The Project Risk Profile - Essay Example

The Project Risk Profile (PRP) The Project Risk Profile (PRP) is a risk management tool that works inside the FAP protocol. The PRP is created by management at the beginning of a project during initial evaluation and is used to place values on the risks involved in the project to determine differing levels of importance for all the risks taken together. This evaluation tool focuses upon the risk exposure and the potential impacts of those risks. Lefley states, “We also need to know what is the variation in the particular risk probability and impact values given by managers” (2008, p. 240), summing up the reasoning behind creating the PRP. Project specific – risk The PRP produces a “risk area index” using a scale from -10 to zero, with -10 being the absolute limit of risk a firm is willing to accept concerning an individual risk type (Lefley and Ryan, 2005). The PRP begins with a corporate risk threshold and the risk area indices illustrate acceptable risk. The values applied to the risk areas vary according to which team member is producing them (and their corresponding comfort levels) and each team member’s values are taken into account to determine the final risk profile for the project under evaluation. Lefley and Ryan indicate there are three stages of assessment which, if followed in the prescribed order, will produce adequate profiles of the project’s risks. The evaluation team must invest time and effort at the initial evaluation stages and this is followed up by the appraisal team’s assessments. The three stages are outlined as: Stage One • Determine the CRT (corporate risk threshold) • Establish potential risk areas and determine manager responsibilities Stage Two • Identify key risk elements (project-specific) • Determine the probabilities and impacts of various risk values Stage Three • Calculate risk importance (R = P x DIV) • Determine the final risk area index based on the -10 to zero scale discussed above • Identify the absolute limits of risk events (worst case scenarios) • Determine the uncertainty of the risks and adjust accordingly Stage one is the responsibility of the corporate management team; stage two is the responsibility of the appraisal team; stage three combines the two into a final assessment. This three stage process produces a good picture of the risk values for each key risk element and the calculations return a final risk area index as shown in Table 1.3 (drawn from Lefley and Ryan, 2005). Table (1.3) Calculation of the ‘agreed’ risk probability and values for key risk elements Management areas of responsibility – suggested values Production Marketing and sales Environment Personnel Transport AV Variance Risk Area [Production]. Risk element (1) Probability 0.12 0.14 0.11 0.07 0.09 0.11 22.8% Impact 9 8 4 11 10 9.17 12.7% DIV* 9.13 8.08 4 11.26 10.19 9.31 Risk Area [Production] risk element (2) Probability 0.14 0.12 0.10 0.14 0.18 0.14 19.5% Impact 7 6 4 5 6 5.83 18.2% DIV 7.05 6.02 4 5 6.02 5.86 Risk Area [Marketing and Sales] Risk element (3) Probability 0.09 0.07 0.06 0.09 0.10 0.08 17.9% Impact 14 12 13 17 16 14.0 12.9 % DIV 14.57 12.36 13.46 18.02 16.85 14.60 Risk Area [Marketing and sales] Risk element (4) Probability 0.10 0.07 0.08 0.09 0.07 0.08 14.2% Impact 11 12 10 8 8 10.17 16.3% DIV 11.26 12.36 10.19 8.08 8.08 10.39 *The disutility impact value (DIV) is arrived at after applying a disutility factor to the suggested impact value. The shaded boxes highlight the values suggested by the manager responsible for the risk area. The degree of variance is the coefficient of variation in the suggested values. This protocol continues for all other risk areas, e.g. Environmental, personnel, and Transport. Source: Lefley &Ryan (2005) In this table it can be seen that each key risk element (R) results from considering the probability of risk occurrence (P) and the specific risk’s potential impact (I). In this instance, impact is considered to be the perceived limit of the consequences and the chances that particular risk will impact the project (including complete failure of the project). Within specific risk areas, the total risk importance values are added together and multiplied by the corporate risk threshold (measured on the -10 to zero scale). For example (referring to table 1.4, drawn from Lefley and Ryan, 2005) if the total for key risk elements is three, and the corporate risk threshold is six, the equation would read 3/6 x -10 = -5. In all calculations, the highest value is determined and thus represents the risk area index for the project in question. The theory goes that a chain is only as strong as its weakest link; thus, the risk area index (RAI) determines the strength of the weakest link (the riskiest part of the potential project. Table (1.4) Calculation of departmental risk values (RV) Details of keys risk Probability of Disutility ‘Importance’ Risk occurrence impact value rating/RV [0 – 1] [0 – 1] Production Risk element (1) 0.11 9.31 1.024 Risk element (2) 0.14 5.86 0.820 Total ‘importance’ rating. 1.844 Agreed production risk area RV [10844/7*- 10] RV – 2.63 Marketing and Sales Risk element (3) 0.08 14.6 1.168 Risk element (4) 0.08 10.39 0.831 Total ‘importance’ rating. 1.999 Agreed marketing and sales risk area RV [1.999/7* - 10] RV – 2.86 Environment Risk element (5) 0.15 11.71 1.757 Risk element (6) 0.14 8.3 1.162 Total ‘importance’ rating. 