Risk management

Risk management in product development

projects

Hans Mikkelsen

The preliminary results from a Danish study of the handling of uncertainty and risk in product development projects are presented. The original intention was to develop tools and methods for risk analysis and the increase of project robustness, But the study revealed that the handling of risks depends on attitudes to risk and on the risk-taking culture in the project organization. Thus a model for description of this culture is presented.

Keywords: risk management, product development, risk, uncertainty, project management

The product design world is full of stories of mistaken projects. In the clear light of hindsight, we see the mistakes and blunders we made. And yet we go on making many of them. We speak of uncertainty and risk, but how do we actually deal with these aspects? Do we have and do we use methods for actively managing risk? Do we need to develop appropriate methods and tools?

In product development projects we are frequently advised to evaluate risk at the conceptual stage of the product. There are several models for doing this. They enable us to discard insufficiently clarified product ideas and ideas with high risk, regardless of the fact that these ideas are accompanied by opportunities for big earnings and for technological advances. We are forced to take on projects involving risk. That can be a condition for a company’s survival. We cut down the product development time, we accelerate the work, we work in parallel on several aspects of the project, early

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in the project process we make decisions with far- reaching consequences, we work at the edge of our experience.

A risk, with a corresponding chance of a gain, may be worth running, but more often than not our lack of project professionalism causes risks that have no corresponding gain. It is not enough to counteract risk by contingency methods (buffer and slack). There is a need for active uncovering of risks and for actively increasing the robustness of projects.

For these reasons, a research project was initiated, aimed at pinpointing relevant and practicable methods for active management of risk in product development projects*. One source of inspiration was the Swedish SBA-method (SBrBarhetsAnalys - vulnerability analysis) for EDP projects’. The research carried out so far has revealed that there may be a need for methods and tools, but that there is also a need to analyse behaviour and attitudes to uncertainty and risk. Different risk-taking cultures in and around project organizations can be identified. The research work focused on product development projects but the findings apply to other types of projects, where a successful result is at stake.

Risk relates to several factors. Usually, we think of technical risk - the risk that the product will not work properly, will not be sufficient durable, can harm the user, etc. In the research mentioned, on the other hand, we focused on the business risk - the risk of not making the anticipated financial profit from the product. In this context, the technical factors are seen as events that can result in the business risk.

* The other participants in the Danish research are Assistant Professor Mogens Myrup Andreasen and Lars Hein, Institute for Product Design, Technical University of Denmark.

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Risk rn~~~gerne~t

CONCEPTIONS OF RISK

The experienced risk is different from the objectively ascertainable risk. We are blind to risk because we know better. We feel sure. We more or less consciously twist or distort the risk picture. We give an impression of certainty. We have learned that ‘faith can move mountains’. We think that sowing doubt and being negative may harm the product development project.

In our research work we have used an analogy, likening the project work to climbing a mountain. The aim of the climb is to reach a specific mountain peak and get back and tell of it.

Some statements about attitudes to risk:

l Do we know when willingness to take risks turns into eagerness to lose?

l Do we understand the difference between courage, daring and foolhardiness?

l Is optimism confused with opportunism’? l Is experience having repeated an operation

several times or having tried new paths several times?

l Does our result orientation jeopardize the result?

l Is risk what we do not talk about‘? l Are risk considerations nobody’s responsibility? l Is talk about uncertainty an accusation against

the project team? l Is speaking of risk simply writing the project’s

epitaph?

It is unacceptable to take the wrong path or for another team to get there first. The goal has in-built risk factors in the form of the topological conditions. the conditions en route, the weather, etc. The time schedule is another contributory factor.

Other risk factors relate to the participants’ experi- ence, equipment and provisions, available aids, etc. In mountaineering, there are principles governing the choice of route and stages. Deviating from the principles is not forbidden, but deviations can increase the risk.

The amateur culture is characterized by inclination and engagement, but experience, physique and equip- ment are imperfect. Stamina and perseverance may also be in short supply. Performance norms are often short-term (stage by stage), action is not accompanied by caution. The amateur does not receive all the signals and does not understand all those he receives. On the plus side, the lack of norms sometimes enables the amateur to see and to grab new, unusual opportunities. But under pressure his ambition may turn into fool- hardiness.

On the way, the participants may experience risk situations of the ‘Good heavens!’ type. Things happen that in a flash reveal shortcomings, something unfore- seen, something unpleasant. The risk revealed by the occurrence is not created at the moment of the occurrence. It was created earlier, during the planning of the route, selection of participants and equipment, in ad hoc decisions concerning choice of routes and procedures.

The native acts in accordance with the situation and by reflex. Signals are received and interpreted. He has respect for the task, and will exploit the possibilities. There is no lack of endurance in the native - he has a ‘do it’ culture. Any weaknesses lie in the ~~~mmitment. He may regard the goal with indifference (‘All moun- tains are alike!‘). Under pressure, the native will not take chances and may ‘abandon’ the team and keep to his own ‘safe’ areas.

