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3/18/18

Project Management Class – 9

Project Risk Management

Uncertainty & Risk Analysis

Ø Projects are all about uncertainty: § Time required to complete a project § Availability and cost of key resources § The whims of clients § Actions taken by competitors

Ø Effective project management requires an ability to deal with uncertainty

Ø Can uncertainty be eliminated?

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Learning Outcomes

Ø Identify project risks

Ø Determine quantitative or qualitative value of project risks and prioritize them

Ø Propose plans to mitigate such risks

Ø Monitor and control the risks

Ø Budget uncertainty and project risk management

Project Risk Management

According to PMBOK® Guide:

Ø Project risk: an uncertain event or condition that, if it occurs, has a positive or negative effect on at least one project objective

Ø Risk management: the processes of identifying, analyzing, monitoring and responding to project risk in order to

§ Maximize probability and consequences of positive events

§ Minimize probability and consequences of adverse events

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Risk Categories

Sources of Risk

Outside the PM’s Control

Within the PM’s Control

Unpredictable Predictable Non-Technical Technical Legal

Government Regulations

Natural Hazards

Acts of God

External Internal

Cost of Money

Availability of Raw Materials

Quality of Inputs from Suppliers

Labor Stoppages HR Availability Health & Safety Cash Flow

Technological Change Design Problems

Technical Operations

Planning Maintenance

Licenses

Law Suits

Subcontractors’ Performance Compliance with Specs

Risk Categories Examples

Category Example Technical Failure to meet customer performance requirements Schedule Vendor delay in delivery of critical equipment Cost Material cost escalate more than anticipated Human resources May not have people available when required to staff the project External Inclement weather

Changes in government regulations Sponsor/customer Delays in approval

Change in customer preferences Other Ø Encountering more than expected rock formations when

excavating Ø Labor strike may occur during the peak of a construction project

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Risk Management Breakdown into Sub-processes

1. Risk management planning: Developing a plan for risk management activities

2. Risk identification: finding those risks that might affect the project 3. Qualitative risk analysis: evaluating the seriousness of the risk and the

likelihood it will affect the project 4. Quantitative risk analysis: developing measures for the probability of the

risk and its impact on the project 5. Risk response planning: finding ways of reducing negative impacts on the

project as well as enhancing positive impacts 6. Risk monitoring and control: maintaining records of and evaluating the sub-

processes above in order to improve risk management

Risk Management Planning

Ø A method for carrying out steps 2 through 5 Ø Must ensure that the necessary resources can be applied in a timely

and well-organized manner Ø The factors that cause uncertainty change over time; therefore the

planning process is a continuous process Ø Planning how to deal with uncertainty is an organizational problem,

not specifically a project problem Ø Many firms create a risk management group whose job is to aid the

project management team in doing steps 2 through 5

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Risk Identification Scenario analysis

Ø Scenario analysis § Well-known method for identifying risk § Involves envisioning likely scenarios and resulting outcomes § These types of risk can often be identified and evaluated by project

stakeholders with previous experience in similar projects § The following data should be obtained:

ü The probability of each risk event occurring ü The range of possible outcomes ü The probability of each outcome ü The expected timing of each outcome

Risk Identification Failure Mode and Effect Analysis (FMEA)

Ø It’s a structured approach to help identify, prioritize, and better manage risk.

Ø FMEA can be applied to projects using the following six steps: 1. List ways project might fail 2. List consequences and evaluate its severity (S: severity) 3. List cause and likelihood (L: likelihood) 4. Estimate the ability to detect each failure (D: detectability) 5. Calculate the Risk Priority Number (RPN) 6. Sort the potential failures by their risk priority number

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FMEA Example

Ø The following table shows the results of a FMEA conducted to assess the risk of a new drug development project at pharmaceutical company.

Failure S

(Severity) L

(Likelihood) D

(Detectability) RPN

Not effective 8 6 5 240 Not safe 8 4 5 160 Drug interacts with other drugs 6 3 8 144 Beat to market 7 3 2 42 Can’t produce in mass quantities 6 4 4 96

FMEA Example (Cont.)

