©chelst & canbolat value-added decision making chapter 8 part iii - decisions and management...
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©Chelst & Canbolat Value-Added Decision Making
Chapter 8
Part III - Decisions and Management under Uncertainty Chapter 8: Value Added Risk Management
Most of the chapter’s figures are included in the file.Instructor must decide how many and which examples to use.
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Part III - Uncertainty
Introduction to risk and uncertainty Risk Management Process
Identify Quantify Eliminate, mitigate, cope
Frame decisions with significant uncertainty Influence Diagram Decision Tree (schematic)- multiple alternatives
Analyze uncertain decisions Solve a decision tree – Maximize (or Minimize) the
expected value Risk Profile
Structured risk management and the value of information
Risk attitude and utility theory
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Risk Management Theme
You cannot manage risk if you do not admit there is uncertainty
Managing uncertainty also includes unrealized upside potential and not just downside losses
You cannot allocate appropriate resources if you do not quantify the risk or uncertainty
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Risk (and Uncertainty) Management Definitions
Risk: Exposure to the chance of injury or loss; a hazard or dangerous chance (Webster)
Risk is NOT just bad things happening, but also good things NOT happening
Risk Measures Consequences: Impact Likelihood: Probability or frequency
Risk Management: A systematic process of identifying, analyzing and responding to risk
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Resources Required Sales - Market Demand
Unanticipated competitive actions Revenue Globalization
Currency fluctuations National and regional politics and
economies Team dynamics in cross-culture paradigm
Is task doable? Will something specific happen?
(election)
Random Elements in Decision Environment
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Random Elements (variables) in Decision Environment
Time: to complete task or reach goal How long each task takes to complete? Can the project deadline be met?
Cost Variable costs of production for a totally new product Uncertainty in learning curves impact long term cost
variability Breakdowns, personnel training
Performance Unfixed bugs in a new software NVH, fuel economy, warranty claims for a car Effectiveness and toxicity of a drug
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Table 8.1: Sources of randomness in a manufacturing company
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Category Sources of Uncertainty
InternalProduct developmentManufacturingPurchasing
Supply ChainDesignManufacturingLogistics
External - Market
Aggregate demand & pricing dwarfs all other industry concernsDisaggregate demand by productCompetitor actions
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Category
Sources of Uncertainty
Revenue
Federal reimbursement (Medicare and Medicaid)
State reimbursementPrivate health insurance reimbursement
Costs
DrugsMedical personnelStaff
Market
Need for servicesChanging local demographicsCompetitor actions – add facilities 9
Table 8.2: Sources of randomness in health care system decision
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Table 8.3: Sources of randomness in personal health decision
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Category
Sources of Uncertainty
External
Doctor competency
Hospital competency
Internal
Nature of illness
Body’s response
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Activity: Randomness in your environment Current company or organization Future career Your community Personal life including family
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Risk management process
Explain and track risk
Risk Identification
Risk Quantification
System Risk Analysis
Risk Mitigation and Contingency
Plan
Communicate and Track Risk
Documentation of Risk Analysis
FMEA, fishbone diagram, brainstorm
Experts assess probability and impact of individual events
Simulation, decision trees, FMEA
Reduce, eliminate, transfer, avoid, absorb or share riskInstitute early warning and tracking of unmitigated risk
Document all aspects of risk
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Risk Identification
Identify all significant sources of risk and uncertainty associated with each of the objectives and key parameters relating to these objectives
Determine the causes of each risk Assess risks relationship to other risks Classify and group risks for evaluation Fishbone diagram organizes risks
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Manufacturing Company
Category Sources of Uncertainty
Internal
Product development
Manufacturing
Purchasing
Supply Chain
Design
Manufacturing
Logistics
External - Market
Aggregate demand & pricing dwarfs all other industry concerns
Disaggregate demand by product
Competitor actions
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Risk Quantification
Identify the consequence and likelihood of each risk event
Consequences: Impact of risk event Example: Delay, dollars,….
