Risk Analysis In Project Management
Risk analysis serves various purposes and aids businesses in mitigating potential risks, leading to enhanced success. Acquiring the necessary skills to perform effective analyses can assist a business in identifying process trends, becoming more efficient, and proactive. Recognizing and averting risks before they transform into threats can help conserve resources and safeguard a brand’s reputation. This article elucidates what risk analysis entails, elucidates why businesses conduct it, and provides a list of risk analysis methodologies.
Key Areas Covered
- What is Risk Analysis
- Risk Analysis Techniques
- Importance of Risk Analysis
What is a Risk ?
A risk is represented by one or more potential negative events which an individual or organization seeks to avoid — at all costs — to achieve their intended objectives. It is therefore important that these potential negative events are identified as well as their impact on the overall project. In project management, a risk is described as a combination of the following elements:
Risk = Potential Negative Event + Impact + Probability of Occurrence
The probability of risk occurrence ranges from 0% to 100%. It is important to note that risk probabilities are not fixed and can change at any time throughout the project life-cycle.
Risk Analysis
Risk analysis is the procedure of evaluating the likelihood of potential risks occurring during a project. It examines the level of uncertainty and the potential impact of risks on project timelines, quality, and costs in case they materialize. The two methods used for risk analysis are quantitative and qualitative. However, it’s crucial to acknowledge that risk analysis isn’t a precise science, hence it’s vital to monitor risks throughout the project life cycle.
Types of Risk Analysis
There are three types of risk analysis in project management as follows:
Qualitative Risk Analysis: It is a subjective analysis by the project team where risks are identified and assessed based on their probability of occurrence.
Quantitative Risk Analysis: It is an objective analysis wherein risks are classified according to their probability of occurrence, using the standard deviation to determine its level.
Technical Risk Analysis: It is a dynamic analysis that requires the project manager to use various tools and techniques in order to identify, rank and evaluate risks.
Although using risk analysis the future cannot be predicted with certainty, but can help anticipate project uncertainties and reduce their probability or impact.
6 Risk Analysis Techniques
There are several risk analysis techniques that help managers through the analysis and decision-making process. Let’s dive into these risk analysis techniques and how they can help us.
1. Break Even Analysis
Break even analysis is used by managers to determine the effectiveness of a sales strategy. If one product takes longer to reach the break even point than certain thresholds set by management, this is useful information in their production strategy. When performing a break even analysis, small business owners consider both fixed and variable costs. This is essential when analyzing what-if scenarios to optimize production cycles. Then, this information can be used to cut costs or replace obsolete equipment. A break even analysis can also be used to determine worst-case scenarios. In other words, what happens if the investments that managers make only break even? The breakeven point represents a minimum investment required not to lose money.
Break Even Analysis Coffee Cup Example
2. Bow Tie Analysis
It is a risk analysis method used to manage and reduce risks. The process begins by observing a potential risk and splitting it into two categories: one that includes all the potential contributing factors and one that lists all the potential consequences. From there, a new practice is created that addresses each of the potential causes and consequences.
For instance, working in the food sector, one may conduct a bow tie analysis to determine which events could cause a power outage and how that would affect both your suppliers and the food you store on site. After that, one would list all the potential ways to avoid the power outage as well as what to do if a power outage occurs. Read More
3. Monte Carlo Analysis
Monte Carlo Analysis is used to conduct a quantitative analysis of risks. It is used to analyze the impact of risks on the project — in other words, if this risk occurs, how will it affect the schedule or the cost of the project. Monte Carlo gives a range of possible outcomes and probabilities that allows us to consider the likelihood of different scenarios.
For example, let’s say you don’t know how long your project will take. You have a rough estimate of the duration of each project task. Using this, you develop a best-case scenario (optimistic) and worst-case scenario (pessimistic) duration for each task. You can then use Monte Carlo to analyze all the potential combinations and give you probabilities of when the project will complete. It successfully provides early indication of how likely you are to meet project milestones and deadlines. Moreover it can be used to create a more realistic budget and schedule.
4. Delphi
The Delphi technique is similar to brainstorming, but the difference is the Delphi technique relies heavily on the use of expert opinions throughout the process. To put it simply, the Delphi Technique is used to make decisions about complex issues based on individual opinions. In this method, a group of experts writes down and shares their thoughts about a problem with a facilitator. Each expert’s view is compiled into a summary report by the facilitator. The experts then review the information and provide updated predictions to the facilitator to produce a new report. This process continues with systematic reviews until participants reach a consensus or agreement on the topic.
5. Probability/Consequence Matrix
The probability/consequence matrix technique is a prominent method of assessing risk severity when conducting a qualitative risk analysis, and it can assess risks at all levels of the company. The probability/consequence matrix is a practical technique of ranking the severity of various risks by calculating the risk’s potential impact. Not only does this allow companies to better determine the overall severity of a risk, but it also allows you to determine the main contributing factors to each potential risk.
A gym owner interested in conducting a risk analysis might use a probability/consequence matrix to assess the rules and procedures about equipment and hygiene in their facility. The probability/consequence matrix can help them determine which areas of their hygiene guidelines need attention to keep their business operating safely. Read More
6. Decision Tree Analysis
The decision tree analysis technique helps people and companies determine the best course of action in a scenario. To execute this method, companies start by analyzing a proposed decision and mapping out the various potential outcomes of the decision. Once you list all potential outcomes, as well as their likelihood of occurring, it is then possible to decide the best course of action for each issue.
For instance, if you work in the beauty industry, you may want to shift your model to accept only appointments and not walk-in customers. You can use this technique to determine whether it is financially viable to focus on only appointments, or if it would be profitable and sustainable to offer a combination of the two appointment types. Read More
Why Perform Risk Analysis
Risk analysis is one of the essential procedures which is not done diligently or not given enough significance will lead to many problems, which may, in turn, could cause the failure of the project. A well-analyzed project will have chances of going more smoothly and have a higher chance of success and will do more to reduce risk than any risk plan, no matter how good it may be. Some benefits of performing risk analysis are:
1. Avoid potential litigation and address regulatory issues
2. Comply with new legislation
3. Reduce exposure and Minimize impact
Final Thoughts
Risk analysis is a crucial aspect of all projects and organizational security. Potential risks can have a direct impact on a project’s success and can lead to negative consequences such as a loss of reputation or revenue. Conducting a risk analysis not only helps in preventing crisis situations but also assists in remembering and learning from past mistakes. This approach enhances the prospects of achieving project success while minimizing the consequences of potential risks.
