Part 2. MM4XL Tools > 1. Strategic Tools > Risk Analyst > Introduction to Decision Analysis

Risk Analyst

Introduction to Decision Analysis

Risk scenarios are representations of real issues that takes into account the uncertainty involved in the events. Scenarios can be reused over time, and they can answer one or more questions.

An illuminating article concerning the promising future of simulation techniques written by Rob Norton for Fortune magazine in 1994 reports the words of Judy Lewent, Chief Financial Officer of Merck Pharmaceuticals, who commented on the utility of scenario building and simulation techniques at the time Merck was deciding whether to acquire Medco for $6.6 billions. She said:

Monte Carlo techniques are a very, very powerful tool to get a more intelligent look at a range of outcomes. It is almost never useful in this kind of environment to build a single bullet forecast.

A typical scenario many managers build one or more times a year is a profitability statement. Such a model is often built to estimate a Net Present Value (NPV), and it uses information that is not always obvious or univocal. For instance, how many new competitors will enter the market in the next 24 months? How will the market size change? What will our market share be? And so on. These are questions every manager could give a rough answer to, but in general they are difficult questions to answer with absolute certainty. Therefore, why should decision-makers rely on a single-bullet model that cannot account for uncertainty?

During the past two decades this question has been approached by a number of economists, and the result is the growing application of modeling techniques able to account for the uncertainty governing most scenarios, including those relating to business activities. Launching new products, optimizing processes, estimating future outcomes, finding optimal solutions, evaluating costs, scheduling operations, and more can be approached from a completely new perspective that puts the whole decisional team and its individual members in the position of thoroughly understanding the nature of managerial problems, explaining why one solution may be better than another, and showing how an action today can affect results tomorrow.

Building successful models is not an easy task, but with practice you will find that modeling will become a very rewarding activity, both in terms of your professional growth as a manager and of the wealth of the business you work in.
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