Quantification

In the last part of the risk management process you should have identified as many risks to your risk subject as possible. Some of these risks will be very important but probably a large number will be quite small in impact or very unlikely so that they will never realistically occur. Sorting out the important and more likely risks is the purpose of the RISK QUANTIFICATION process.

The Tiber well was drilled to a total depth of approximately 35,055 feet (10,685 metres) making it one of the deepest wells ever drilled by the oil and gas industry (photo courtesy of BP p.l.c.)

Risk quantification is often a rather subjective process – comparisons with similar known risks can help with understanding (photo courtesy of BP p.l.c.)

As you will probably be dealing with a large number of risks which will later need to be sorted it is a good idea to list them on the left hand column of a spreadsheet. Along the top row of the spreadsheet you should add the following headings:

Risk Name  :  Value  :  Likelihood  :  Importance  :  Action Plan  :  Completion Time

These are the most basic headings you will need. In the past I have worked with spreadsheets which also contained more detailed headings such as: Risk Descriptions, Risk Owners, Action Owners, Monitoring Frequency, Contingency Plans etc. This speadsheet will be a key tool in your risk management process and therefore it is worth spending some time deciding what kind of information you will need. It is also important to be very careful about the format of the information you input – later you will want to use these inputs to sort the risks (so make sure value information is entered in a numerical format – not alphabetic – e.g. use ‘$1,000,000’ not ‘a million dollars’).

For risk quantification we will focus on the Value and Likelihood columns. The other columns will be used later as part of risk management. In my book I describe this spreadsheet as an ExposureTracker (it is used for tracking the business exposure to the risks identified).

The Trans Alaska Pipeline (photo courtesy of BP p.l.c.)

When assessing the value impact of a risk occurrence like a supply failure consider the cost of quickly getting a viable alternative to allow continued business  (Trans Alaska Pipeline photo courtesy of BP p.l.c.)

For each risk try to identify a value impact that that risk could have on the business and the likelihood of it actually having that impact. By its very nature this is usually a rather subjective, judgemental process. Therefore the level and breadth of experience of the people in your evaluation team can be crucial to the quality of the output.

In order to assess the value of the risk impact ask yourself what is the overall negative effect the risk could have on the businesses value. This could include the impact on profitability, share price or business worth, customer/supplier goodwill, legal costs like fines or lawyers fees, the impact on a loss of the business’ license or permit to operate, etc. If you try to evaluate this impact on a worse case basis you should also then determine the likelihood of precisely this scenario happening. It is important to estimate the likelihood which is linked to the value estimate so if the value is not a worse case option the likelihood should also not be for the worse case option.

Value should be entered into the spreadsheet using a single currency to allow the entries to be directly comparable. Likelihood should be entered as a probability (for example if there is a 50% chance of a risk occurring the probability will be 0.5).

BPs Containment Cap Project (photo courtesy of BP p.l.c.)

When evaluating the value and likelihood of risks it is important to bring together a team of knowledgeable experts. These same people can help with analysing the risks and determining suitable action plans (Containment Cap Project photo courtesy of BP p.l.c.)

It is not possible to provide a lot of detail about specific examples in an introductory site like this (I have tried to include some examples in my book). The important thing is to remember to think of both the long as well as the short term value consequences. Also try to estimate a monetary value for non-financial impacts (like loss of good will, customer dissatisfaction, etc.) –  An estimate of the potential impact on the share price or the value of the business if it is sold can be a useful value indicator for such impacts.

Also be careful not to get bogged down with unnecessary detail. If the value impact of a risk is minuscule in comparison to the overall size of the business do not spend a long time debating what comes after the decimal point. The main purpose of this quantification process is to help you determine which risks are important enough to need more detailed attention. This will be addressed as part of the risk prioritisation stage – using the link here.

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