Quality Progress - January 2016 - 52

BACK TO BASICS Best of FEBRU A 2014 RY BY PETER J. SHERMAN Calculated Risk Balancing the cost of risk and uncertainty AFTER READING Jeffrey A. Robinson's As the figure illustrates, organizations have ability of occurrence also may mitigate insightful QP article, "Keep Moving,"1 I four basic responses for any identified risk: risk by implementing the preventive thought of other ways decision makers can 1. Risk acceptance (bottom-left quad- measures outlined in No. 3. Before deciding on a response to the effectively manage risk and uncertainty. rant). Accepting risk often is the best Risk and uncertainty is what management strategy for organizations facing issues identified risk, an organization must bal- is all about. If there were no risks, there characterized by low magnitude of loss ance the cost of the risk response against would be no need for managers. In other and low probability of occurrence. For the risk level. The resources expended to words, if everything were certain and example, an organization seeking to mitigate risk should be less than the conse- predictable, there would be nothing to grow its market share by distributing its quence of inaction. manage. software online generally accepts the in- Risk is something you can put a price herent risks of piracy by protecting itself on; uncertainty is risk that's difficult to through secure access, limited licenses measure. Organizations tend to either be and encryption. risk-tolerant or risk-averse. An organiza- 2. Risk transfer or avoidance (top-right Risk level is commonly described using the following cost justification formula: Risk level = probability of occurrence x magnitude of loss. tion's tolerance of risk plays a role in how quadrant). Organizations can avoid risk For example, a 5-year-old piece of equip- it responds to it. entirely. For example, some pharmaceuti- ment valued at $100,000 has a 10% probabil- cal organizations choose not to develop ity of breaking down in the next 12 months. benefits of accepting risks that outweigh vaccines to avoid lawsuits spurred by The risk level can be quantified at $10,000 potential harm (that is, commodity products claims of harmful side effects. Alterna- ($100,000 x 0.10). The response should cost or services). Organizations willing to accept tively, organizations can transfer risk to a no more than $10,000. higher risks may have a higher potential for third-party insurance provider or supplier. return on investments. Risk-averse organiza- This requires purchasing insurance or when presenting plans and budgets for ap- tions (such as pharmaceutical organizations) contractually transferring risk to an out- proval. Keep in mind that cost justifications sourced supplier. are not always as simple as doing math. Risk-tolerant organizations see the are more cautious about accepting risks because risk events can cause lawsuits, 3. Risk mitigation (bottom-right Quality professionals can use this formula Understanding the context is critical. For quadrant). Organizations facing cir- example, product liability insurance often The combination of risk (magnitude cumstances of high magnitude of loss costs more than the expected value, but the of loss) with uncertainty (probability of and low probability of occurrence can insurance is justified because the potential occurrence) creates four basic categories mitigate the probability and severity of loss is so great. The bottom line is that man- of risk levels that are shown in Figure 1. identified risks by applying preventive agers who understand risk and uncertainty measures. These include: properly de- will better manage the organization. QP negative publicity and even death. Uncertainty (probability of occurrence) Risk levels / FIGURE 1 4 Risk mitigation 2 Risk transfer 1 Risk acceptance 3 Risk mitigation signed products, facilities and processes; employee training; compliance management; preventive maintenance; busiredundant systems. Organizations also the monetary, physical or reputation damage from risk events. 4. Risk mitigation (top-left quadrant). Organizations facing circumstances with 52 QP * www.qualityprogress.com 1. Jeffrey A. Robinson, "Keep Moving," Quality Progress, November 2012, p. 71. ness diversification; and the creation of may use contingency plans to minimize Risk (magnitude of loss) REFERENCE low magnitude of loss and high prob- PETER J. SHERMAN is the director of Process Excellence with Cbeyond Communications in Atlanta. He earned a master's degree in civil engineering from the Massachusetts Institute of Technology in Cambridge and an MBA from Georgia State University in Atlanta. A senior member of ASQ, Sherman is a certified Lean Six Sigma Master Black Belt, an ASQ-certified quality engineer and an Association for Operations Management-certified supply chain professional. http://www.qualityprogress.com

Table of Contents for the Digital Edition of Quality Progress - January 2016

According to Plan
Solid Proof
Use Your Head
Stakeholder Management 101
Customer Delight
All About Data
Eight Simple Steps
Minimizing Chaos
Take Note
Pyramid Scheme
Assessing Failure
Which Six Sigma Metric Should I Use?
Turning ‘Who’ Into ‘How’
In the Beginning
Outputs and Outcomes
That’s So Random—Or Is It?
Understanding Variation
Improving a System
Putting It All on the Table
Know the Drill
It’s Fun To Work With an F-M-E-A
Solve Problems With Open Communication
Tell Me About It
Separate the Vital Few From the Trivial Many
To DMAIC or Not to DMAIC?
Breaking It Down
Smart Charting
1 + 1 = Zero Defects
QFD Explained
Curve Your Enthusiasm
Make a Choice
What Is a Fault Tree Analysis?
Successful Relationship Diagrams
The Benefits of PDCA
Creative Combination
Return on Investment
The Art of Root Cause Analysis
Why Ask Why?
Get to the Root of It
Checks and Balances
Calculated Risk
Sufficient Evidence
Sample Wise
Clearing SPC Hurdles
Supplier Selection and Maintenance
Team Advantage
Building a Quality Team
Plan Experiments to Prevent Problems
Substantiation Test
Training Day

Quality Progress - January 2016

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