Ø The most significant risk is the risk of developing a new drug that is not effective.

Ø It is unlikely that much can be done to reduce the severity of this outcome

Ø Steps can be taken to reduce the likelihood of the outcome or increase its detectability: § Advanced computer technologies can be utilized to generate chemicals

with more predictable effects § Earlier human clinical and animal trials can be used to help detect the

effectiveness of new drugs sooner § If both L and D could each be reduced by one, the overall RPN would be

reduced from 240 to 160.

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Ø Interviewing is a fact-finding technique for collecting information in face-to-face, phone, e-mail, or instant-messaging discussions

Ø Interviewing people with similar project experience is an important tool for identifying potential risks § What are your company’s top risks, how severe is their impact and how likely

are they to occur? § Who owns the top risks and is accountable for results, and to whom do they

report? § What is the risk threshold in your projects? § How effective is your company in managing its top risks?

Risk Identification Interviewing

Risk Identification Brainstorming Ø A process for teams to generate ideas and to find solutions on project issues

and problems. Ø It can be accomplished either in a structured or in an unstructured way:

§ Structured: When team members provide ideas in turn § Unstructured: When team members provide ideas at random

Ø What to do 1. Gather team members in a conference room 2. Make sure there is whiteboard, and colored markers 3. Involving all members of the team will create more input, and more input is

better 4. Team members need to spend time on idea generation before each

brainstorming session

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Risk Identification Delphi Technique

Ø The Delphi technique is a group decision process about the likelihood that certain events will occur.

Ø The goal of the Delphi method is to obtain a reliable response to a problem from a group of experts.

Ø A series of questionnaires are sent either by mail or email to a pre-selected group of experts.

Ø In a Delphi study, the participants do not interact with one another; their responses are anonymous.

Ø Each round of questionnaires results in a median answer.

Ø The process guides the group towards a consensus.

Risk Identification Outputs

1. Risks: A risk is an uncertain event or condition that, if occurs, has positive or negative effect on a project objective.

2. Triggers (or risk symptoms): They are indications that a risk has occurred or is about to occur. § Failure to meet intermediate milestones may be an early warning signal of an

impending schedule delay. § A negative cost variance (EV – AC) after 10% of project completion time may be

a warning signal that the project may go over budget.

3. Inputs to other processes: Risk identification may identify a need for further action in another area. § The WBS may not have sufficient detail to allow adequate identification of risks § The schedule may not be complete or entirely logical

Adapted from Figure 11-10, A Guide to the Project Management Body of Knowledge (PMBOK® Guide) - Fourth Edition, Project Management Institute, Inc., 2013. Copyright and all rights reserved. Material from this publication has been reproduced with the permission of PMI.

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Qualitative Risk Analysis

Ø Qualitative Risk Analysis is the process of assessing the impact and likelihood of occurrence of identified risks.

Ø Used to prioritize risks according to their potential effect on project objectives (scope, time, cost, quality)

Ø Rapid and cost-effective way to prioritize risks lay the foundation for quantitative analysis and planning risk responses

Ø Organizations can enhance their performance by focusing on and managing high-priority risks

Ø Accurate data should be used in all analyses in order to ensure results are reliable, and useful

Risk Probability and Impact

Ø Risk probability and risk consequences may be described in qualitative terms such as very high, high, moderate, low, and very low.

Ø Risk probability is the likelihood that a risk will occur Ø Risk consequences is the effect on project objectives if the risk

occurs

Ø Analysis of risks using probability and consequences helps identify those risks that should be managed aggressively

Adapted from Table 11-1, A Guide to the Project Management Body of Knowledge (PMBOK® Guide) - Fifth Edition, Project Management Institute, Inc., 2013. Copyright and all rights reserved. Material from this publication has been reproduced with the permission of PMI.

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Probability/Impact Risk Rating Matrix

Ø A matrix may be constructed that assigns ratings (very low, low, moderate, high, and very high) to risks.

