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Understand the Risk Tolerance Level in Your Organization

January 29 2015

All projects have risks and all risks have the potential for negatively impacting the project. You use risk management to determine the risks that are important enough to manage. During the risk identification process, you may encounter many risks that have some likelihood to occur and have a marginal impact to the project. The question to ask is whether the risk has enough impact on the project to worry about (this same question occurs for both qualitative and quantitative approaches). The answer says something about your risk tolerance.

For example, let’s say you identify a risk that is very likely to occur, but has an impact of $100 and one-half day duration. You may choose not to manage it. You cannot list this as an assumption since there is a good chance the risk will occur. However, the impact is small enough that you are willing to absorb the cost if it occurs, rather than deal with managing the risk (which would probably be more costly). Therefore you would choose a risk management strategy of leaving the risk.

In the prior example, the numbers were fairly trivial and the risk was easier to ignore. But, ratchet the impact up a little higher. Let’s say the risk now was $500 and one day duration. What about $100,000 and three months duration? Of course, the answers are all relative based on the size of the project. If your project had a $20,000 budget, a $1,000 risk impact might be worth managing. If your project budget is one million dollars, the risk impact of $1,000 would just be marginal.

When you are performing risk identification, you need to determine your tolerance level for risks. This will help you focus on the risks that are important and above your tolerance level, while ignoring risks where the impact falls below the tolerance level. Risk tolerance is also cultural in your organization. Some organizations are bigger risk-takers and will accept a higher level of risk on projects. They will also tend to have a higher threshold before they chose to manage a risk.

On the other hand, some organizations are more risk-averse. They will tend to accept less risky projects and they will also tend to have a lower threshold to manage risks. For example, let’s say you have a similar project in both organizations. The project managers in these risk-averse organizations will tend to manage risks that a project manager in the other organization might choose to leave.