Risk Management

Dr. M. Ramkumar
Assistant Professor
Indian Institute of Management Raipur

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 Where We Are Now

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 Learning Objectives

7-1 Describe the risk management process.

7-2 Understand how to identify project risks.

7-3 Assess the significance of different project risks.

7-4 Describe the five responses to managing risks.

7-5 Understand the role contingency plans play in the risk management
process.

7-6 Understand opportunity management and describe the five approaches

to responding to opportunities in a project.

7-7 Understand how contingency funds and time buffers are used to manage
risks on a project.

7-8 Recognize the need for risk management being an ongoing activity.

7-9 Describe the change control process.

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 Chapter Outline

7.1 Risk Management Process

7.2 Step 1: Risk Identification
7.3 Step 2: Risk Assessment
7.4 Step 3: Risk Response Development
7.5 Contingency Planning
7.6 Opportunity Management
7.7 Contingency Funding and Time Buffers
7.8 Step 4: Risk Response Control
7.9 Change Control Management

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 7.1 Risk Management Process

Risk Defined
• An uncertain event or condition that if it occurs, has a
positive or negative effect on project objectives.
• No amount of planning can overcome or control risk.
Risk Management Defined
• An attempt to recognize and manage potential and
unforeseen trouble spots that may occur when the project is
implemented.
• What can go wrong (risk event).
• How to minimize the risk event’s impact (consequences).
• What can be done before an event occurs (anticipation).
• What to do when an event occurs (contingency plans).
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 Risk Event Graph

FIGURE 7.1 Access the text alternative for slide images.

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 Benefits of Risk Management

A proactive rather than reactive approach.

Reduces surprises and negative consequences.
Prepares the project manager to take appropriate action.
Provides better control over the future.
Improves chances of reaching project objectives on time,
within budget, and of meeting required performance.

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 The Risk Management Process

FIGURE 7.2 Access the text alternative for slide images.

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 7.2 Step 1: Risk Identification

Generate a list of all the possible risks that could affect the
project through brainstorming and other problem identifying
techniques.
Focus on the events that could produce consequences, not
on project objectives.
Use risk breakdown structure (RBS) in conjunction with work
breakdown structure (WBS) to identify and analyze risks.
Identify the macro risks first then specific areas can be
checked.
Use risk profile (a list of questions) to address traditional
areas of uncertainty on a project.

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 The Risk Breakdown Structure (RBS)

FIGURE 7.3 Access the text alternative for slide images.

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 Partial Risk Profile for Product Development Project

Technical Requirements Quality

Are the requirements stable? Are quality considerations built into the
Design design?
Does the design depend on unrealistic or Management
optimistic assumptions? Do people know who has authority for
Testing what?
Will testing equipment be available when Work Environment
needed? Do people work cooperatively across
Development functional boundaries?
Is the development process supported by Staffing
a compatible set of procedures, methods, Is staff inexperienced or understaffed?
and tools? Customer
Schedule Does the customer understand what it will
Is the schedule dependent upon the take to complete the project?
completion of other projects? Contractors
Budget Are there any ambiguities in contractor
How reliable are the cost estimates? task definitions?

FIGURE 7.4
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 7.3 Step 2: Risk Assessment

Scenario analysis assesses the significance of each risk event in terms

of probability and impact.

Risk assessment form evaluates the severity, probability of risk events

and its detection difficulty.

Risk severity matrix prioritizes which risks to address.

• Failure Mode and Effects Analysis (FMEA) extends the risk severity
matrix by including ease of detection in the equation:
Risk Value  Impact  Probability  Detection
Probability analysis uses statistical techniques in assessing project risk.