Ø Probability: The likelihood of occurrence § The ratio of the number of chances that an event may happen, to the sum of the

chances of it both happening and not happening § It falls between 0.0 (no probability) and 1.0 (certainly)

Ø Impact: reflects the severity of risk’s effect on the project objective § Ordinal (very low, low, moderate, high, very high) or § Cardinal

ü Linear scale: 0.1 / 0.3 / 0.5 / 0.7 / 0.9 ü Non-linear scale: 0.05 / 0.1 / 0.2 / 0.4 / 0.8

Risk Score = Probability x Impact

Organization desires to avoid high-impact risks.

Rating Likelihood Matrix

Ordinal Impact Cardinal Very High > 80% 0.9

High 60% to 80% 0.7 Medium 40% to 60% 0.5 Low 20% to 40% 0.3

Very Low < 20% 0.1

Ø One-to-one correspondence of ordinal and cardinal impact

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Rating Impact Matrix

Ø Evaluating impact of a risk on major project objectives

Ø The impacts can be assessed on a scale from Very Low to Very High or on a numerical scale (here cardinal and non-linear scale)

Project Very Low Low Moderate High Very High Objective 0.05 0.10 0.20 0.40 0.80

Cost Insignificant cost increase

<5% Cost increase

5 - 10% Cost increase

10 - 20% Cost increase

> 20% Cost increase

Schedule Insignificant schedule slippage

Schedule slippage <5%

Overall project slippage 5 -

10%

Overall project slippage 10 -

20%

Overall project schedule slips

> 20% Scope Scope

decrease barely

noticeable

Minor areas of scope are affected

Major areas of scope are affected

Scope reduction

unacceptable to the client

Project end item is

effectively useless

Quality Quality degradation

barely noticeable

Only very demanding

applications are affected

Quality reduction

requires client approval

Quality reduction

unacceptable to the client

Project end item is

effectively unusable

Risk Score for a Specific Risk Probability Risk Score = 𝐏 × 𝐈

0.9 0.05 0.09 0.18 0.36 0.72 0.7 0.04 0.07 0.14 0.28 0.56 0.5 0.03 0.05 0.10 0.20 0.40 0.3 0.02 0.03 0.06 0.12 0.24 0.1 0.01 0.01 0.02 0.04 0.08

0.05 0.10 0.20 0.40 0.80 Impact on an Objective (e.g., cost, time, or scope)

(Ratio Scale)

Probability-Impact (P-I) Matrix

Ø Determining whether a risk is considered low, moderate or high.

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Probability-Impact (P-I) Matrix

Ø The P-I matrix can be developed using cardinal or ordinal scales.

Ø The organization must determine which combinations of probability and impact result in a risk’s being classified as high risk (red condition), moderate risk (yellow condition), and low risk (green condition).

Ø The risk score helps put the risk into a category that will guide risk response actions.

Outputs from Qualitative Risk Analysis

1. Overall risk ranking for the project: Risk ranking may indicate the overall risk position of a project relative to other projects by comparing the risk scores.

2. List of prioritized risks: Risks can be prioritized by a number of criteria including § Rank (high, moderate, and low) § WBS level § Immediate response or handled at a later date

3. List of risks for additional analysis: Risks classified as high or moderate would be prime candidates for more analysis, specifically quantitative risk analysis.

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Quantitative Risk Analysis

Ø State outcomes as probability distribution and use distributions to evaluate the desirability of certain decisions

Ø Objective is to illustrate the risk profile of the outcomes (e.g., profits, completion dates, return on investment) on investing in some projects

Ø Techniques for analysis include: § Expected value: When probability information is available or can be

estimated, many risk analysis techniques use the concept of expected value of an outcome.

§ Simulation: Evaluating the desirability of certain managerial decisions by iteration and estimating probability distributions of outcomes and key parameters

Expected Value Analysis Example

Ø Find the best alternative given the cost outcomes below. The probability of rain is 0.3, clouds is 0.2, and sun is 0.5.