On the way, the participants in the climb receive The tourist culture is characterized by a desire for signals from their surroundings - from the weather new experiences but not necessarily by the will to reach conditions, from the radio they have taken with them, the goal. The tourist lacks experience and physique. from the people they meet. There can be a plethora of His planning and equipment are deficient. Either he signals, there can be conflicting signals, and there can has no strategy or tactics or they are the wrong ones. be false signals. But they must be received and Signals go unnoticed or are incorrectly interpreted. His

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evaluated. Decisions must be taken. The base manage- ment, which is not on the climb itself, also affects the situation. It may perhaps decide to call back one of the participants.

The occurrences in a development project are of the same nature as in a climb. The project organization must make decisions on an uncertain basis, and the decision may later prove to have been wrong. Experience and the attitude to procuring knowledge are particularly important to the success of a climb. We have identified four different cultures with respect to risk-taking:

Conscious Unconscious

Experienced and practised Professionals Natives

Inexperienced and unpractised Amateurs Tourists

The ~~~~e,~.~i~~~z~~ culture is characterized by good performance norms, determination and self-confidence. It implies thinking strategically and economizing on energy. It implies good preparation, planning, checking. Equipment is chosen carefully. If possible, training is carried out. On the way, reconnaissance takes place, and attention is paid to signals, which are properly interpreted. The professional also acts according to the situation, and with forethought. A choice is made which may be ambitious, but with a keen eye on safety. Under pressure, the professional will take up a challenge, but will also set limits by underlining what he knows.

Project Management

Risk m~n~g~rnent

goal changes on the way. The tourist can sometimes be tempted to undertake a risky tour; he wiil have some unpleasant surprises, and will soon give up.

We have described the four cultures in the belief that the model may be useful in two ways. The analogy with the mountain climb can be used in analysing uncertain- ties and risk in actual development projects. The various types of uncertainty and occurrence in the mountain climb have their parallels in the development project. The four cultures can be used in a characteriza- tion of the actual project organization, revealing strengths and weaknesses.

ATTITUDES TOWARDS RISK

Our choice of risk is usually determined by our personal attitude towards risk. For some, the prospect of loss weighs heavier than the prospect of gain. For others, the reverse is true.

There is a theory that a person has a constant threshold for acceptance of risk - meaning that the difference between perceived risk and safety measures carried out is constant. If one prepares the safety measures, one will choose a course of action with a higher risk.

We seem disinclined to analyse risk but are more oriented towards a situation’s ~ssibilities when we recognize a risk situation. Our action is guided more by the prospect of gain than by that of risk. The third power of gain is held up against the first power of risk.

Figure 1 shows a number of factors that seem to be of importance in decision situations in which we have to make a choice about which there are uncertainties and thus risks.

Degree of voluntariness. We are often willing to run a greater risk ourselves than we will allow others to impose on us. Our evaluation includes the amount of choice, our personal influence on the decision, the possibility of our ‘thinking better of it’ and oppor- tunities to make changes. Control of consequences. Studies indicate that we would rather ‘gamble’ in games where the result depends on knowledge/ability than in pure lotteries, even when the chances of winning or losing are the same. This phenomenon has been called the ‘ittusion of control’. Timing of consequences. The general hypothesis is that we focus on the immediate advantages/gains and the losses that may first appear a long way ahead. Placing of consequences. Similarity, the hypothesis here is that we are more inclined to accept risks when their effect will be felt far from our own department. Possi~~l~t~ of judgj~g consequences. Consequences are often complicated. Our evaluation depends on whether we can envisage the consequences. Total consideration. It is a common feature of human behaviour that we normally insure ourselves against small losses with a high probability, but not against heavy losses with a low probability.

Figure 1. Factors of importance in decision situations invofving risk or certainty

Our conception of risk can be divided into two essentially different sets of views - gambling and control. With the gambling viewpoint, we use our experience of earlier occurrences (our statistics) to evaluate the chance/risk of winning/losing. We judge intuitively events which we have not experienced but which we can imagine. With the control viewpoint, we use our experience of the ‘uncontrollability’ of earlier events to evaluate the chance/risk of winning/losing. We consider events which we have not experienced but which we can imagine with an intuitive evaluation of our possibilities for control in the situation.

THE RISK PHENOMENON

In the ‘technical’ consideration of risk, risk is a product of the probability and effect of an event. The commercial risk is more difficult to get hold of because the relationship between event and effect is not easy to see. The probability of a business fiasco is not the same as the probability of a risk-triggering event occurring.

There seems to be a need for a better conceptuai apparatus to understand risk in relation to the course of events in product development projects.

As mentioned, the concept of risk is related to the business -the ultimate economic results of the project. The effects appear in the form of lower earnings than anticipated. The change in economy relates to the individual economic elements - cf. the cash-flow curves in Figure 2.

