Know your unknown-unknowns

For capital project risk, there are no unknown-unknowns; there are only the risks that we decided didn't matter. I have been involved in project benchmarking and reviews for 25 years, and have never seen a risk or uncertainty that did not occur before (although the flavor may change). What I have seen all too often is that projects fail with the cause being ascribed to unknown-unknowns or black swans. What would we do without those precious scapegoats! E.g., escalation, labor shortages, supply chain disruption (which is what Covid was for labor), weather, etc. AACE International has been working hard for the last decade to document a toolbox of QRA tools to address ALL risks (re: see PGD-02 in the AACE website). I am not going to get into that toolbox in this article, nor how to identify and quantify each type of uncertainty and risk. But I want to focus on is one common practice where risk practitioners everywhere are deciding to ignore most risks that drive project cost and schedule failure.

That practice comes from use of the lowly risk matrix. We all know its weaknesses, and that it is certainly useless for direct quantification. But as a practical way to screen and prioritize risks for treatment, it is a fact of life everywhere in the project world. The weakness (among many) I want to focus on here is the fact that low probability risks, regardless of the potential impact, are almost always being rated as not worthy of much if any attention or treatment action, nor are they quantified.

The figure above shows a typical case with the "red" risks tucked neatly into the upper right corner (high impact, high probability). But at least for AACE, "red" impact (aka critical) means that if the risk occurs it will result in cost or schedule failure (e.g., IRR no longer meets threshold, etc.) Most company policies mandate that teams mitigate red risks to the fullest extent. On the other end, "green" risks are usually just accepted. However, the logic breaks down when P*I is applied to HILPs (high impact, low probability risks). By multiplying P*I, we, by design, tell ourselves that HILPs are risks that do not matter. We render the knowns into unknowns (e.g., the figure from an actual project team shows a near disaster, low probability risk rated as "green" - really?).

When I do QRAs for projects, ALL critical cost or schedule impact risks, regardless of probability (i.e., the whole top row in the figure), get quantified for management awareness and funding decisions. Quantified in full, one-by-one, not reduced by probability. The usual funding mechanism that I recommended is to establish specific management reserves on top of general management reserves for risk aversion/tolerance purposes. Every large project I analyze (or have seen in benchmarking) has one or more HILPs. When there are many, one can fund one and usually have prudent reserve for whichever risk does occur (if you have 7 HILPs of 10% probability each, that is about 50% chance one will occur). Remember; even one HILP = failure! Again, there are no unknown-unknowns or black swans for capital projects; there are only the risks we choose to ignore.