Ø Alternatives “c” and “d” have the lowest expected cost. Ø What if you base your decision on the best, and the worst possible outcome

for each alternative?

Alternative State Rainy Cloudy Sunny Expected Value

a 6 3 4 b 2 4 5 c 5 4 3 d 5 4 3

𝟔×𝟎.𝟑 + 𝟑×𝟎.𝟐 + 𝟒×𝟎.𝟓 = 𝟒.𝟒 𝟐×𝟎.𝟑 + 𝟒×𝟎.𝟐 + 𝟓×𝟎.𝟓 = 𝟑.𝟗 𝟓×𝟎.𝟑 + 𝟒×𝟎.𝟐 + 𝟑×𝟎.𝟓 = 𝟑.𝟖 𝟓×𝟎.𝟑 + 𝟒×𝟎.𝟐 + 𝟑×𝟎.𝟓 = 𝟑.𝟖

Worst case: 𝒂 → 𝟔;𝒃 → 𝟓;𝒄 → 𝟓;𝒅 → 𝟓 → either b, c, or d Best case: 𝒂 → 𝟑;𝒃 → 𝟐;𝒄 → 𝟑;𝒅 → 𝟑 → b

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Decision Trees

Ø A decision tree is a decision support tool that uses a tree-like graph or model of decisions and their possible consequences, including chance event outcomes, resource costs, and utility.

Ø Three types of “nodes” § Decision nodes - represented by squares (□) § Chance nodes - represented by circles (Ο) § Terminal nodes - represented by triangles (optional)

Ø Solving the tree involves pruning all but the best decisions at decision nodes, and finding expected values of all possible states of nature at chance nodes

Decision node

Chance node Event 1

Event 2

Event 3

Decision Trees Example

Ø John Smith is a writer of romance novels. A movie company and a TV network both want exclusive rights to one of his more popular works.

Ø If he signs with the network, he will receive a single lump sum, but if he signs with the movie company, the amount he will receive depends on the market response to his movie.

Ø What should he do?

Ø The list of payouts under each contract and success probability in box office are as follows.

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Decision Trees Example Payouts and Probabilities

Movie company Payouts Ø Small box office - $200,000 Ø Medium box office - $1,000,000 Ø Large box office - $3,000,000

TV Network Payout Ø Flat rate - $900,000

Probabilities Ø P(Small Box Office) = 0.3 Ø P(Medium Box Office) = 0.6 Ø P(Large Box Office) = 0.1

Decision Trees Example Payoff Table

Decisions

States of Nature

Small Box Office

Medium Box Office

Large Box Office

Sign with Movie Company

$200,000 $1,000,000 $3,000,000

Sign with TV Network $900,000 $900,000 $900,000

Prior Probabilities

0.3 0.6 0.1

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Decision Trees Example Decision Tree

Small Box Office

Medium Box Office

Large Box Office

Small Box Office

Medium Box Office

Large Box Office

Sign with Movie Co.

Sign with TV Network

$200,000

$1,000,000

$3,000,000

$900,000

Expected Value (Sign with Movie C.) = 𝟎.𝟑×𝟐𝟎𝟎,𝟎𝟎𝟎 + 𝟎.𝟔×𝟏,𝟎𝟎𝟎,𝟎𝟎𝟎 + 𝟎.𝟏×𝟑,𝟎𝟎𝟎,𝟎𝟎𝟎 = $𝟗𝟔𝟎,𝟎𝟎𝟎

Expected Value (Sign with TV Network) = 𝟎.𝟑×𝟗𝟎𝟎,𝟎𝟎𝟎 + 𝟎.𝟔×𝟗𝟎𝟎,𝟎𝟎𝟎 + 𝟎.𝟏×𝟗𝟎𝟎,𝟎𝟎𝟎 = $𝟗𝟎𝟎,𝟎𝟎𝟎

Information Technology Project Management, Seventh Edition

Ø Simulation uses a representation or model of a system to analyze the expected behavior or performance of the system

Ø Monte Carlo analysis simulates a model’s outcome many times to provide a statistical distribution of the calculated results

Ø The model is run repeatedly based on random choices of values from the probability distributions of the input variables

Ø Outputs of the model are used to construct statistical distributions of items of interest such as costs, profits, and completion dates.

