Quantitative Risk Analysis (Definition, Benefits and Steps)
Risk analysis allows you to identify potential adverse events and outcomes that may occur over
the course of a project. Both quantitative and qualitative risk analysis can benefit your project
planning, and while quantitative analysis takes more time to complete, it can offer more accurate
projections of possible risk. Because quantitative analysis produces precise outcomes, it requires
methodical calculations. In this article, we discuss what quantitative analysis is, how it differs
from qualitative risk analysis and how to perform it.
What is quantitative risk analysis?
A quantitative assessment is a risk analysis performed with a focus on numerical values of the
risks present. The quantitative risk analysis allows you to determine the potential risk of a
project. This can help you decide if a project is worth pursuing. It also is useful in the
development of project management plans, as understanding the risks present allows you to
reduce the likelihood of certain risks and to prepare for others that you cannot fully eliminate.
Benefits of quantitative risk analysis
When performing a risk analysis, the first decision is whether you want to perform a qualitative
or quantitative assessment. These are the top reasons you may choose to perform a quantitative
risk analysis:
• Objective assessment: Because a quantitative assessment involves assigning numerical
values to each risk, it returns objective results. Conversely, a qualitative assessment
expresses risk in subjective terms, which people may interpret differently. Objective
estimates help ensure that all parties have the same understanding of the projected risks.
• Detailed information: A quantitative assessment breaks down a project by the expected
cost of each potential risk. This allows you to focus reduction efforts on the risks deemed
"most likely" or "most costly."
• Client confidence: When presenting a project assessment to a potential client, the
specificity of a quantitative assessment may provide more confidence because there is
little room for misinterpretation. By providing your client with a specific number
regarding potential financial risk, they can more confidently make their decision about
the proposal.
• Improved decision making: By creating risk assessments with objective measures, you
and others involved in decision making have an accurate assessment of potential risks.
This can help you make the best decision for the company.
Quantitative risk analysis methods
Quantitative risk analysis does not refer to one specific method of determining potential risk. It is
a category of analysis styles, so you can choose the method that best suits your needs. Common
types of quantitative risk analysis include the following:
• Expected monetary value (EMV) risk analysis: This is the most simple form of
quantitative risk analysis. In an EMV analysis, all you need is an expected cost of a risk
you face and the probability of that risk occurring. You often set these values through a
combination of analyzing data, consulting with experts and estimating from experience.
By multiplying the cost of each risk by its probability and adding up all the resulting
numbers, you generate an overall projected risk amount for the project.
• Decision tree risk analysis: A decision tree allows you to assess the risk of one or more
choices. Each tree represents a choice as well as any costs associated with it. Assign
probabilities and costs at each point. By following a chain and adding all the costs along
it, you identify which choice paths offer the lowest risk.
• Monte Carlo risk analysis: A Monte Carlo analysis creates a range of potential outcomes
and is best used around risks related to project duration or yield. In a Monte Carlo
analysis , you often assign the highest probability to the expected outcome. As outcomes
get further from this expectation, assign lower probabilities. Estimate costs for each
outcome and combine with the probabilities for each to find the total expected cost.
• Sensitivity risk analysis: Sensitivity assessment allows you to examine uncertainty within
a risk analysis and determine which elements are most responsible for uncertainty. For
example, in a project with two key components, if the more expensive component is
stable and the less expensive is highly variable, the latter would be responsible for more
uncertainty, even though it is a smaller fraction of the overall cost. Identifying sensitive
components may allow you to identify methods of reducing uncertainty and make
estimates more exact.
• Three point risk analysis: Three point analysis is a method of determining the expected
cost of a risk on a project. To calculate a three point assessment, determine the most
likely cost of a risk, your most optimistic cost of a risk and most pessimistic cost of a
risk. For a basic triangular three point risk analysis, add all three numbers then divide by
three. A more common approach to three point analysis is the beta distribution. Multiply
the most likely value by four, then add the optimistic and pessimistic values and divide
the total by six.
Quantitative versus qualitative risk analysis
A qualitative risk analysis is the primary alternative to a quantitative risk analysis. Although
there are many significant benefits to quantitative analysis listed above, there are also reasons
that you may prefer to perform a qualitative assessment instead.
