August 22, 2013
Project management usually entails a portion of risk management within its elements, which often prompts the question, what is risk management? Risk management can be used to extract value out of a risk situation based on your investment. Downside risk, is the likelihood of a negative outcome from an uncertain event or condition, and upside risk is the likelihood of a positive outcome. Let’s take a closer look at what forms of risk can be addressed:
Types of Risk Management
• Pure risk describes a risk management situation that only has a negative outcome. If the negative outcome doesn’t happen, you don’t receive a benefit, but only avoid a loss. The possibility of your being in a car accident for example, is a pure risk. If it doesn’t happen, your life continues the way; the best you can do is avoid the downside.
•Business risk management, on the other hand, combines the possibility of positive and negative outcome in the same decision or event. If you buy stock, for example, there’s a possibility that the stock will increase in value, and a possibility that the stock will decrease in value.
There are also risks that are pure upside, with no cost or effort that needs to be invested to achieve the result, and no negative consequence (status quo) for failing to achieve them. These are normally considered outside the sphere of risk management thinking because there’s no real decision that must be made: they are the essence of “no-brainer.”
Changing the Value of a Risk
There are two basic ways to change the value of a risk:
To make it less likely that you’ll be in an accident, you can drive safely. obeying the speed limit, being sober, paying attention, and keeping both hands on the wheel lower the chance of being in an accident. To make it less expensive to be in an accident, you can buy car insurance. (The total financial effect of an accident isn’t actually changed by the act of buying insurance. What changes is who signs the check.)
Pure risks have a cost if they occur, and there is normally a cost associated with reducing or eliminating them: there’s a cost of being in a car accident and there’s a cost associated with buying insurance. The risk mitigation cost is what you would need to spend to reduce the risk to an acceptable level. When you make decisions about risks, you are comparing the risk mitigation cost to the cost of simply accepting the risk—doing nothing about it unless the risk should actually occur.