Ø We can use Oracle Cristal Ball, a widely used Excel Add-In to improve the PM’s understanding of the risks associated with budget uncertainty.

Ø The Oracle Cristal Ball is available with the textbook.

Project Risk Simulation with Crystal Ball Simulating Budgets and Cash Flows

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PsychoCeramic Sciences, Inc. Review from Class 2

§ PsychoCeramic, Inc. is a large producer of pots and other fragile items. § The firm is considering the installation of a new manufacturing line

that will allow more precise quality control on the size and shape. § The plant engineering department has submitted the project proposal

that estimates the following investment requirements: § Initial investment of $125,000 at the beginning of 2016 § Additional investment of $100,000 to install the machines at the end of 2016 § Another $90,000 to add new material handling system at the end of 2017 § Maintenance expenditures about $15,000 every second year starting from

2019

PsychoCeramic Sciences, Inc. Review

§ Projected manufacturing savings and added profits resulting from higher quality are estimated to be $50,000 in the first year of operation (which is 2018), and to peak at $120,000 in the second year of operation.

§ The machinery will have a salvage value of $35,000 after 10 years; the project life.

§ It then follows a gradually declining pattern presented below.

2018 2019 2020 2021 2022 2023 2024 2025 50,000 120,000 115,000 105,000 97,000 90,000 82,000 65,000 35,000

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PsychoCeramic Sciences, Inc. (Review) Fixed Inflow (No Uncertainty)

PsychoCeramic Sciences, Inc. Cash Flow and Inflation Estimates Ø Similar to our discussion in

scheduling, we assume budget/profit estimate follows beta distribution with the following estimations § Minimum (Pessimistic) § Most likely § Maximum (Optimistic)

Ø We also assume that the rate of inflation (p) is normally distribution with a mean of 2 percent and standard deviation of 0.33 percent.

Inflow Year Minimum Most Likely Maximum 2018 $35,000 $50,000 $60,000 2019 $95,000 $120,000 $136,000 2020 $100,000 $115,000 $125,000 2021 $88,000 $105,000 $116,000 2022 $80,000 $97,000 $108,000 2023 $75,000 $90,000 $100,000 2024 $67,000 $82,000 $91,000 2025 $51,000 $65,000 $73,000 2025 $30,000 $35,000 $38,000 Total $621,000 $759,000 $847,000

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PsychoCeramic Sciences, Inc. Cash Flow and Inflation Estimates (Cont.) Ø In CB the cells that contain variables or parameters that we make assumptions

about are defined as assumption cells § Inflows are variables § Inflation is parameter

Ø The cells that contain the outcomes (or results) we are interested in forecasting are called forecast cells § We want to predict the NPV of the project

Ø The forecast cell typically contains a formula that is dependent on one or more of the assumption cells

Ø We need to add a new column to capture uncertainty in every year inflation rate Ø With CB Add-In define each inflow based on beta distribution and inflation rate

based on normal distribution

PsychoCeramic Sciences, Inc. Cash Flow and Inflation Estimates (Cont.)

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PsychoCeramic Example: Frequency Chart of Net Present Value

PsychoCeramic Example: Summary Statistics

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Crystal Ball Chart for Project Completion Time

Risk Response Planning

Ø Risk Response Planning is the process of developing options and determining actions to enhance opportunities and reduce threats to the project’s objectives.

Ø It includes the identification and assignment of individuals or parties to take responsibility for each agreed risk response.

Ø It must be appropriate to § Severity of the risk § Cost effective in meeting the challenge § Timely to be successful § Realistic within the project context § Agreed upon by all parties involved § Owned by a responsible person

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Tools and Techniques for Risk Response Planning

Ø Several risk response strategies are available. Ø The strategy that is most likely to be effective should be selected for

each risk followed by specific actions to implement the selected strategy.

