Chapter 9: Risk and uncertainty Flashcards
What is risk?
number of outcomes and the probability of each outcome is known
What is uncertainty?
number of outcomes but probability is unknown
What is scenario planning?
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
How can you assess and reduce uncertainty
Market research e.g focus groups, desk research (secondary research), field research (primary research) -(motivational & measurement research)
What are focus groups
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
What are the problems with focus groups
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
What is desk research
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
What to consider when using desk research
data may not be exactly what the research wants/ up to date/ accurate
Quicker/ cheaper than field research
What 3 mains types of info can be collected from desk research
1) Economic intelligence
2) Market intelligence
3) Internal company data
What is economic intelligence
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
What is market intelligence
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
What is internal company data
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
What is field research?
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
What is motivational research?
understand factor that influence why consumers do/don’t buy certain products
What are some techniques for motivational research?
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
What is measurement research
build on motivation research
Quantify issues involved
Techniques of measurement research
sample surveys- how many people buy the product, the quantity bought, where & when
e.g in retail from sales & loyalty cards
What are the types of measurement research
Random sampling
Quota sampling
Panelling
Surveying by post
Observation
What is random sampling
each person in the population has an equal chance of being selected
Representative- make predictions more reliable
Can be unfeasible in practice
What is quota sampling
samples are designed to be representative to pre-selected criteria
e.g population split into % then take a representative size sample
What is a disadvantage of quota sampling?
samples can still be biased for non-selected criteria
What is panelling
sample is kept for subsequent investigations
Trends are easier to spot
What is surveying by post
Mail shot method
sample’s self selecting- biased
What is observation
cameras in shops- how long people spend reading nutritional info
What is sensitivity analysis
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
What is the process of sensitivity analysis
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 %)
What are the strengths of sensitivity analysis?
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
What are the weaknesses of sensitivity analysis?
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
What is simulation
modelling technique showing the effect of more than 1 variable changing at the same time
Used in capital investment appraisal
What is the Monte Carlo simulation
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
What are the drawbacks of simulation
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
What are expected values (EV)?
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
.What is the advantage of EV?
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
What are the disadvantages of EV?
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
What are pay-off tables
aka profit tables
represent & analyse a range of possible outcomes and responses
Illustrates all possible profits/ losses
columns = decision variable
rows= risk
What is the maximax rule?
select the alternative that maximises the maximum pay-off achievable
Risk seeking investors
What is the maximin rule
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
What is the minimax regret rule
minimises the maximum regret
Regret= opportunity loss through making the wrong decision
What is a decision tree
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
What are the 3 steps to a decision tree
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
What is perfect information
future forecast = 100% correct
always undertake the most beneficial course of action
What is imperfect information
forecast usually correct
not as valuable as perfect
rare
What is the calculation for the value of information
Expected profit (outcome) with the info - expected profit w/o info
