Chapter 9- Risk and uncertainty and opportunity cost Flashcards
What do those running a business need to try to identify?
- all the possible uncertainties and risks that they face
What are the two types of risk?
- pure risk
- speculative risk
Pure risk
- an event beyond someone’s personal control
- it can only result in a loss of some sort, never in a gain
- e.g. possibility of a fire at a factory
- doesn’t mean nothing can be done about such risks , solution is to ensure that premises and goods are adequately insured and contingency plan constructed for the event
Speculative risk
- different to pure risk because it carries the possibility of a gain as well as a loss
- if a large risk is taken then there is an expectation of a high reward
- e.g. opening a new factory to increase output
- for this to occur, the costs and benefits of the decision will have been considered in great detail
- financial costs and benefits will be the easiest to quantify e.g. cost of construction
- not all of these costs and benefits will be readily measurable
Uncertainty
Could be described as a situation where the current state of knowledge possessed by a businesses managers are imperfect
- meaning making a decision could be difficult because the outcomes of the decision aren’t known
- inability to calculate the costs and benefits of a decision precisely
Risk
The chance or possibility of an adverse occurrence
Reward
The possible return that a particular activity may make
Uncertainty and the risks associated with it
External uncertainty
1. Economic uncertainty: true state of the economy in terms of consumer confidence, income levels and spending plans. Also could include uncertainty about government economic policy or the bank of englands decisions on interest rates
- Political uncertainty: if an election is due, will the new government have a different attitude to business in terms of employee rights, attitude to global warming
- Competitive uncertainty: action of competitors
Internal uncertainty
1. Organisational and human resource uncertainty: does the organisational structure of the business support the decision? Does the culture of the business support the decision?
- Stakeholder uncertainty: how could stakeholders react to a decision?
- Technological uncertainty: will existing technology be able to cope with any decision the business takes. Another issue is whether to upgrade technology frequently to maintain competitive edge
Uncertainty, risk and setting objectives
- high degree of uncertainty- higher degree of risk- can have a significant effect on a businesses decision making
- a decision involving considerable uncertainty and risk will be associated with a greater degree of planning
- uncertainty affects this decision because of the unknown responses from competitors, stakeholders and future direction of the economy
If there is a good deal of uncertainty and the risk is perceived to be high, what may that mean?
That the decision to adopt the objective of expansion is made but the nature and extent of the expansion is cautious rather than ambitious
Management of risk
Economic risk could be managed by:
- analysis of a wide variety of economic indicators (not just GDP)
- use of time series analysis to forecast trends
Political risk could be managed by:
- managers being up to date and aware of the policy intentions of the main political parties
Competitive risk could be managed by:
- building a strategy based on regular and thorough SWOT analsyes
- ongoing market research
- use of tools such as Boston matrix
Organisational risk could be managed by:
- clear understanding of how one departments actions impact upon one another
- fostering a change culture
Stakeholder risk could be managed by:
- consultation with any stakeholders likely to be affected by the decision well in advance; employees and suppliers could be essentially important
Unquantifiable risk
The risk of an event that is unexpected
Sometimes referred to as ‘the unknown unknowns’
Not possible to put a value on this sort of risk
Quantifiable risk
- the likelihood of a predictable risk occurring
- it is possible to put a value on this sort of risk
Opportunity costs
- not the financial costs of the decision but what has to be ‘given up’ when a course of action is chosen
- when a business decision is going to be taken, the concept of opportunity costs means that all possible courses of action have to be considered very carefully
