Advanced Performance Management (APM)
Risk &
Uncertainty
BS ACF 2k17 (A&B)
Risk and Uncertainty
• Risk
• Returns may vary
• There are number of outcomes
• Probability of each outcome is known
• Uncertainty
• Returns may vary
• There are number of outcomes
• Probability of each outcome is not known
• Exogenous variables
• External to the organization
• Not controllable
Deal with Risk/uncertainty
• Scenario Planning
• Preplan for various scenarios like Business continuity plan
• Computer simulations
• Like what if analysis in excel
• Sensitivity Analysis
• How each variable would change to reverse the decision
• Expected Values
• Weighted average of possible outcomes
• Maximax, Maximin, Minimax regret
• Tools to choose a course of action for different risk appetites
Expected Values
• EV is the average return that will be made if a decision is repeated again and
again.
• Useful decision rule for a risk neutral decision maker.
• Because a risk neutral decision maker neither seeks or avoids risk; he is happy
to accept the average outcome.
Expect
ed
Values
• Payoff (Profit)
tables
Solution: Payoffs table
Supply Salads
Demand 40 50 60 70
Salads Probability
40 0.10 80 0 (80) (160)
50 0.20 80 100 20 (60)
60 0.40 80 100 120 40
70 0.30 80 100 120 140
Expected Values 80 90 80 30
Maximax, Maximin, Minimax Regret
• Maximax
• Best outcome of each scenario – best out of the best
• Maximin
• Worst outcome of each scenario – Best out of the worst
• Minimax Regret
• Maximum opportunity cost for each scenario – Minimum opportunity cost in all
Solution: Maximax- best out of the best
Supply Salads
Demand 40 50 60 70
Salads Probability
40 0.10 80 0 (80) (160)
50 0.20 80 100 20 (60)
60 0.40 80 100 120 40
70 0.30 80 100 120 140
MAXIMAX 80 100 120 140
Solution: Maximin – Best out of
worst
Supply Salads
Demand 40 50 60 70
Salads Probability
40 0.10 80 0 (80) (160)
50 0.20 80 100 20 (60)
60 0.40 80 100 120 40
70 0.30 80 100 120 140
MAXIMIN 80 80 0 (80) (160)
Solution: MiniMax Regret -Minimum opportunity cost in all
Supply Salads
Demand 40 50 60 70
Salads Probability
40 0.10 Right Decision 80 160 240
50 0.20 20 Right Decision 80 160
60 0.40 40 20 Right Decision 80
70 0.30 60 40 20 Right Decision
MINIMAX 6060 80 160 240
Usefulness of maximin,
maximax and minimax regret
• With maximin the decision maker chooses the outcome which is guaranteed to
minimise his losses and is used by decision makers who are risk averse.
• With maximax the decision maker chooses the outcome which is guaranteed to
maximise his profit and is used by decision makers who are risk seeking.
•
• With minimax regret the decision maker chooses the outcome which minimises
the maximum regret. In the process, he risks making a lower profit. It is often seen
as a technique for a ‘sore loser’ who does not want to make the wrong decision.
• Each of the above techniques can be used for oneoff or repeated decisions.
Risk Appetite
Risk Culture Features
Fatalist Assumes that they have no control over incidents
Hierarchists Follow a well structured approach for managing risk. Bureaucratic
Individualist Control their lives themselves, likes less formal structures and risk management
Eaglitarians Prefer sharing or transfer of risk to best possible
Levels of risks
• Strategic risks
• Threats to profits due to products and services (unsystematic risk)
• Threats to profits other than above (systematic risk)
• Going concern issues (single supplier/ single customer)
• Operational risks
• Internal control related
• Non compliance with laws
• Human error
• Loss of key persons
• Business Risk and financial risk
• Business risk is borne by both Shareholders and Lenders
• Financial risk is only borne by equity holders
Risk Profiling
Consequences
Low High
Low Accept Transfer
Loss of suppliers Loss of Key staff
Loss of sale VS competitor
Loss of sale due to
macroeconomic factors
Likelihood
High Mitigate Transfer or Mitigate
Loss of lower level staff Loss of key customers
Failure of computer system
