Chapter 9: Risk and uncertainty

Question 1

What is risk?

Answer 1

number of outcomes and the probability of each outcome is known

Question 2

What is uncertainty?

Answer 2

number of outcomes but probability is unknown

Question 3

What is scenario planning?

Answer 3

1) Identify high-impact, high uncertainty factors
2) Identify different possible futures
3) Identify consistent future scenarios
4) Write the scenario
5) Each scenario - identify/ assess possible courses of action for firm
6) Monitor reality
7) Revise scenarios & strategic options

Question 4

How can you assess and reduce uncertainty

Answer 4

Market research e.g focus groups, desk research (secondary research), field research (primary research) -(motivational & measurement research)

Question 5

What are focus groups

Answer 5

normally involves 8-10 people from a broader population
Interviewed through a facilitator- led discussion in an informal environment
Gather opinions & reactions to a particular subject

Question 6

What are the problems with focus groups

Answer 6

1) results are qualitative
2) Small sample size- results may not be representative
3) Individuals may feel under pressure to afree with other members or give a right answer
4) cost & logistical complexity - barrier especially for smaller companies - online ones can overcome this issue

Question 7

What is desk research

Answer 7

collected from secondary sources
Obtains existing data by studying published and other available sources of info e.g press articles, published accounts, census info
can eliminate need for extensive field work

Question 8

What to consider when using desk research

Answer 8

data may not be exactly what the research wants/ up to date/ accurate
Quicker/ cheaper than field research

Question 9

What 3 mains types of info can be collected from desk research

Answer 9

1) Economic intelligence
2) Market intelligence
3) Internal company data

Question 10

What is economic intelligence

Answer 10

Info relating to the economic environment which a company operates. Converned with Gross National Product (GNP), investment, expenditure, population, employment, productivity/ trade.
Looks at past/ future trends with an indication of a company’s position in the economy as a whole
Can get info from Gov ministries, nationalised industries, universities etc

Question 11

What is market intelligence

Answer 11

Info about a company’s present/ possible future markets.
Commercial & technical info
e.g levelof sales of competitors products recorded by Busines Monito/ census of production, product range by existing or potential competitors , number of outlets forming the distribution network, structure & size of network, location, relation to end user

Question 12

What is internal company data

Answer 12

Normally record sales for accountancy purposes.
Some blue chips companies and public services can be seen to produce data for no reason
therefore not always used by marketing- potential to be used

Question 13

What is field research?

Answer 13

info from primary sources by direct contact with target group
More expensive & time consuming than desk research
More accurate/ relevant/ timely

Can be motivational or measurement

Question 14

What is motivational research?

Answer 14

understand factor that influence why consumers do/don’t buy certain products

Question 15

What are some techniques for motivational research?

Answer 15

1) Depth interviewing - undertaken by a trained person to appreciate conscious/ unconscious associations, motivations and their significance

2) Group interviewing - 6- 10 people consider the relevant subject (object) under trained supervisions

3) Word association testing- being given a word by the interviewer and the 1st word to come to mind

4) Tried testing - asked for fav out of 3 items - if the chosen ones have similar characteristics it shows what influences consumer behaviour

Question 16

What is measurement research

Answer 16

build on motivation research
Quantify issues involved

Question 17

Techniques of measurement research

Answer 17

sample surveys- how many people buy the product, the quantity bought, where & when
e.g in retail from sales & loyalty cards

Question 18

What are the types of measurement research

Answer 18

Random sampling
Quota sampling
Panelling
Surveying by post
Observation

Question 19

What is random sampling

Answer 19

each person in the population has an equal chance of being selected
Representative- make predictions more reliable
Can be unfeasible in practice

Question 20

What is quota sampling

Answer 20

samples are designed to be representative to pre-selected criteria
e.g population split into % then take a representative size sample

Question 21

What is a disadvantage of quota sampling?