2.919 Agreed environment risk area RV [2.919 /7* - 10] RV – 4.17 Personnel Risk element (7) 0.07 7.92 0.554 Risk element (8) 0.09 11.47 1.032 Total ‘importance’ rating 1.586 Agreed personnel risk area RV [1.586/7* - 10] RV – 2.27 Transport Risk element (9) 0.05 7.67 0.384 Risk element (10) 0.09 11.47 1.032 Total ‘importance’ rating 1.586 Agreed transport risk area RV [0.537 /7 * - 10] RV – 0.77 To arrive at a RV for each risk area, a corporate risk threshold (CRT – which in this example is 7) factors is applied to the total ‘importance’ rating for each area, so that only ‘acceptable’ risk is measured on the risk area index scale of 0 – 10. Source: Lefley & Ryan (2005) Another key illustration revealed in the project risk profile is the coefficient of variation as it applies to manager-assigned values of risk probabilities and impacts. Taken all together, these calculations represent a full risk profile and allow the manager to keep probabilities and impacts firmly in mind during evaluations. It is not just the straightforward calculation of risk equals probability times impact (R=P x I); the differing effects of high risk versus low risk coupled with high probability versus low probability produce sufficient scenarios to measure the true potential risk involved in a given project. A disutility weighting is applied to impact values, producing a disutility impact value (DIV), so the straightforward equation above becomes R=P x DIV. This model finds efficacious use for managers in that it provides for worst case scenarios and presents the true potential risk profile for consideration. This is illustrated in Table 1.5, drawn from Lefley and Ryan, 2005. Table (1.5) Determination of the project risk profile (PRP) Risk areas (Departments/areas of responsibility) risk value/profile Production - 2.63 Marketing and sales - 2.86 Environment - 4.17 Personnel - 2.27 Transport - 0.77 Project risk area index [Environment] RAI = - 4.17 The project RAI is based on the hightest risk value shown in the risk profile. Extreme ‘risk impact’ – area and value: Marketing & sales: 14.0 (Variance 12.9%) Highest Variance: Probe: risk element 1. Production. 22.8% Source: Lefley & Ryan (2005) Project strategic – benefits Now that risks are clearly in mind, the FAP protocol continues to the strategic benefits a project might produce by calculating the strategic indeed (SI). The process used to evaluate benefits is similar to the three-stage process used to evaluate risks and also consists of three stages, namely: Stage One • Determine overall strategic benefits • Rank each benefit on a corporate ranking (CR) scale from 1 to 10 • Determine project specific/overall key strategic benefit areas Stage Two • Focus upon project specific key strategic benefits • Formulate each key benefit’s project strategic score value (PSSV) on a scale from 0 to 10 Stage Three • Determine the weighted average of the CRs and PSSVs and apply a positive scale of zero to 10 (zero is no benefit whatsoever and 10 is great benefit) Stage one is the responsibility of the management team; stage two is the responsibility of the appraisal team; stage three combines calculations to determine overall and specific benefits. This is illustrated in Table 1.8, drawn again from Lefley and Ryan, 2005. Competitive advantages and the possibility/probability of extending the strategic vision of the company must be considered in project evaluations. The strategic index thus produces a clear calculation of the competitive advantages and the project’s contribution to the overall firm strategic vision, both considered to be non-quantifiable projections which must become quantified in order to ensure the continued survival of the company. Lefley and Sarkis state, “Briefly, the strategic index adopts the same team approach as for the net present value profile (NPVP) and the project risk profile (PRP) to arrive at a project strategic score value (PSSV) for each strategic benefit” (2005, p. 80). Corporate rankings (CR) are applied to the PSSVs as shown in Table 1.6 (drawn from Lefley and Ryan, 2005) to reach a total unique strategic index. This ranking accounts for the varying levels of importance for each benefit, because not all benefits have the same importance in relation to the project in question and the overall strategic vision of the company. The PSSV is concerned with particular benefits and how much emphasis the company places on those benefits. Corporate rankings are assigned values from 1 to 10 and to check consistency of the rankings are calculated using a pair-wise approach (Lefley and Sarkis, 2005). After all these calculations and rankings are applied, the project strategic score values can finally be determined, creating a properly weighted and adjusted strategic index. Again, this is the PSSV of all the strategic benefits and is measures on a scale of zero to 10. Table (1.6) corporate ranking of key strategic benefits – pair wise comparisons A B C D E A 1 9/10 9/6 9/5 9/10 B 10/9 1 9/6 2 1 C 6/9 6/10 1 5/6 6/10 D 5/9 2 5/9 1 2 E 10/9 1 10/6 2 1 Source: Lefley & Ryan (2005) Table (1.7) calculation of the project strategic score value (PSSV) Suggested PSSVs for each team members managerial area of responsibility Key strategic benefits Production Marketing & Environment personnel Transport Agreed Sales PSSV [A]Manufacturing Flexibility 5.4 5.8 5.2 6.1 4.5 5.4 [B] Marketing Competitive advantages 7.3 7.5 7.8 