Ø There are four main risk response strategies 1. Avoidance 2. Transference 3. Mitigation 4. Acceptance

Risk Response Strategies Threats

Avoid Ø Eliminate a specific threat,

usually by eliminating its causes Ø Change project plan to eliminate

the risk condition or protect project objectives from the impact

Ø Example: remove new technology from the project scope

Transfer Ø Transfer the impact of a risk and

ownership of its response to a third party

Ø It gives another party responsibility, but it does not eliminate it.

Ø Use of insurance, performance bonds, warranties, guarantees

Ø Use of a contract Ø Example: use fixed-price contract to

transfer liability to seller

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Risk Response Strategies Threats

Mitigate Ø Reduce the consequences of a risk

event by reducing its probability and/or its impact to an acceptable threshold

Ø Taking early action is more effective than repair the consequences if risk occurred

Ø Example: add 2 weeks to schedule to allow for permit approval

Accept Ø Do nothing due to below

threshold or cost of response Ø If risks occur use backup plans

or contingency

Risk Response Strategies Opportunities

Exploit Ø Eliminate uncertainty that may

hinder an opportunity to be realized. Ø Example: Allocate expertise to finish

early and collect on an incentive

Share Ø Team up with a third party who is

best able to realize an opportunity and reap the benefit.

Ø Example: Joint venture agreement

Enhance Ø Increase the probability and/or impact

by identifying and maximizing key drivers of the risk to ensure it occurs.

Ø Example: Hire cutting edge researchers to be the first on the market to introduce miracle drug

Accept Ø Do nothing due to below threshold

or Cost of response Ø If risks occurs use backup plans or

Contingency

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Risk Assessment Matrix or Risk Register

Ø A tool for assessing and managing risks Ø It includes potential risks, their potential impact, likelihood of occurrence,

and response plan

Ø It helps to: § List the impact of the risk § Evaluate the likelihood of occurrence § Determine the degree of impact § Identify the action trigger § Name a person responsible § Create a response plan to avoid, mitigate, transfer, or accept the risk

Successful Project Management, 6th Edition, Gido & Clements

Risk Assessment Matrix Example

The significant risks and their associated information for an outdoor concert:

Successful Project Management, 6th Edition, Gido & Clements

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Risk Analysis Example

Ø You are managing the project to move your family to a new home.

Ø In talking to the family and friends you have the following lists of risks:

§ You cannot find a new home in time

§ Mover’s truck breaks down

§ Fragile items break

§ More friends show up to move

Ø Which are project risks?

Risk Example

Probability Cardinal Definition Low 1 < 30% Medium 2 30% to 70% High 3 > 70%

Risk Probability Scale Objective Low (1) Medium (2) High (3) Cost < $100 $100 to $1000 > $1000 Schedule < 1 day 1 to 3 days > 3 days Scope None Minor Major Quality None Poor Not usable

Risk Impact Scale

Id Risk Event Type Prob Impact Score Response A Mover's truck breaks down Threat 1 2 2 B Family does not know how to pack Threat 3 3 9 C More friends to move Opportunity 2 3 6

Risk Register

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Risk Example (Cont.)

1 2 3 3 3 6 9 2 2 4 6 1 1 2 3

Threats Probability and Impact Matrix

Probability

Id Risk Event Type Prob Impact Score Response A Mover's truck breaks down Threat 1 2 2 Accept B Family does not know how to pack Threat 3 3 9 Transfer C More friends to move Opportunity 2 3 6 Accept

Risk Register

Risk Monitoring and Control

Ø Risk control includes implementing risk response plans and monitoring risks. Risk response plans should be implemented as appropriate when their trigger point is reached.

Ø Risk monitoring involves: § Regularly reviewing the risk management matrix throughout the duration of

the project § Regularly reviewing and evaluating all risks to determine if there are any

changes to the likelihood of occurrence or the potential impact of any of the risks

§ Seeking to identify new risks § Tracking and documenting which risks actually occurred and the impact of

those risks