
- Previous experience.
We are also affected by whether the decision is likely to result in a major gain or loss. The possibility of gaining increases a person’s appetite for risk taking eg, someone may bet on a horse or buy a lottery ticket because their emphasis is on winning. Anxiety about suffering a loss, on the other hand, increases risk aversion but this may not always result in the anticipated behaviour.
A model known as ‘Prospect Theory’ states that you are likely to take a risk rather than suffer a sure loss. An example of this is investors in the stock market who continue to gamble in a falling market rather than take a sure loss immediately.
In determining which option an individual will take the concept of utility (u) is a useful one. Let’s take the simple example of buying a lottery ticket (option A) or not buying a ticket (option B). Someone badly in need of money will have a high u value for option A which may result in a win and a low u value for option B where they have little to gain other than the sure £1 in their pocket.
We do of course view risks differently depending on how directly the consequences affect us. Somebody contemplating laser surgery to correct their vision is likely to focus on the downside risks whereas their friends may focus on the opportunities and encourage them to go for it. To take another example what would be the u value to you of a decision that resulted in your pet project being scrapped?
The emotional element in decision-making is highlighted by a famous mathematical problem known as the Monty Hall dilemma. Monty Hall was the host of an American game show where the winning contestant had to select their prize from behind one of three closed doors. Behind one of the doors was a car and behind the other two were goats. The contestant would pick a door and Monty Hall (who knew what was behind each door) would open a different door to reveal a goat.
At this point the contestant would be offered the chance to stick with the door s/he had chosen or to switch. What should they do?
The answer to the Monty Hall dilemma is that, based on purely logical, mathematical reasoning, it is better for the contestant to switch doors (assuming of course that they want to win the car). The contestant initially had a one in three chance of picking a car. If they stick with the same door those odds don’t change. However, now that one goat has been revealed, if they switch doors there is a two in three chance that their second choice will win them a car.
Human nature however encourages us to stick with the first choice. This is for the simple reason that we don’t want to look foolish. If you have changed your mind and then selected the wrong option the embarrassment factor is far greater than if you simply chose wrongly in the first place.
The emotion and politics involved is compounded when it comes to organisational decision-making. Making choices exposes you but committee structures can mask this and help avoid individual responsibility. Of course the situation is compounded by the fact that not all of the players involved will have the same utility value for each option.
It pays to have an overall understanding of your organisation’s culture and attitude to risk. The risk tolerance of an organisation will lie somewhere on this spectrum from risk-averse to actively risk-seeking.
Many organisations lie towards the risk-averse end of the spectrum and view risk as something to be avoided at all cost whereas leading edge and entrepreneurial companies see the opportunities to be found in a high-risk environment. The risk-averse mind set often results in the expectation from senior management that a Project Manager’s role is to remove risk. This is not the case. Managing risk is not the same as removing it and risk management is undoubtedly easier in the right type of supporting culture.