Home > Risk > Let’s talk about assumptions and risk

Let’s talk about assumptions and risk

September 4, 2020 Leave a comment Go to comments

When we make a decision, we normally make a number of assumptions about what we expect to happen.

My view of risk management, or should I say risk management that adds value and helps an organization succeed rather than just avoid failure, is all about what might happen.

Anticipating what might happen, evaluating and assessing it, then taking appropriate actions through informed and intelligent decisions, leads organizations to success.

It helps them take the right risks, considering both upsides and downsides, to achieve enterprise objectives.

An assumption is made when you state that you think this or that will or will not happen. If you are smart, you define what event or situation that is, how it could affect your objective, and your assessment of its likelihood.

In other words, you are assessing a risk (if adverse) or opportunity (if favorable).

A forecast is also an assumption, or at least based on a set of assumptions about what will happen.

What we should do with assumptions is monitor them.

But, as Estell and Grant say in Deciding, not all assumptions are equal.

There are some that are incidental and some that are critical.

Critical assumptions are those that, should they not bear out, mean that your objective will probably not be achieved.

Other things are often documented as assumptions, but the desired outcome is not dependent on them.

Monitor the critical assumptions and be prepared to respond at the first indication that they will not hold up. If you want, you can refer to this as the monitoring of key risk indicators (KRI). But KRI normally refer to things that might happen to hurt you, and you should also be monitoring for things that might help you.

If the assumption is that a new product will be ready for market on June 1st, you need to be prepared to take action not only if readiness is delayed but also if it is early!

Understanding assumptions that have been identified as critical to achieving an objective is essential to effectively managing for success.

Do you agree?

Is this what your organization does?

  1. September 4, 2020 at 11:05 AM

    I’ve seen planning slides that talk about “upside” (opportunity) and “downside” (risk) events/assumptions relative to particular revenue and profit targets. If these events happen, presumably you either beat or miss the target. Sometimes these events are quantified, showing which are more critical than others.

    For example, the sales forecast might include assumptions about how much new business volume will be won supporting a given target revenue figure. If that volume is not won as expected, there is downside risk.

    The CBO also quantifies the impact of certain policy options on the deficit or specific programs. If policy X is implemented, it will have Y effect on the budget deficit. For example, removing the cap on the payroll tax without increasing benefits covers 70% of the social security shortfall (expenses > revenue) for 75 years.

    I like the idea of using these events for identifying KRI.

    I think Drucker’s article “The Theory of the Business” has some good insight for understanding assumptions underlying a business model, and how to test that those assumptions remain valid.

  2. September 4, 2020 at 1:52 PM

    Norman,
    Assumptions are an important aspect of decision-making and it was nice of you to reference the book that Grant Purdy and I published earlier this year (although it is called “Deciding”, not Decisions) for dedicate a whole chapter to this topic.
    However, apart from concurring with you that virtually every decision is based on one or more assumptions and that to have sufficient certainty that the is intended to be delivered by the decision will be achieved, it is necessary to monitor the ongoing validity of the most significant assumptions, I’m afraid I part company with you on several aspects of what you have said in this post.
    For example, the ordinary meaning of assumption (we try in our book to only use words with their ordinary meaning) refers to “something that one believes to be true, but without proof”. Assumptions are not therefore “..[stating] that you think this or that will or will not happen..”. That is a prediction, not an assumption, even though a prediction might or might not be based in part anyway, on assumptions.
    The distinction is pertinent because in order to have sufficient certainty about the outcomes that will be delivered by their decision, all Deciders need to be explicitly aware of their assumptions and the significance of each assumptions in terms of both importance and level of certainty. This also enables practical judgements as to which assumptions to monitor to detect any change that would invalidate the assumption.
    It is very difficult to offer a view about those aspects of your article that are predicated on the word ‘risk’ … for example pairing ‘risk’ and ‘opportunity’ as if they were antonyms or in some other way related. Both Grant and I have previously written in responses to other posts, and also write in an appendix in “Deciding” that the word ‘risk’ has no value in communicating ideas as there is no agreement as to what it means – as, indeed, is evident in today’s post where it is used with several different implied meanings. The same, inevitably, is the case with ‘risk management’.
    ‘Opportunity’ on the other hand has a straightforward meaning (although even it often gets mangled). It refers to a set of circumstances that can be exploited (by making a decision) that will allow an organisation (or an individual) to advance their purpose.

  3. September 4, 2020 at 1:59 PM

    Ooops. Something went wrong with a couple of words in the first two paragraphs of my above comment which might make it a bit hard to follow….for which I apologise. I would be grateful if any readers would read those two paragraphs as follows :

    “Assumptions are an important aspect of decision-making and it was nice of you to reference the book that Grant Purdy and I published earlier this year (although it is called “Deciding”, not Decisions) for we dedicate a whole chapter to this topic.
    However, apart from concurring with you that virtually every decision is based on one or more assumptions and that to have sufficient certainty that the outcome intended to be delivered by the decision will be achieved, it is necessary to monitor the ongoing validity of the most significant assumptions, I’m afraid I part company with you on several aspects of what you have said in this post.

    • Norman Marks
      September 4, 2020 at 2:50 PM

      Roger, thank you for taking the time to respond at length.

      I am afraid we are not in agreement here.

      Assumption vs. prediction is a distinction without meaning.

