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Definition: Risk impact assessment is the process of assessing the probabilities and consequences of risk events if they are realized. The results of this assessment are then used to prioritize risks to establish a most-to-least-critical importance ranking. Keywords: risk, risk impact assessment, risk management, risk prioritization.
Humans have perpetually sought new tools and insights to help them make decisions. Lundquist College of Business. So Barnard—and such later theorists as James March, Herbert Simon, and Henry Mintzberg—laid the foundation for the study of managerial decision making. But decision making within organizations is only one ripple in a stream of thought flowing back to a time when man, facing uncertainty, sought guidance from the stars.
Decision Trees for Decision Making
The decision hinges on what size the market for the product will be. Possibly demand will be […]. Possibly demand will be high during the initial two years but, if many initial users find the product unsatisfactory, will fall to a low level thereafter. Or high initial demand might indicate the possibility of a sustained high-volume market.
If demand is high and the company does not expand within the first two years, competitive products will surely be introduced. If the company builds a big plant, it must live with it whatever the size of market demand.
If it builds a small plant, management has the option of expanding the plant in two years in the event that demand is high during the introductory period; while in the event that demand is low during the introductory period, the company will maintain operations in the small plant and make a tidy profit on the low volume.
Management is uncertain what to do. The new product, if the market turns out to be large, offers the present management a chance to push the company into a new period of profitable growth. The development department, particularly the development project engineer, is pushing to build the large-scale plant to exploit the first major product development the department has produced in some years.
The chairman, a principal stockholder, is wary of the possibility of large unneeded plant capacity. He favors a smaller plant commitment, but recognizes that later expansion to meet high-volume demand would require more investment and be less efficient to operate.
The chairman also recognizes that unless the company moves promptly to fill the demand which develops, competitors will be tempted to move in with equivalent products. The Stygian Chemical problem, oversimplified as it is, illustrates the uncertainties and issues that business management must resolve in making investment decisions. These decisions are growing more important at the same time that they are increasing in complexity.
Countless executives want to make them better—but how? The decision tree can clarify for management, as can no other analytical tool that I know of, the choices, risks, objectives, monetary gains, and information needs involved in an investment problem.
We shall be hearing a great deal about decision trees in the years ahead. Although a novelty to most businessmen today, they will surely be in common management parlance before many more years have passed. Later in this article we shall return to the problem facing Stygian Chemical and see how management can proceed to solve it by using decision trees.
First, however, a simpler example will illustrate some characteristics of the decision-tree approach. Let us suppose it is a rather overcast Saturday morning, and you have 75 people coming for cocktails in the afternoon. You have a pleasant garden and your house is not too large; so if the weather permits, you would like to set up the refreshments in the garden and have the party there.
It would be more pleasant, and your guests would be more comfortable. On the other hand, if you set up the party for the garden and after all the guests are assembled it begins to rain, the refreshments will be ruined, your guests will get damp, and you will heartily wish you had decided to have the party in the house.
We could complicate this problem by considering the possibility of a partial commitment to one course or another and opportunities to adjust estimates of the weather as the day goes on, but the simple problem is all we need. Much more complex decision questions can be portrayed in payoff table form. However, particularly for complex investment decisions, a different representation of the information pertinent to the problem—the decision tree—is useful to show the routes by which the various possible outcomes are achieved.
The problem is posed in terms of a tree of decisions. Exhibit I illustrates a decision tree for the cocktail party problem. This tree is a different way of displaying the same information shown in the payoff table. However, as later examples will show, in complex decisions the decision tree is frequently a much more lucid means of presenting the relevant information than is a payoff table.
The tree is made up of a series of nodes and branches. At the first node on the left, the host has the choice of having the party inside or outside. Each branch represents an alternative course of action or decision. At the end of each branch or alternative course is another node representing a chance event—whether or not it will rain.
Each subsequent alternative course to the right represents an alternative outcome of this chance event. Associated with each complete alternative course through the tree is a payoff, shown at the end of the rightmost or terminal branch of the course.
When I am drawing decision trees, I like to indicate the action or decision forks with square nodes and the chance-event forks with round ones. Other symbols may be used instead, such as single-line and double-line branches, special letters, or colors. It does not matter so much which method of distinguishing you use so long as you do employ one or another.
A decision tree of any size will always combine a action choices with b different possible events or results of action which are partially affected by chance or other uncontrollable circumstances. The previous example, though involving only a single stage of decision, illustrates the elementary principles on which larger, more complex decision trees are built.
Let us take a slightly more complicated situation:. You are trying to decide whether to approve a development budget for an improved product.
You are urged to do so on the grounds that the development, if successful, will give you a competitive edge, but if you do not develop the product, your competitor may—and may seriously damage your market share. You sketch out a decision tree that looks something like the one in Exhibit II. Your initial decision is shown at the left. Following a decision to proceed with the project, if development is successful, is a second stage of decision at Point A.
Assuming no important change in the situation between now and the time of Point A, you decide now what alternatives will be important to you at that time. At the right of the tree are the outcomes of different sequences of decisions and events. These outcomes, too, are based on your present information. Of course, you do not try to identify all the events that can happen or all the decisions you will have to make on a subject under analysis. In the decision tree you lay out only those decisions and events or results that are important to you and have consequences you wish to compare.
