Cost-Benefit-Risk Index
pejman says : I gained my Bachelor degree in Computing and Information Systems, currently an IT Project Manager contractor having worked for various companies within UK, and also the Managing Director at Risk Consultancy Limited. My research in risk analysis, modelling and simulation, and management is only affiliated to Risk Consultancy Ltd.
In 1997 I explored my risk method with the Director General of Information and Communication Systems, for the British Ministry of Defence, and hence it involved major IT projects.
Under “HEADING 1 – requested information and procedures”; the information readers need to provide and procedures they need to follow to ultimately derive a simple cost-benefit-risk index from a formula has been explained. To bypass the prior procedures and view this formula; go directly to subheading i) The cost-benefit-risk index.
These procedures require information to be provided by the readers (e.g. cost of project). Figures are given as example based on an actual ongoing major Liquid Natural Gas project worth about $2 Billion between a gas extraction and liquefying private company and a country. In this example five risks have been addresses. Risk 1: Human Error, Risk 2: Equipment Breakdown, Risk 3: Explosion and/or fire, Risk 4: Penalisation by pulling out of the contract after having started due to unforeseen circumstances, Risk 5: Replacement of an old software systems with a new software system. The example is from the perspective of the company and not the country. This company classifies the contract as Win-Win and the cost-benefit-risk index quantifies this Win potential.
HEADING 1 - requested information and procedures.
For a project or a change in a project the readers are requested to provide an average estimate for:
a) Financial cost. (e.g. $1,700,000,000)
This financial cost should be inclusive of all costs such as:
• The cost allocated to or spent on any preventative and contingency action.
• The cost allocated to or spent on risk analysis and management programme.
b) Financial benefit. (e.g. $2,000,000,000 to recover the cost and make the estimated $300,000,000 benefit)
Note: For subheadings c to h both a top-down or bottom-up approach for providing the requested information can be used. An aspect of risk (e.g. cause, effect, source, target susceptibility, contingency action, and prevention action) can be shared with a different occurrence of the same risk or another risk. For simplicity in this document it is assumed that risks do not interact.
For subheadings c to h it would greatly help the accuracy of the cost-benefit-risk index if the risk figures are provided within the break-even point; if there is one. This is because the initial bid could be very low due to poor material and workmanship, however the maintenance cost due to risks will be expected to be very high.
Advice: For subheadings d and g a good approach to deriving these negative and positive financial figures is to use five categories: 1) Resource Cost such as human cost, 2) Non-resource Cost such as overhead, 3) Quality, 4) Time, and 5) Scope. Any regression or progression in these five categories can be converted in to a financial value.
c) Probability for the occurrence of the rise in financial cost (i.e. over budget) and/or decrease in financial benefit (i.e. decrease in return on investment). (e.g. Risk 1: 0.07 , Risk 2: 0.05 , Risk 3: 0.005 , Risk 4: 0.08)
d) The rise in financial cost and/or the decrease in financial benefit; as mentioned in subheading c. (e.g. Risk 1: -$300,000 , Risk 2: -$2,000,000 , Risk 3: -$20,000,000 , Risk 4: -$12,000,000)
e) The negative financial risk exposure by multiplying the figure in subheadings c by d for each respective risk; and accumulating the result of multiplication. ( e.g. (Risk 1: 0.07 x -$300,000 = -$21,000) + (Risk 2: 0.05 x -$2,000,000 = -$100,000) + (Risk 3: 0.005 x -$20,000,000 = -$100,000) + (Risk 4: 0.08 x -$12,000,000 = -$960,000) = -$1,181,000)
f) Probability for the occurrence of the decrease in financial cost (i.e. under budget) and/or increase in financial benefit (i.e. increase in return on investment) (e.g. Risk 5: 0.6)
g) The decrease in financial cost and/or increase in financial benefit; as mentioned in subheading f. (e.g. Risk 5: $700,000)
h) The possible positive financial risk exposure by multiplying the figure in subheadings g by h for each respective risk; and accumulating the result of multiplication. (e.g. Risk 5: 0.6 x $700,000 = $420,000)
i) The cost-benefit-risk index by:
• Adding the negative financial risk exposure with possible positive financial risk exposure to give net financial risk exposure. (e.g. -$1,181,000 + $420,000 = -$761000)
• Adding the benefit to net financial risk exposure and then dividing this resulting figure by the cost. (e.g. ($2,000,000,000 + -$761000) / $1,700,000,000) = 1.176 to three decimal points)
Version of the formula based on subheadings: ( b + ( e + h ) ) / a = Cost-Benefit-risk index
Note: In principle, based on a quantitative perspective, the smaller the figure in the cost-benefit-risk index, in terms of size and possible negation, the worse the project or change, and the larger the index the better the project or change. Negative index is particularly undesirable, and should be looked at carefully.
An ideal project or change will have high benefit compared to cost, and considerably low negative financial risk exposure, and maybe a high positive financial risk exposure. This will produce a relatively high index. The opposite also holds true.
The mentioned cost-benefit-risk index is the least complex index of its type. Even if we consider the project circumstances to be a static snapshot, as opposed to dynamic in terms of possible outcomes (e.g. worst or best possible scenario) at various points in time (e.g. start or middle of the project), this index does not take in to consideration the spread in the range of data values (e.g. Standard Deviation, Skewness, Kurtosis), rate of return on investment, Net Present Value, risk exposure financial spread (e.g. from -$1,181,000 to $420,000) and the confidence level in these values.
If you are willing to: trial my work and provide feedback and/or information as required under HEADING 1, explore the use of my risk method that can be used with a spreadsheet, explore the more complex version of the cost-benefit-risk index formulas or for any other reason, the following are my contact details:
Mr Pejman Khojasteh
Risk Consultancy Limited
17 Millwell Crescent, Chigwell, Essex, IG7 5HX, UK.
[email>pejman_khojasteh@riskconsultancy.co.uk[/email>
Any information as required under HEADING 1 or even a general short feedback will be much appreciated. In terms of privacy the information provided will strictly be used in anonymity and for research and development purposes only, unless otherwise stated by the provider of information.