7.1 6.3 7.3 [C] Organizational 5.6 5.7 5.0 5.1 4.7 5.2 [D] Environmental 3.1 3.2 2.9 2.8 2.7 2.9 [E] Logistics 7.4 7.8 8.1 7.4 6.6 7.3 Source: Lefley & Ryan (2005) Final stage in the FAP process The final stage of the FAP process is compiling the data arrived at through the various other stages, including the NPV, PRP and the SI. Once the final report is completed, the investment appraisal team makes final recommendations to corporate management, who examines the various risks and benefits of the proposed project to reach a final decision. Table (1.8) Determination of the strategic index (SI) Key strategic benefits CR (a) PSSV (b) (a) * (b) [a]manufacturing flexibility [b] Marketing competitive Advantage [C) organizational [D] environmental issue [E] logistics Totals 0.225 0.25 0.15 0.125 0.25 1 5.4 7.3 5.2 2.9 7.3 1.215 1.825 0.78 0.3625 1.825 6.0075 SI = 6.0 Source: Lefley & Ryan (2005) Advantages of the FAP model This might seem like an involved process, but the biggest advantage of completing each stage of the FAP protocol is the actual simplicity contained in the structure. The paradigm contains both hermeneutic and rational elements (Lefley, 2008). The protocol produces meaningful project profiles using a consistent approach and fully quantifying concepts which might be considered non-quantifiable. Importantly, this protocol allows for the assessment of risks and strategic factors which are important for good decision-making. The PRP and SI are somewhat subjective calculations, and the FAP protocol forces management and appraisal teams to consider reasonable values for important, subjective judgments. Management will reject projects outright if the risks are too great or if the projects do not fit with the company’s overall strategic vision, but using the FAP protocol allows for a full understanding of financial and strategic potentials. Aspects of projects such as deferment, growth or abandonment are important considerations, and the FAP protocol structure allows evaluation teams to include those aspects in the evaluations. Since several sub-models play into the overall structure of the FAP model, evaluators are afforded flexibility. No project is rejected based on a single aspect of consideration, nor are projects accepted which may produce undesirable results because strategy and risk were not accounted for during assessment. The FAP model produces a dynamic and pragmatic approach to capital project evaluations and allows the management and appraisal teams to introduce their judgments into the model in a straightforward and structured way. Through the various calculations, the non-quantifiable becomes quantified and corporate managers can give them the consideration they are due (Lefley, 2008). The applications of the FAP model Although the literature regarding the FAP model is fairly extensive, two studies from Lefley (2007) and Lefley and Sarkis (2005) provide full explanations of the protocol and its uses. Lefley (2007) applies the FAP model to an information communication technology case study within the context of a real-life professional association and produces an effectiveness and applicability assessment of the model itself. This application produces clear evidence of the protocol’s practicality to real-life situations. The second study (Lefley and Sarkis, 2005) applies the FAP model to the strategic information technology within an organization. This example illustrates that the FAP model can bring greater awareness of risks, benefits, and strategic considerations which will allow management to reach reasonable decisions once all aspects of the protocol have been incorporated. Bibliography Cross, R., & Brodt, S. (2001). How assumptions of consensus under mine decision - making. Sloan Management Review , 42 (2), 86-94. Fredrickson, J. (1985). Effects of Decision motive and organisational performance level on strategic decision processes. Academy of Management Journal , 32 (12), 2751-2776. Gregory, A., Rutterford,J., & Zaman,M;. (1999). The Cost of Capital in the UK: Acomparison of the perception of industry and city. London: CIMA. Kaplan, R. (1986). Must CIM be justified by faith alone? Harvard business Review , 64 (2), 87-95. Lefley. (2008). Research in applyting the financial appraisal profile model to an information communication technology project within a professional association. International Journal of managing Projects in Business , 1 (2), 233 - 259. lefley, F. (1996). Strategic methdologies of Investment Appraisal of AMT projects: a review and Synthesis. Engineering Economist , 41 (4), 345-363. Lefley, F., & Ryan, B. (2005). The Financial Appraisal Profile Model. New York: Palgrave Macmillan. Lefley, F., & Sarkis, J. (2005). Applying the FAP Model to the Evaluation of Strategic Information Technology Projects. International Journal of Enterprise Information Systems , 1 (2), 69 - 90. Mohanty, R., & Deshmukh, S. (1998). Advanced manufacturing technology selection: A strategic model for learning and evaluation. International Journal of Production Economics , 41 (4), 295-307. Pike, R. (1989). Do sophisticated capital budgeting approaches improve investment decision - making effectiveness? Engineering Economist , 34 (2), 149 - 161. Small, M., & Chen, I. (1997). Economic and strategic justification of AMT: inferences from industrial practices. International Journal of production Economics , 49 (1), 65 - 75. Read More