Types of Risk & Creating Contingency Plans

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  • 0:03 Introduction to Risks
  • 0:27 Risk and the Risk Matrix
  • 1:13 Risk Measurements
  • 4:01 A Risk Contingency Plan
  • 5:09 Lesson Summary
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Lesson Transcript
Instructor: Christian George

Christian has a PhD in Business Management and an MA in Accounting & Financial Management

This lesson discusses various types of risk, including variance, contingency risk, and unknowns. We also explore the need for a risk contingency plan for each project that a company undertakes.

Introduction to Risks

The business world is ruthless.

If you want to succeed as a business through continual growth and market dominance, you have to take risks. But risks are scary...and you want to play it safe. The lack of knowledge concerning what will happen and the other unknown variables in life can leave a bit of a sour taste in your mouth, but there are ways to manage the risk and create a contingency plan to deal with the potential risks when they surface.

Risk and the Risk Matrix

Risk can be defined in multiple ways because risk is prevalent in every aspect of life. For this lesson, we'll define risk as the danger involved in any situation, whether known or not. Companies can lose money, market share, and other types of resources due to risk.

Many times they will use a chart to map out the risks that can potentially harm the company. As companies plan for, execute around, and manage risks as they happen, they often will use a risk matrix as a visual aid to better see how risks affect operations. The matrix applies probability reasoning to certain events to determine the level of risk. The risk matrix provides a risk rating, which combines severity and likelihood of a risk happening to calculate the rating.

Risk Measurements

ABC, Inc. is a company that provides construction management and contracting to commercial construction projects. These projects are the result of contractual agreements between ABC and outside parties that are looking to build a commercial real estate building or complex. ABC contracts with Property Partners LLC to build a 100-unit apartment complex. During the planning phase of the project, ABC must determine the risk involved in the project and how to plan adequately for the probability of the risk happening. They also include with the project plan a risk contingency plan to deal with the problems if they surface.

Variance Risk

Let's first look at variance risk. Variance is a common metric used in business to calculate risk. This metric can be used to determine if a project is over or under budget. Variance is the measurement of the spread between numbers in a set. For example, if ABC expects to spend $10,000 on labor on the project, they should calculate a variance risk, meaning that they expect the true cost of labor to be $10,000 plus or minus a calculated amount of variance.

The risk involved presupposes that there will be a variance in multiple factors. In this example, we used labor costs for the project. Management can reliably calculate the variance in labor costs to effectively manage the risk of a variance in those labor costs. This variance will be added to the project plan along with other variance measurements.

Contingency Risk

Now let's look at contingency risk. Contingency is a future event that has the possibility of happening but cannot be predicted with certainty. For example, ABC will determine that the upcoming winter flu season will negatively affect their labor hours because there is a chance that many workers will get the flu. They will assign this as a contingency to the project plan and the risk that the labor hour losses will delay the project. This delay is also part of the contingency. In order to address the risk, ABC must assess the need to add additional time requirements to the scope of the project to cover the contingency.

It's impossible for management to perfectly determine contingency risk in a project. There are many unforeseeable circumstances that cannot be predicted. Management must determine the level of risk involved in the event of a contingency and plan appropriately for the occurrence.

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