Answer 21

samples can still be biased for non-selected criteria

Question 22

What is panelling

Answer 22

sample is kept for subsequent investigations
Trends are easier to spot

Question 23

What is surveying by post

Answer 23

Mail shot method
sample’s self selecting- biased

Question 24

What is observation

Answer 24

cameras in shops- how long people spend reading nutritional info

Question 25

What is sensitivity analysis

Answer 25

takes each uncertain factors, calcs the change needed before the original decision is reversed - what if questions

Can eastablish which estimates are more critical than others in affecting a decision

Question 26

What is the process of sensitivity analysis

Answer 26

1) Best estimates for variables made & decision arrived at

2) Each variable is analysed- see how much the original estimate can change before the original decision is reversed

3) Estimates for each variable- reconsidered to assess liklihood of estimate being wrong

4) Maximum possible change (as a %)

Question 27

What are the strengths of sensitivity analysis?

Answer 27

1) No complicated theory to understand
2) Info presented to management for subjective judgement and decide likelihood of various outcomes considered
3) Identifies areas crucial to success and these can be monitored

Question 28

What are the weaknesses of sensitivity analysis?

Answer 28

1) Assumes changes to variables can be made independently- simulation allows us to change more than 1 at a time

2) Only identifies how far a variable needs to change - not probability of that change

3) provides info on the basis where decisions can be made- doesn’t point in to the correct decision directly

Question 29

What is simulation

Answer 29

modelling technique showing the effect of more than 1 variable changing at the same time
Used in capital investment appraisal

Question 30

What is the Monte Carlo simulation

Answer 30

uses random numbers & probability statistics
Includes random events that can affect the success/ failure of a proposed project

Identifies key variables in a decision e.g cost/ revenue
Random numbers assigned to each variable in proportion to prob distribution

Computer repeats decision many times - shows likely range & level of outcome depending on risk appetite

Only good if underlying probability distribution can be estimated with some degree of confidence

Question 31

What are the drawbacks of simulation

Answer 31

1) Doesn’t necessarily make a decision- gives extra info about possible outcomes

2) complex

3) time & cost to build can be greater than value of improved decision

4) Probability distribution can be difficult to formulate

Question 32

What are expected values (EV)?

Answer 32

weighted average of all possible outcomes

Calcs average return if a decision is repeated multiple times

= value of each outcome (x) * probability of outcome (p) and summing results

Good for risk neutral decision makers- happy to accept the average

Question 33

.What is the advantage of EV?

Answer 33

1) Takes uncertainty into account by considering the prob of each possible outcome & using it to calc an EV

2) info is reduced to a single number= easier decision

3) calcs are relatively simple

Question 34

What are the disadvantages of EV?

Answer 34

1) probs used are usually subjective

2) Just a weighted average - little meaning for a 1 off project

3) No indication of the dispersion of possible outcomes about the EV i.e risk so it’s a neutral decision

4) may not correspond with any actual possible outcomes

Question 35

What are pay-off tables

Answer 35

aka profit tables
represent & analyse a range of possible outcomes and responses

Illustrates all possible profits/ losses
columns = decision variable
rows= risk

Question 36

What is the maximax rule?

Answer 36

select the alternative that maximises the maximum pay-off achievable

Risk seeking investors

Question 37

What is the maximin rule

Answer 37

select the alternative that maximises the minimum pay-off achievable

Look at worst possible outcome at each supply level and select the highest one

Choose outcome guaranteed to minimise losses

Risk averse investors

Question 38

What is the minimax regret rule

Answer 38

minimises the maximum regret

Regret= opportunity loss through making the wrong decision

Question 39

What is a decision tree

Answer 39

All possible courses of action are represented and each outcome is shown
Considers logical sequence of events
complex problem is broken down into smaller, easier to handle sections

Question 40

What are the 3 steps to a decision tree

Answer 40

Step 1: Draw tree with the decisions & events/ outcomes
Square= decision point - between 2 outcomes
Circle= chance point - all probs coming away from this add to 1
Label the tree and cash inflows/ outflows and probs

Step 2: Evaluate the tree right to left
Calc EV at each chance point
Choose best option at each decision point

Step 3: Recommend a course of action to management

Question 41

What is perfect information

Answer 41

future forecast = 100% correct
always undertake the most beneficial course of action

Question 42

What is imperfect information

Answer 42

forecast usually correct
not as valuable as perfect
rare

Question 43

What is the calculation for the value of information

Answer 43

Expected profit (outcome) with the info - expected profit w/o info