Making better business decisions with risk analysis

Businesses make decisions every day. Where to invest, what product to produce, which vendor to use, what price to charge - the list is endless. Most organisations probably base their decisions on whatever data is available - historical costs, competitors' prices, vendor estimates, etc. But how often do businesses have full, complete information? Prices change, demand fluctuates, costs rise. It's easy to make the wrong decision if you don't take all possible scenarios into account. Making the best business decisions means performing risk analysis.

Risk analysis need not be a daunting task, because software tools are available to ease the transition—for example, @RISK software produced by Palisade. @RISK is a straightforward-to-use add-in to Excel that allows users to perform risk analysis in a few easy steps. Using Monte Carlo simulation, @RISK will allow an organisation to determine how wrong the baseline outlook can be and - more importantly - why.

What is Monte Carlo simulation?

When we use the word simulation, we refer to any analytical method meant to simulate a real-life system.

Without the aid of simulation, a spreadsheet model will only reveal a single outcome, generally the most likely or average scenario. Spreadsheet risk analysis uses both a spreadsheet model and simulation to automatically analyse the effect of varying inputs on outputs of the modelled system.

One type of spreadsheet simulation is Monte Carlo simulation, which randomly generates values for uncertain variables over and over to simulate a model. This gives users a quantification of the probability of different results occurring, and greatly aids the decision-making process.

Monte Carlo simulation on your desk top: @RISK

Palisade’s @RISK is the world’s most widely used risk analysis tool. Users replace values in their spreadsheet with @RISK distributions to represent uncertainty and then simulate the model using powerful Monte Carlo simulation methods. @RISK recalculates the spreadsheet hundreds (or thousands) of times. The results: distributions of possible outcome values. This not only tells you what could happen, but how likely it is it will happen. Results are displayed graphically and through detailed statistical reports. Sensitivity and scenario analysis identify critical factors which drive risk.

Halcrow Group use of @RISK for Flood Defence

Halcrow Group Ltd has been using Monte Carlo simulation for some time, having implemented @RISK for portfolio optimisation and budgetary compliance. Halcrow Group specialises in the provision of planning, design and management services for infrastructure development worldwide. With interests in transportation, water, maritime and property, the company has commissions in over 70 countries. It has a network of 73 offices around the world (27 of which are in the UK), nearly 6,000 employees, and an annual turnover of more than £280 million.

Halcrow often undertakes projects to mitigate the risk of flood damage for the UK’s Environment Agency. For these projects, Halcrow employs @RISK in the risk quantitative stage to set risk budgets at the start of each phase of the project commission. Starting with the ‘sunny day estimate’ of the project risk, it identifies, assesses and quantifies every potential threat that could affect (i.e. increase) this base figure.

For example, severe weather could lead to a delay in the collection of survey data, with knock-on effects for related work. Or poorly articulated project outputs can result in tasks with weak focus that lead to inefficient resourcing and the need for reworking. Equally, novel techniques might fail to deliver robust results, again leading to abortive work and an overall delay to the programme. Other hazards that can potentially affect National Capital Program Management Service (NCPMS) projects include: increases in material costs; changes to the team; equipment failure; delay for required approvals; unforeseen ground conditions and errors and more.

Using @RISK for ongoing risk quantification on individual projects allows Halcrow to monitor progress against original budget incentive thresholds and potentially allows the NCPMS to make strategic decisions on allocating funds across the whole portfolio of flood defence projects.

@RISK Shows “Most Effective Use” of Public Funds

Tim Wells, project manager at Halcrow, comments: “Halcrow’s line of business makes robust risk analysis an essential part of our daily lives, and the Environment Agency’s core principles reinforce this way of working. Palisade and @RISK provide us with a flexible product that is easy to use, as a result of which we are able to maximise our own revenues on projects. In addition they ensure that the Environment Agency is accountable to the UK public by putting its funds to the most effective use to guard against flooding.”

About Palisade Palisade Corporation is the world’s leading developer of software and services for risk and decision analysis. Founded in 1984, Palisade’s leading products include @RISK, the DecisionTools Suite and NeuralTools to name a few. These products provide decision makers with Monte Carlo simulation, decision trees, optimisation, neural networks, statistical analysis, and other cutting edge techniques. The DecisionTools Suite is included with top MBA textbooks, and is established as the risk and decision analysis tool of choice by the world’s leading business schools and Fortune 500 companies. In addition, Palisade products are being used by over 90% of today’s FTSE 100 companies and over 80% of the fortune 100.

@RISK Benefits Summary

• Factoring in all variables
• Show all possible outcomes Minimises uncertainty
  • Identify opportunities and avoid pitfalls
• Apply Monte Carlo simulation to see all possible outcomes in your Excel models
• Works in Excel where you’re comfortable
• Uncover the risks in your research, business or activity
• Use historical data to describe uncertain factors
• Instantly examine different scenarios with stress analysis
• Identify key risk drivers with sensitivity analysis
• Extensive chart and reports communicate results
• Easy to use and navigate