Likelihood of a risk event Point estimate of probability Range of probability Probability distribution for the
uncertain probability parameter
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Figure 8.2: Fishbone diagram of storage tank risk
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Table 8.5: Likelihood-impact map (3 x 3)
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Relative Impact
Low Medium High
Relative Likelihood
Low
Medium
High
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Table 8.6: Rating for severity of equipment failure
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Severity Description Explanation1 None Variation within performance limits2 Very Minor Variation correctible during
production3 Minor Reparable within 10 minutes4 Very low Reparable within 30 minutes5 Low Reparable within 1 hour6 Moderate Reparable within 4 hours7 High Not worth repair; degraded
functionality8 Very High Not worth repair; mission failure9 Hazardous –
with warningAffects safety of operator and others but with advance warning
10 Hazardous – without warning
Affects safety of operator and others but with no advance warning.
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Table 8.7: Rating for likelihood of occurrence of equipment failure
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Occurrence
Description
1 Mean time to failure (MTTF) is 50 times greater than the user’s required time
2 MTTF is 20 times greater than the user’s required time
3 MTTF is 10 times greater than the user’s required time
4 MTTF is 6 times greater than the user’s required time
5 MTTF is 4 times greater than the user’s required time
6 MTTF is 2 times greater than the user’s required time
7 MTTF is equal to user’s required time8 MTTF is 60% of user’s required time9 MTTF is 30% of user’s required time
10 MTTF is 10% of user’s required time
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Figure 8.4: Likelihood-impact: financial organization risk (What about personal?)
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Career risk
Assume that you are assessing your career risk.
Identify risk factors that are specific to your career and their potential impact on your career.
Risk factors Impact_________________ _________________________
Describe risk management strategies that you could use to reduce your career risk.
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Organization risk
Assume that you are assessing the risks your organization faces in the near term. Identify risk factors that are specific to your organization and its potential impact on it.
Risk factors Impact_____________________ ________________________
Describe risk management strategies that your organization could use to reduce your organization risk.
What risk messages does your organization routinely communicate, and how does it do so?
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After identification and quantification Take action Manage risk
Control sources of risk: occurrence: likelihood Control impact of risk: magnitude Focus on different environmental elements of
risk Internal management controls External supervision
Where does risk go? Eliminate Transfer Share Live with
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Systems Risk Analysis Action
Calculate overall project risk using Decision tree Simulation FMEA
Conduct sensitivity analysis Prioritize risk events in terms of
magnitude and frequency of impact
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Risk management actions and process
Define risk management alternatives Evaluate risk management alternatives in terms of
Cost Effectiveness Design and select the optimum risk management
plan Select and commit the resources required for
specific risk management plan Implement risk management plan
Early warning indicators Communication and organizational awareness Rapid and effective response strategy
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Risk mitigation or elimination strategies Reduce or eliminate risk: Develop a risk
reduction plan and then track to the plan Example: Inventory Reduces production disruption
risk Transfer (e.g. to a contractor or an insurance
company): An attempt to pass the risk to another program element Example: Supplier is responsible for warranty cost
Avoid risk: Use an alternate approach that does not have the risk Example: Use well-established supplier for sourcing
complex components though it offers higher piece price
Absorb or pool risk : e.g. Dual sourcing Accept risk: Develop contingency plan or live
with it.
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Example: Managing Risk to Avoid Supply-Chain Breakdown Risk Identification - Risk Drivers – Detail: Table 8.4
Disruptions Natural disaster Labor dispute Supplier bankruptcy War and terrorism or disease Single sourcing and availabilities of alternative
suppliers Delays
High capacity utilization at supply source Inflexibility of supply source Poor quality and or yield at supply source Excessive handling due to border crossing or to
change in transportation modes
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Supply-Chain Breakdown Risk Identification - Risk Drivers – Detail cont.
System problems Information infrastructure breakdown System integration or extensive systems
networking E-commerce
Forecast errors Inaccurate forecasts due to long lead times,
seasonality, product variety, short life cycles, small customer base
Ownership and protection of intellectual property Vertical integration of supply chain Global outsourcing and markets
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Supply-Chain Breakdown Risk Identification - Risk Drivers – Detail cont.
Procurement challenges Exchange rate risk Percentage of a key component or raw material
procured from a single source Industry-wide capacity utilization Long-term versus short-term contracts
Receivables Number of customers; financial strength of customers
Inventory Rate of product obsolescence; inventory holding cost Product value; demand and supply uncertainty
Capacity Cost of capacity Capacity flexibility
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Which Categories of Supply Chain Risk are the most significant to your company?