For more illustrations, see the Appendix. We shall not concern ourselves here with costs, yields, probabilities, or expected values. The choice of alternatives in building a plant depends upon market forecasts. The alternative chosen will, in turn, affect the market outcome.
For example, the military products division of a diversified firm, after some period of low profits due to intense competition, has won a contract to produce a new type of military engine suitable for Army transport vehicles. The division has a contract to build productive capacity and to produce at a specified contract level over a period of three years. Figure A illustrates the situation. The dotted line shows the contract rate. The solid line shows the proposed buildup of production for the military.
Some other possibilities are portrayed by dashed lines. The company is not sure whether the contract will be continued at a relatively high rate after the third year, as shown by Line A, or whether the military will turn to another newer development, as indicated by Line B. The company has no guarantee of compensation after the third year. There is also the possibility, indicated by Line C, of a large additional commercial market for the product, this possibility being somewhat dependent on the cost at which the product can be made and sold.
If this commercial market could be tapped, it would represent a major new business for the company and a substantial improvement in the profitability of the division and its importance to the company. It might undertake the major part of the fabrication itself but use general-purpose machine tools in a plant of general-purpose construction. The division would have a chance to retain more of the most profitable operations itself, exploiting some technical developments it has made on the basis of which it got the contract.
While the cost of production would still be relatively high, the nature of the investment in plant and equipment would be such that it could probably be turned to other uses or liquidated if the business disappeared. The company could build a highly mechanized plant with specialized fabrication and assembly equipment, entailing the largest investment but yielding a substantially lower unit manufacturing cost if manufacturing volume were adequate.
Following this plan would improve the chances for a continuation of the military contract and penetration into the commercial market and would improve the profitability of whatever business might be obtained in these markets. Failure to sustain either the military or the commercial market, however, would cause substantial financial loss. Either of the first two alternatives would be better adapted to low-volume production than would the third.
Some major uncertainties are: the cost-volume relationships under the alternative manufacturing methods; the size and structure of the future market—this depends in part on cost, but the degree and extent of dependence are unknown; and the possibilities of competitive developments which would render the product competitively or technologically obsolete. How would this situation be shown in decision-tree form? Before going further you might want to draw a tree for the problem yourself.
Figure B shows my version of a tree. Note that in this case the chance alternatives are somewhat influenced by the decision made. A decision, for example, to build a more efficient plant will open possibilities for an expanded market. The claimed advantages of the system will be a reduction in labor cost and an improved product yield. These benefits depend on the level of product throughput, which is likely to rise over the next decade.
It is thought that the installation program will take about two years and will cost a substantial amount over and above the cost of equipment.
What would this investment yield? Will actual product sales be higher or lower than forecast? Will the process work? Will it achieve the economies expected? Will competitors follow if the company is successful? Are they going to mechanize anyway? Will new products or processes make the basic plant obsolete before the investment can be recovered? Will the controls last eight years?
Will something better come along sooner? Each alternative will be followed by resolution of some uncertain aspect, in part dependent on the action taken. This resolution will lead in turn to a new decision. The dotted lines at the right of Figure C indicate that the decision tree continues indefinitely, though the decision alternatives do tend to become repetitive.
In the case of postponement or further study, the decisions are to install, postpone, or restudy; in the case of installation, the decisions are to continue operation or abandon. An immediate decision is often one of a sequence. It may be one of a number of sequences.
Tools for Decision Analysis: Analysis of Risky Decisions If you will begin with certainties, you shall end in doubts, but if you will content to begin with doubts, you shall end in almost certainties. This site offers a decision making procedure for solving complex problems step by step. It presents the decision-analysis process for both public and private decision-making, using different decision criteria, different types of information, and information of varying quality. It describes the elements in the analysis of decision alternatives and choices, as well as the goals and objectives that guide decision-making. The key issues related to a decision-maker's preferences regarding alternatives, criteria for choice, and choice modes, together with the risk assessment tools are also presented. Enter a word or phrase in the dialogue box, e. In general, the forces of competition are imposing a need for more effective decision making at all levels in organizations.
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Subscription price CiteScore 0. Organisational resiliency through risk assessment, contingency planning, systems security, crisis and disaster management, and recovery planning, as well as public policy regarding infrastructure and security, are integrated in the journal's coverage. The goal of IJBCRM is to provide an academic and professional forum to develop and disseminate research, practical methods, theories, and experiences in the developing area of business continuity and risk management. This growing body of knowledge is vital to lead an organisation in the process of systematic decisions to protect people, assets and operations and to ensure the survivability of an organisation from disaster. A broad spectrum of threats, vulnerabilities and risks will be addressed and the most useful strategies and plans to prevent and mitigate disaster will be addressed. IJBCRM publishes scholarly research, methodological articles, review papers, case studies, conference reports, book reviews, educational approaches, and news. Special issues are devoted to important topics falling within the scope of business continuity and risk management.
Ramifications of Implementing a Probabilistic Risk System For This to Be Risk Assessment and Decision Making in Business and Industry: A Practical Guide.
Decision Trees for Decision Making
The decision hinges on what size the market for the product will be. Possibly demand will be […]. Possibly demand will be high during the initial two years but, if many initial users find the product unsatisfactory, will fall to a low level thereafter.
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