      Assumptions in a business plan are labeled as that, but could equally (and perhaps more accurately) be labeled as a prediction. It is a prediction that is assumed to be correct. The fact is that business plans have things that are called assumptions and not called predictions.

      There is never any proof that something in the future will happen.

      I know Grant will pick on the fact (as you have) that I have used the word risk, which he knows full well I prefer not to use. It does in fact have a plain English dictionary meaning. I am using it in those plain English ways because people understand it that way.

      I have not said that risk and opportunity are antonyms. You are putting other people’s words into my mouth. I am using both words in the plain English way: a risk is something that might happen that you don’t want, and an opportunity is something that you can seize to gain something you do. They are not antonyms because something can happen with a combination of positive and negative effects that may not occur at the same time.

      These words do have great value because people understand and use their common meanings, if not the way they are used in the frameworks.

      I urge you and others to set aside any four-letter bias and consider the ideas that are presented. What I read in your comment, apart from the argument over words, is that you agree.

      I apologize for getting the name of your book wrong and have changed the post accordingly.

      • Roger Estall
        September 4, 2020 at 7:36 PM

        Hi Norman. Sorry can’t agree that ‘assumption’ and ‘prediction’ are in common parlance, essentially synonymous. If they were, they would be interchangeable but they are not. As I said in my post, assumption means “a thing that is accepted as true or as certain to happen, without proof” whereas a prediction is “a forecast”. Not all assumptions relate to the future whereas predictions are concerned only with the future. As I said, predictions may be based on assumptions. It is important to acknowledge the difference because decisions of any type are inevitably based on assumptions – too often however, unconsciously. By contrast no one makes a prediction unconscious of having done so. It is the output of deliberate thought and analysis.
        I will just touch on another of your other challenges. First the pairing of ‘risk and opportunity’. My difficulty in this is of course, we don’t know what risk means (contrary to your assertion of there being ‘a plain English meaning’, my dictionary – as do most dictionaries – give multiple meanings (5, in my case). However, that aside, your statement ‘In other words, you are assessing a risk (if adverse) or opportunity (if favorable).’ is surely unmistakeable in postulating the two as opposites – distinctively and binarily different.

        • Norman Marks
          September 4, 2020 at 9:04 PM

          Thank you, but I will leave this thread without further comment.

  4. grantpurdy
    September 4, 2020 at 7:03 PM

    Norman,

    One thing I think we would agree is that decisions must take into account the context, or setting of the decision. This is about what is present and exists now, not what might happen in the future.

    But, of course, what you believe about the current situation is an assumption – and this is probably the greatest source of uncertainty in any decision. This is why in our book we emphasise the need for Deciders to hold conversations when they make decisions to ensure they obtain a balanced and full view on context and the assumptions inherent in that.

    One unpleasant little word (other than the ‘r’ one) that you have not mentioned for a while is ‘control’. Skipping over (as the IIA does) whether this is a noun or a verb, all the ‘things’ that risky and audity people might choose the label a ‘control’ are, of course, merely assumptions about the internal context.

    So you see, an assumption is not just about: “when you state that you think this or that will or will not happen”, but is mostly about what exists now and its influence on the decision you are making.

    The upshot to all this is that if we stick to normal words with normal meanings, then we can best help normal people make even better decisions. On the other hand, if we use ‘code’ or ascribe whacky meanings to normal words (because they fit our narrow philosophy or theories) not only do we waste people’s time and energies but we also become largely irrelevant to normal people and decision making and, if anything, hinder it. This latter situation is represented by many belief systems, of which ‘Risk management’ is one.

    • Norman Marks
      September 4, 2020 at 7:05 PM

      I don’t disagree, Grant, although English may vary between UK, US, and Australia. As I think Churchill said of the US and UK: two nations separated by a common language.

  5. Carlo Muzzarelli
    September 5, 2020 at 10:03 AM

    Mr Marks,
    Why do you use “risk” for possible negative outcomes when there is broad consensus among non-financial professionals that risk is as described by ISO31000, PMI and many more organizations?

    • Norman Marks
      September 5, 2020 at 10:12 AM

      Good question, Carlo.

      I try to connect with lay people and also with COSO advocates who see risk as limited to harms. Dictionary definitions and the regulators do as well.

      By adding opportunity to the phrase, so its risk and opportunity, I am able to have a constructive conversation.

      BTW, I am not alone in talking about risk and opportunity (although I prefer talking about ‘what might happen’): the King IV Code of Corporate Governance uses that phrase.

      I don’t know whether you have seen my books, including Risk Management in Plain English.

      • Carlo Muzzarelli
        September 5, 2020 at 10:28 AM

        Thanks for your reply.
        Even if I’m 53, I am a recent fan of yours, thanks to Alexei Sidorenko that always speaks so well about you on LinkedIn and now that I read your materials I believe I struck gold listening to his suggestion.
        I understand your point on plain English, but I’m also convinced that insurances and banks are taking advantage of the negative attached to the word risk and that this is detrimental to the well-being of general population.
        I’m an idealist, I realize that, and. I obviously know that a lot depends upon when and where the words are used but I will review both the code you mention and, as soon as I will find a new employment (been unemployed 7 months) I’ll invest in purchasing your book(s) to improve my knowledge.

        • Norman Marks
          September 5, 2020 at 10:33 AM

          Thank you

  1. September 5, 2020 at 6:40 AM

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