Disruptions Delays Systems risk Forecast risk Intellectual property
risk
Procurement risk
Receivables risk
Inventory risk Capacity risk
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Figure 8.6: Risk mitigation for supply chain risks
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Table 8.8 FMEA – Sourcing to Emerging Markets: Specific quantification of probability and not just likelihood scale Calculate expected values
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Table 8.9: Case studies for sourcing to emerging markets
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Case Studies
Complexity of
Component
Potential Saving
EM Supplier Risk After Risk
ManagementDecision
1 Simple Medium Low EM supplier2 Simple Low Low Current supplier3 Simple Medium Low EM supplier
4 Relatively complex High Low EM supplier
5 Simple Low Medium Current supplier
6 Relatively complex Medium Medium Current supplier
7 Complex Medium Medium Current supplier
8 Relatively complex High Medium EM supplier
9 Complex High Medium Dual supplier10 Complex High High Current supplier
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Table 8.11: Product Development Risk and Risk Mitigation
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Risk Risk driver Risk MitigationInitial demand is low
Product not aligned with customers’ wantsInaccurate forecastsProduct not competitive
Use QFD and extensive customer clinics and surveysAssess competitive productsValidate the forecasting model assumptions
Changing demand totals and mix
Competitive actions Technological advances
Modular design to facilitate upgradesR&D integrated into product developmentFlexible manufacturing systems
Product does not meet performance goals
Mismanagement of product development processToo many advances in technology designed into one new product
Focus on performance targets at each product gate reviewIncremental strategy for integrating new technology
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Table 8.11: Product Development Risk and Risk Mitigation
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Risk Risk driver Risk MitigationSuppliers fail to deliver systems in timely fashion
Late design changesCommunication problemsSupplier’s limited technical expertise
Disciplined approach to design changes that are clearly communicated to suppliersUse proven suppliers with long-standing relationship
Product quality problems
Late design changesToo aggressive cost-cutting targetsPoor integration of design and manufacturing
Disciplined approach to design changesRealistic balance between manufacturing cost and designExperienced teams of product and manufacturing engineers Require product designers to gain manufacturing experience
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Other risk management frameworks Focus on environment Contrast internal vs. external sources
and controls
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Figure 8.5: Controlling risk – change environment
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Table 8.10: Four categories of risk abatement strategies
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Risk Modify environment
Avoid or modify exposure processes
Avoid or modify effects processes
Mitigate or compensate for effects
Risk of getting shot by handgun
Eliminate poverty and other causes of crimeTeach anger management
Ban handgunsHarsh penalties for gun usageAvoid high crime areasLive with people who do not get angry
Wear bullet-proof clothingDuck
Good emergency trauma centersCarry health insuranceSue the shooter
Job lossWork for federal govt. or military?Work for company in growth areaWork for company with tradition of no layoffsBuild your own co. Live in area with low unemployment
Increase your value to the organizationDevelop relationships with key jobs decision makers Help boss look good
Second jobSpouse with complementary career
Low debt Significant savingsLow-cost lifestyleLarge social networkUpdated list of other potential jobs
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Table 8.12: Management actions reduce riskInternal Management of Firm
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Cost controlssetting milestonemonitoring outflowsquick response
Productivity increases
incentive systemslabor coordination
Technological innovation
computer simulation of performance
extensive prototype testing
use of proven designspilot plant
Product improvementsmarketing studiesfield testsshared developmenttried and true fallback
systems
Manufacturing capacityflexible machinescommonality of product
designagile workforceglobally integrated planningspare capacity (machines,
parts)
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Table 8.12: Management actions reduce riskExternal Arrangements
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Financial payment controlsreduce accounts receivableincrease accounts payabledelivery timessupplier cooperation
Contract arrangementstake or pay clause penalty clause or warrantyincentive clauseperformance-based contingent
claimmatch exposure to interests length of contract commitmentreliability requirementstermination optionvariable usage option
Financial Marketshedgesoptionsderivativesshared ownership (risk
sharing, alliance or joint venture)
Insurance against contingencies
Targeted Marketing