Risk Threshold vs. Risk Tolerance

Instructor: Olga Bugajenko

Olga is a registered PRINCE2 Practitioner and has a master's degree in project management.

To make decisions that correspond with the organizational direction, it is important for a project manager to know how much risk is too much. In this lesson, we discuss the difference between risk tolerance and risk threshold.

Risk Attitude of an Organization

Imagine yourself selling a house. Luckily for you, the real estate market is booming and the prices are growing. Would you be keen to sell as soon as possible, while the market conditions are still favorable, or would you prefer to wait for a little longer hoping that the price will increase even further? The answer to this question depends on your risk attitude - how much risk you are willing to tolerate in expectation of a bigger reward.

The risk attitude of an organization will define the way it will act when a risk will occur on a project. Planning a specific risk response is an integral part of the risk management process. A four-step process begins with identifying potential risks and carrying out risk analysis, followed by selecting a risk response in accordance with the organizational risk attitude and monitoring project performance.

In this lesson, we will discuss two terms—risk tolerance and risk threshold. These are both used to discuss the maximum amount of risk an organization is willing to take on.

Risk Tolerance

The risk attitude of an organization defines how much or how little risk an organization is willing to take on. While some organizations will generally be more risk averse than others due to the industry characteristics or the current financial position, the attitude towards taking on additional risks may also differ from one project to another. For strategically important projects, an organization might be willing to take on larger risks in hopes of larger rewards.

Risk tolerance quantifies the amount of risk an organization is willing to take on. Risk tolerance is a range and is usually expressed as a percentage below and above the planned value - either project budget or schedule.

Imagine yourself successfully selling the house from the earlier example, and now using the funds to build a bigger house for your family. While you should create both a budget and a schedule, it is wise to assume that some things might not go as planned and have a certain financial and time cushion. The cost tolerance of your construction project can be +/-10% of the original budget.

Risk Threshold

In contrast to risk tolerance, risk threshold is a fixed number, not a range. Risk threshold is a level of uncertainty and impact from risk below which an organization an organization will accept a risk and above which an organization will not accept a risk. Similarly to risk tolerance, risk threshold is expressed in measurable units together with the probability of occurrence. The risk thresholds are usually set at individual project activity level. This helps to quantify the impact and probability more accurately.

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