Uncertainty and Risks

As explained earlier, projects are subject to uncertainty due to their one-time nature and the resulting lack of historical information to support future decisions. Special planning and control methods were developed for project

management. These planning and control methods depend on the following alternative assumptions regarding uncertainty:

• There is negligible uncertainty: When the level of uncertainty is rela- tively low, commonly, predictions are made regarding how long each project activity will take, how much it will cost, and how many resource units will be required to perform it. If the actual level of uncertainty is not very low, “the usefulness of plans” based on these assumptions is limited, as their ability to accurately predict the course of the project will be low.

• There is significant uncertainty that can be assessed correctly and taken into account in planning the project, evaluating its cost, and predicting its duration. This is a very difficult task. Not only does the uniqueness of a project make it hard to assess its uncertainties, the frequent strong correlation between uncertainty in time and uncertainty in cost must also be taken into account. The longer the duration of the project, the more some of the costs increase (e.g., the cost of full-time employees, rent of facilities, and leased equipment). Models for planning and control are selected based on the sources and the level of uncertainty. For example, when uncertainty is low, assuming that the task durations are following the beta distribution enables using the program evaluation and review technique (PERT) model (to be discussed later in this chapter), whereas higher uncertainty may require using simulation.

Sources of uncertainty include the following:

• Availability of resources: It is difficult to predict the availability of resources because unexpected changes in their availability may occur. For example, the availability of human resources is very often subject to fluctuation as a consequence of sickness, resignation, or assignment of the needed person to another task. Materials may be in short supply and equipment may break down or be in short sup- ply for some reason. Lack of resources can cause delays and cost overruns in a project. As a result of uncertainty, a need for additional resources or other resources than those planned for may arise, and such resources may not be readily available.

• Uncertainty in the environment: This uncertainty is present in all types of projects and refers to uncertainty related to such factors as weather, market condition, changes in laws and regulations, changes in political conditions, changes in the economy, etc.

• In addition to the above sources of uncertainty that are common to all projects (including lack of past information due to the one-time nature of projects), R&D projects are especially susceptible to techno- logical uncertainty as well.

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Project Management

• Technological uncertainty: This uncertainty is common to develop- ment projects based on new technology, and knowledge that does not exist within the organization. The time to develop new technolo- gies and the probability of success are both uncertain.

It is possible to deal with uncertainty and the risk that it generates in proj- ects in different ways:

1. Accept the risk and treat it if it materializes. This is typical of risks that are associated with low damage and have a low prob- ability of occurring. This is reactive risk management. Reactive risk management is an effort to deal with problems caused by risks that have already occurred. For example, project managers may be aware beforehand that there is a chance that a building project may run out of a resource but they will also know that it might be possible to get the needed resource from a local, more expensive supplier who has inventories of such material on hand and can supply the resource immediately from his inventory. In this case, the cost might be the difference between the cost of the local expensive supplier and the cost of the less expensive but late supplier.

2. Transfer the risk: Usually, the risk is transferred to insurance compa- nies. This is typical of risks that are associated with large damage but slim probability. For example, insuring construction workers against injuries transfers the risk of an accident to the insurance company.

3. Share the risk: This includes not only sharing the ownership on the project, but also its financing. Taking loans from a bank to finance projects effectively shares the risk of the project with the bank. Sharing ownership means spreading the risk across partners. 4. Reduce the risk: Proactively reduce the risk in an effort to identify

possible risks and protect the project against those risks as part of the project plan. An example is an effort to protect a construction project against the risk of delayed delivery by a supplier of building material. The protection can be in the form of ordering the building material earlier than needed, and keeping it in inventory until it is used. If the supplier ships the order late, having such inventories at the project’s end can protect the project from delays. Most proac- tive risk management activities have costs. In the above example, the cost of carrying inventory and the cost of money spent earlier than needed must be traded off against the cost of delays.

The decision regarding the way to deal with risk is based on statistical analysis of the risks and the cost of managing them.