• Decision trees, net present value (NPV), program evaluation and

review technique (PERT), PERT simulation

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 Defined Conditions for Impact Scales of a Risk on Major
Project Objectives (examples for negative impacts only)

Relative or Numeric Scale

Project 1 2 3 4 5
Objective Very Low Low Moderate High Very High
> 40% cost
Insignificant cost <10% cost 10% to 20% cost 20% to 40% cost
Cost increase
increase increase increase increase

Insignificant time < 5% time 5% to 10% time 10% to 20% time > 20% time
Time
increase increase increase increase increase
Project end
Scope reduction
Scope decrease Minor areas of Major areas of item is
Scope unacceptable to
barely noticeable scope affected scope affected effectively
sponsor
useless
Only very Quality reduction Project end
Quality Quality reduction
demanding unacceptable to item is
Quality degradation requires sponsor
applications are sponsor effectively
barely noticeable approval
affected useless

FIGURE 7.5
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 Risk Assessment Form

Risk Event Likelihood Impact Detection Difficulty When

Interface problems 4 4 4 Conversion

System freezing 2 5 5 Start-up
User backlash 4 3 3 Postinstallation
Hardware
1 5 5 Installation
malfunctioning

FIGURE 7.6
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 Risk Severity Matrix

Failure Mode and Effects Analysis (FMEA)

Impact × Probability × Detection = Risk Value

User Interface
4 Backlash problems
Likelihood

Red zone (major risk)

3 Yellow zone (moderate
risk) Green zone (minor
risk)
System
2 freezing

Hardware
1 malfunc-
tioning

1 2 3 4 5

FIGURE 7.7
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 7.4 Step 3: Risk Response Development

Mitigating Risk
• Reducing the likelihood that the event will occur.
• Reducing the impact that the adverse event would have on the
project.
Avoiding Risk
• Changing the project plan to eliminate the risk or condition.
Transferring Risk
• Passing risk to another party.
• Examples: Fixed-price contracts, insurance, Build-Own-Operate-Transfer
(BOOT) provisions.
Escalating Risk
• Notifying the appropriate people within the organization of the threat.
Retaining Risk
• Making a conscious decision to accept the risk of an event occurring.
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 7.5 Contingency Planning

Contingency Plan Defined

• Is an alternative plan that will be used if a possible foreseen risk
event becomes a reality.
• Is a plan of action that will reduce or mitigate the negative
impact of the risk event.
• Is not a part of the initial implementation plan and only goes into
effect after the risk is recognized.
Risks of the absence of a contingency plan
• Cause a manager to delay or postpone the decision to
implement a remedy.
• Lead to panic and acceptance of the first remedy suggested.
• Make the decision making under pressure which can be
dangerous and costly.
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 Risk Response Matrix

Risk Event Response Contingency Plan Trigger Who Is

Responsible
Interface Mitigate: Test prototype Work around Not solved Nils
problems until help comes within 24 hours
System freezing Mitigate: Test prototype Reinstall OS Still frozen after Emmylou
one hour
User backlash Mitigate: Prototype Increase staff Call from top Eddie
demonstration support management
Equipment Mitigate: Select reliable vendor Order replacement Equipment fails Jim
malfunctions Transfer: Warranty

FIGURE 7.8

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 Risk and Contingency Planning

Technical Risks
• Backup strategies if chosen technology fails.
• Assess whether technical uncertainties can be resolved.
Schedule Risks
• Expedite or “crash” the project to get it back on track.
• Schedule activities in parallel or use start-to-start lag relationships.
• Use the best people for high-risk tasks.
Cost Risks
• Review price to avoid the trap of using one lump sum to cover price
risks.
Funding Risks
• Evaluate the risk of reductions in funding—a cut in the project.
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 7.6 Opportunity Management

An opportunity is an event that can have positive impact on project objectives.

Exploit
• Seek to eliminate the uncertainty associated with an opportunity to ensure that
it definitely happens.
Share
• Allocate some or all of the ownership of an opportunity to another party who is
best able to capture the opportunity for the benefit of the project.
Enhance
• Take action to increase the probability and/or the positive impact of an
opportunity.
Escalate
• Notify the appropriate people within the organization of the opportunity.
Accept
• Be willing to take advantage of the opportunity if it occurs, but not taking action
to pursue it.