In a qualitative assessment, instead of using exact numbers, you calculate risks using descriptive
scales. For example, a simple qualitative risk analysis may rate potential risks as either high,
medium or low based on how likely they are to occur.
Although a qualitative assessment does not allow for as precise of calculations, you can complete
it more quickly and with fewer resource investments, as there is no need to make precise
calculations of probabilities and costs. A qualitative analysis is effective for smaller projects that
do not merit a more exhaustive investment of resources and time or for situations where you
need to make a quick assessment but are not confident enough to set a precise probability.
Steps in the quantitative risk analysis process
If you are planning a project and want to calculate your potential risks, quantitative analysis is an
excellent option. Follow these steps to perform a simple quantitative risk analysis:
1. Identify areas for uncertainty
No matter which method of performing a quantitative or qualitative risk analysis you use, in
order to generate an accurate assessment, it's important that you do not overlook any potential
areas for risk within the project.
When identifying areas of potential risk, examine every step of the project. Using a project
outline or management plan that breaks the overall project into smaller sections is an excellent
way to search for areas where risk or uncertainty exist. For example, a construction company
building a home in Florida during the late summer knows that there is an elevated risk of severe
weather like hurricanes, which could impact development schedules.
Create a list of all areas of potential risk, noting the phase of the project, the potential risk that
you identified and how that risk can affect the execution of the project. Common effects include
making costs increase, causing delays or reducing the quality of the output.
2. Assess the costs of each risk
Once you have identified where risk exists within your project, you can calculate the relative cost
of each risk. To do this, determine the expected cost when each potential risk occurs. For basic
risks that are likely to present the same way any time they occur, simply record the expected cost
of remedying the risk.
For complicated risks that may have variable costs, there are two methods of identifying this
number. The easier option is to decide upon an average cost for all potential responses to the
risk. A more accurate option is to further breakdown variable risks into multiple items.
For example, the construction company that is building a home in Florida assesses the potential
ranges of weather delays and how costly each would be. In some situations, severe weather could
cause a minor interruption, but in others, the results might be more extensive. Rather than
creating one entry in the analysis for adverse weather, the company includes an item for mild
weather delays and an item for severe weather delays.
3. Determine the probability of each risk occurring
The total numbers identified in the prior step are a listing of all potential risks, which means you
are unlikely to encounter all of them over the course of one project. In order to determine how
much risk your project carries, you then have to determine how likely it is that each risk may
occur.
The two most important elements when calculating probabilities are research and experience.
The more you know about each scenario, the more accurately you can estimate the chances that a
problem will occur during execution. With the hypothetical construction project mentioned
above, for example, a contractor may study weather patterns for the period of planned
construction so they can more accurately predict the chances of having no delays, mild delays or
severe delays.
Seeking outside help during this step is an excellent option to increase the accuracy of your
estimates. This is particularly important for any areas where you have minimal experience. An
expert can more accurately set a probability for a type of risk, which makes your overall
calculations more accurate.
4. Calculate the expected cost of each potential risk
Determining the expected cost of each risk is as simple as multiplying the estimated cost of each
error by its probability. If you wrote your probabilities out as percentages instead of fractions or
decimals, divide the resulting number by 100 to find the expected risk costs of each element. To
calculate the total estimated cost of risk on the project, add up the risk costs for each individual
element.
In our example scenario, the construction company would combine the probabilities they placed
on severe or mild delays and multiply each by the corresponding costs of those delays to
determine the estimated severe weather risk in their project.
Major Project Management Risks and How to Mitigate them
Project risk management. Not a very exciting or pleasant topic, you might think. It would be nice
if we could all go about our work without considering the bad things that might happen.
However, as a Project Manager, it’s your job to think about the potential risks to your project.
The good news is that if you take a risk identification part of your project planning process,
you’ll be prepared before a crisis presents itself, and then it’s not as much of a crisis.
What is project risk?
Project risk is a problem that may or may not arise over the course of your project management.
There’s no way to control for all potential risks, but thinking through them ahead of time can
save your project from failure. It may give a positive or negative effect on the project.
What is risk assessment in project management?
Risk assessment, or risk identification, is an acknowledgment that something could go wrong. In
a risk assessment, you compile a list of risks and discuss how to mitigate them. Risk analysis is
something several if not all, members of your project team should be part of. Hold a meeting and
then separately ask for insight from all team members about the risks you should consider.