In principle, risk factors occur in two different ways. We can differentiate between:

Risk dispositions, which can either create risks or reduce them. Our actions in the course of the project can predispose the business to risk. Risk events, which take place during the project work and the implementation. Many of them occur in the project’s or product’s surroundings.

The effect of a risk event depends on the vuf~era~~li~ of the business (project) and its sensitivity to the event.

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Figure 2. Cash-flow curves

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Risk management

A risk event occurs when a risk-triggering event penetrates or triggers a chain of events that lead to an unacceptable consequence for the business. We can regard the place where the event penetrates or the way it does so as a vulnerability (an exposure), and regard the way in which the event has consequences as sensitivity.

The sensitivity is an expression of the degree to which we are able to avert the effects of the event, including how quickly we react in relation to the speed at which the consequences of the event appear.

Figure 3 illustrates our model. The risk dispositions relate to five elements:

The overall project plan - that is, the management’s planning of the project organization and later the operating organization and their facilities. This planning takes place from a conception of future reality. The conception can be diffuse and the reality unknown and unpredictable. Theprojectgoal-i.e. in determining the development project’s business and product goals, we may be incorporating a risk. We may be ambitious about marketing and technology. We may ‘stretch the bow’ too far. The goal’s correspondence with reality can be fortuitous, but note that the goal can still be formulated precisely and clearly. The project organization - i.e. the organization we form and the resources with which we provide it. It can lack knowledge and be weakly staffed and thus managed incorrectly. Similar aspects relate to the implementing/operating organization. The methods and procedures in the project work. Tn the procedure we can perform acts that increase the risk and acts that reduce it - for example, taking chances and guessing against experimenting and investigating. The surroundings. The surroundings are a relative concept and include matters on which ‘the project’ has no influence but against which it must guard itself with respect to risks. Among these are events that change the priority of the project - for example, the competitors’ marketing, new tax legislation or an oil crisis.

I prefer to use the concept of risk in the implementation and operating process. In project work, on the other

Figure 3. Elements of risk

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hand, I Iike to speak of uncertainty relating to the development activities. The uncertainty must be regarded as the degree of good performance and quality in the work (inner uncertainty) and as lack of correspondence between the results of activity and the later reality (outer uncertainty).

CONSCIOUS AND ACTIVE RISK MANAGEMENT

In the research, material has been collected on the management of risk in product development projects. It is striking that most of the methods serve to uncover uncertainty and risk. Only a few methods deal with active measures against ascertained risk. This is not unnatural. Risks are reduced and robustness increased with the methods of professional project planning and management. The methods can be broken down into four categories:

screening methods uncertainty analyses vulnerability analyses methods to increase robustness.

The aim of the screening methods is to reject/choose development projects and stop/go decisions in the development process. The methods are typically in the form of checklists, prioritization/ranking systems and feasibility analyses. They may be of limited value, but they can uncover some areas of uncertainty and risk in the project or rather in the product business.

The aim of the uncertainty analyses is to uncover areas of uncertainty, the range of uncertainty and gaps in knowledge. The methods include checklists (including SBA), reviews, trials/testing, the Delphi method, three-estimate methods and interface analysis.

The aim of the vulnerability analyses is to clarify the possible effect of risk events on the business. The methods include traditional potentiat risk analyses, events tree/chain analyses, effect analyses (cause and effect analyses), and scenario.

Robustness-increasing methods of particular relev- ance here include reviews, what-if planning methods, early-warning methods, configuration management, prototypes/models and testing/trials.

Some statements about planning:

l You accept the risk l Accept only the sure-gain part of the risk l What does not happen is also of value l The unforeseen can be foreseen l The unpredicted can be predicted l The unpredictable can be foreseen l You can actively create robustness l It takes certainty to accept uncertainty.

Project Management

DARE WE?

The research has given some answers to how risk and uncertainty can be uncovered and managed. However, it has also raised a couple of questions that weigh more heavily than the answers.

Dare we relate very consciously and actively to uncertainty and risk - or is it better to be an optimist and believe in the product? How do we overcome three serious barriers: speaking about and understanding the risk phenomenon; accepting that risk can be managed; and accepting that this demands methods?

How do we create management methods that go hand in hand with optimism and faith and that are feasible, that is, do not require huge resources?

REFERENCES

1 Riksdatafiirbundet SBA. SBrbarhetsanalys Sweden (1988)

2 Vlek, C and Stallen, P-J Rational and personal

Risk management

aspects of risk Institute for Social and Organizational Psychology, University of Groningen, Holland (1988)

3 Mikkelsen, H, Myrup Andreasen, M and Hein, L The handling of risks in product development Denmark (1989) (in Danish)

Hans Mikkelsen gained his MSc in production management from the Technical University of Denmark. He has worked in production management, covering most aspects in that area. Furthermore, since 1970 he has been engaged in pro- ject management in several types of projects and branches, working as a management consultant. Over a number of years, he has been actively involved with Danish pro- ject management societies, and has taken a particular interest in project management training.

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