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 7.7 Contingency Funding and Time Buffers

Contingency Funds
• Are funds to cover project risks—identified and unknown.
• For control purposes, contingency funds are divided into:
• Contingency reserves—cover identified risks and allocated to specific
segments or deliverables of the project.
• Management reserves—cover unidentified risks and are allocated to risks
associated with the total project.
Time Buffers
• Are amounts of time used to cushion against potential delays in the
project.
• Add to activities with severe risks.
• Add to merge activities that are prone to delays.
• Add to noncritical activities to reduce the likelihood that they will create
another critical path.
• Add to activities that require scarce resources.

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 Budget Estimate

Budget Contingency Project

Activity Baseline Reserve Budget
Design $500,000 $15,000 $515,000
Code 900,000 80,000 980,000
Test 20,000 2,000 22,000
Subtotal $1,420,000 $97,000 $1,517,000
Management reserve — — 50,000
Total $1,420,000 $97,000 $1,567,000

TABLE 7.1

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 7.4 Step 4: Risk Response Control

Risk Register
• Details all identified risks, including descriptions, category, probability
of occurring, impact, responses, contingency plans, owners, and
current status.
Risk Control involves:
• Executing the risk response strategy.
• Monitoring triggering events. (Thamhain, 2013)
• Initiating contingency plans.
• Watching for new risks.
Establishing a Change Management System
• Monitoring, tracking, and reporting risk.
• Fostering an open organization environment.
• Repeating risk identification/assessment exercises.
• Assigning and documenting responsibility for managing risk.
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 7.9 Change Control Management

Sources of Change
• Project scope changes.
• Implementation of contingency plans.
• Improvement changes.
Change Management Systems
1. Identify proposed changes.
2. List expected effects of proposed change(s) on schedule and budget.
3. Review, evaluate, and approve or disapprove of changes formally.
4. Negotiate and resolve conflicts of change, conditions, and cost.
5. Communicate changes to parties affected.
6. Assign responsibility for implementing change.
7. Adjust the master schedule and budget.
8. Track all changes that are to be implemented.

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 Change Control Process

FIGURE 7.9 Access the text alternative for slide images.

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 Benefits of Change Control Systems

1. Inconsequential changes are discouraged by the formal

process.
2. Costs of changes are maintained in a log.
3. Integrity of the WBS and performance measures is maintained.
4. Allocation and use of contingency and management reserves
are tracked.
5. Responsibility for implementation is clarified.
6. Effect of changes is visible to all parties involved.
7. Implementation of change is monitored.
8. Scope changes will be quickly reflected in baseline and
performance measures.

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 Sample Change Request

FIGURE 7.10 Access the text alternative for slide images.

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 Change Request Log
Owner Requested Change Status Report—Open Items OSU—Weatherford

Dates
Rc# Description Reference
Document Date Rec’d Date Submit Amount Status Comments
51 Sewer work offset −188,129 OPEN FUNDING
FROM OTHER
SOURCE
52 Stainless Plates at restroom ASI 56 1/5/2013 3/30/2013 9,308 APPROVED
Shower Valves
53 Waterproofing Options ASI 77 1/13/2013 169,386 OPEN
54 Change Electrical floor box RFI 113 12/5/2013 3/29/2013 2,544 SUBMIT
spec change
55 VE Option for Style and rail Door samples 1/14/2013 −20,000 ROM
doors
56 Pressure Wash C tower Owner request 3/15/2013 3/30/2013 14,861 SUBMIT
57 Fire Lite glass in stairs Owner request 8,000 QUOTE ROM BASED ON
FIRELITE NT
58 Cyber Café added tele /OFOI ASI 65 1/30/2013 3/29/2013 4,628 APPROVED
equipment
59 Additional Dampers in C wing ASI 68 2/4/2013 3/29/2013 1,085 SUBMIT
60 Revise Corridor ceilings ASI 72 2/13/2013 3/31/2013 −3,755 SUBMIT

