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300 Risk and uncertainty management
Cumulative probability
Callum
Falls
1
0.8
0.6
0.4
0.2
0
−5 0 5 10
Profit $m
Littleton
Figure 11.2 – Cumulative probability distributions for annual profit at the two sites
The managers wanted to investigate the possibility of reducing this risk
and also wanted to explore the possibility of taking actions that would
make the Littleton site even more profitable by increasing the payoffs
that are associated with the higher levels of demand.
Identifying possible areas for uncertainty management
A structured method of risk management first allows the manager to
identify and evaluate the most promising areas where risk might be
reduced or payoffs enhanced. 1 This can involve the following approach.
1. Calculate the effect of perfect control
This can be achieved by first looking at the option that the decision model
suggests should be preferred and determining how the probability
distribution of the annual profit would change if the decision maker is
able to exercise control over the events that the model assumed were
uncertain. Of course, in reality it is very unlikely that the decision maker
will have perfect control, but the results of the calculations will provide
some guidance on whether it is worth devoting effort to try to improve
the probabilities or values associated with these uncertain events.
Table 11.1 shows that in the Two Valleys problem the managers were
uncertain about (i) annual fixed costs, (ii) variable costs, (iii) whether the
contract is agreed with the major customer and (iv) the level of openmarket
demand. Suppose that actions could be taken to ensure that the
contract was agreed. By how much would this increase the expected