OPEN—Requires estimate SUBMIT—RC letter submitted ASI—Architect’s supplemental instructions

ROM—Rough order magnitude APPROVED—RC letter approved RFI—Request for information
QUOTE—Subcontractor quotes REVISE—RC letter to be reviewed

FIGURE 7.11
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 Key Terms

Avoiding risk Risk

Change management Risk breakdown structure
system (RBS)
Contingency plan Risk profile
Contingency reserves Risk register
Escalating risk
Risk severity matrix
Management reserves
Scenario analysis
Mitigating risk
Time buffer
Opportunity
Transferring risk
Retaining risk

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 PERT—Program Evaluation and Review Technique

Assumes each activity duration has a range that statistically

follows a beta distribution.

Uses three time estimates for each activity: optimistic, pessimistic,

and a most likely time estimate to represent activity durations.
• From these three time estimates, a weighted average time
estimate and a variance is calculated.
• Knowing the weighted average and variances for each activity
allows the project planner to compute the probability of meeting
different project durations.
• The longer the project duration is, the higher is the probability of
meeting that duration.

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 Activity and Project Frequency Distributions

FIGURE A7.1 Access the text alternative for slide images.

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 Activity Time Calculations 1

The weighted average activity time is computed by the

following formula:
a  4m  b
te  (7.1)
6
where te = weighted average activity time
a = optimistic activity time (1 chance in 100 of
completing the activity earlier under normal
conditions)
b = pessimistic activity time (1 chance in 100 of
completing the activity later under normal
conditions)
m = most likely activity time
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 Activity Time Calculations 2

The variability in the activity time estimates is approximated

by the following equations:
The standard deviation for the activity
ba
t    (7.2)
e
 6 

The standard deviation for the project

T 
E  t
 2
e
(7.3)

The above formula is just the square-root of the sum of the

variances of all critical tasks.

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 Activity Times and Variances

Activity a m b te [(b − a)/6]2

1 to 2 17 29 47 30 25
2 to 3 6 12 24 13 9
2 to 4 16 19 28 20 4
3 to 5 13 16 19 16 1
4 to 5 2 5 14 6 4
5 to 6 2 5 8 5 1

TABLE A7.1

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 Probability of Completing the Project

The equation below is used to compute the “Z” value found in

statistical tables (Z = number of standard deviations from the
mean), which, in turn, tells the probability of completing the project
in the time specified.

Ts  TE
Z (7.4)
 2
te

where TE = critical path duration

TS = scheduled project duration
Z = probability (of meeting scheduled duration)
(see statistical Table A7.2)

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 Hypothetical Network

FIGURE A7.2 Access the text alternative for slide images.

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 Possible Project Durations

Probability project is completed Probability project is completed

before scheduled time (TS) of 67 units by the 60th unit time period (TS)

TS  TE 60  64
Z Z
 t
 2
e
25  9  1  1
67  64 4
 
25  9  1  1 36
3  0.67

36 P  0.26
 0.50
P  0.69

FIGURE A7.3 Access the text alternative for slide images.

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 Z Values and Probabilities
Z Value Probability Z Value Probability
−3.0 .001 +0.0 .500
−2.8 .003 +0.2 .579
−2.6 .005 +0.4 .655
−2.4 .008 +0.6 .726
−2.2 .014 +0.8 .788
−2.0 .023 +1.0 .841
−1.8 .036 +1.2 .885
−1.6 .055 +1.4 .919
−1.4 .081 +1.6 .945
−1.2 .115 +1.8 .964
−1.0 .159 +2.0 .977
−0.8 .212 +2.2 .986
−0.6 .274 +2.4 .992
−0.4 .345 +2.6 .995
−0.2 .421 +2.8 .997
TABLE A7.2

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