Risk!
Paul Koza
Vistakon – Quality Engineering
Background
Quality Engineer with Vistakon for 5 years
BS in Business from The University of
Tennessee
MS in Mathematical Science from Clemson
University
Experience in transportation, pulp & paper,
plastics, and medical device industries
Risk approaches based upon collective writings
of Peter Bernstein
Why We Do The Things We Do
Risk management Effective decision making
Complex tools
Catastrophic failures and breakdowns
Far-reaching consequences
“You want a valve that doesn’t leak and
you try everything possible to develop
one. But the real world provides you
with a leaky valve. You have to
determine how much leaking you can
tolerate.”
- Arthur Rudolph, Saturn 5 Rocket Scientist
Contemporary Examples
Amtrak derailment in Crescent City
Enron Financial Collapse
Domestic Anti-terrorism Procedures
NFL Draft
New Product Development (R&D)
Product Marketing Strategy
Find a New Job vs. Stay Put
Conflict
Management of a business is a process that
constantly looks into the future.
The future cannot be quantified because it
is unknown.
We can use numbers to quantify past events.
To what degree should we rely on historic
patterns to tell us about the future?
What matters more –
–The facts as we see them
–Our subjective beliefs about what lies hidden in time
Bottom Line
The consequences of the choices we face
should outweigh probabilities of the
outcomes we expect.
Decision makers have free will and make
rational choices even when the future is
uncertain.
A Walk Down Memory Lane
Approach #1 – Blaise Pascal
Pascal spent his life alternating between casinos
and fleshpots followed by intense religious
periods. Religion won in the end. Pascal’s last
days were spent at the monastery of Port-Royal.
Pascal’s Wager –
“God is, or is he not. Which way should we
incline? Reason cannot answer.”
Is an outcome in which ‘God is’ more valuable
than an outcome where ‘God is not’?
Our guess about the probability of God’s
existence doesn’t help – we have no method to
test the hypothesis.
Suppose you act as though God exists and lead a
life of virtue. Suppose you are wrong and God
is not. You’ve passed up some fun, but gained
some other rewards in the process.
Now suppose you act like God is not. You enjoy
life and place ‘me’ above all else. Suppose you
are wrong. You enjoy goodies in your lifetime,
but suffer eternal damnation.
The value of the bet that God is, is infinitely
greater than the value of the bet that God is
not. The probability that God is or God is not is
irrelevant.
Business Application
• Product launch in a new country with a growing
market for this product type.
• Probability of success is high but the market is
competitive.
• Price is dominant variable – product differentiation is
difficult.
• Given interest rate spreads and the exchange market’s
optimistic outlook for this nation’s currency, you see no
need to hedge the foreign currency at this time.
• Do you hedge or not hedge?
Suppose you hedge and you’re wrong: exchange rates are
stable. Although you incur the cost of hedging, you can
still price the product correctly for the market,
regardless of the exchange rate.
Suppose you agree with the optimistic exchange market
and don’t hedge. But the currency depreciates and
surprises the market. You will receive fewer $ for each
unit sold in a market where raising the local currency
price by even a little will put you out of business.
You cannot afford to make this bet. The consequences of
being wrong are too serious. Regardless of the
exchange rates or the probabilities, maintaining a
competitive local price is the single most important
element in success.
Approach #2 – Jacob Bernoulli
The Bernoulli family was extraordinarily talented
but also mean and nasty – even with one
another. When one family member and his son
competed for the same prize from the French
Academy of Sciences for work on planetary
orbits, and the son won, the father was so
infuriated that he threw his son out of the
house.
Death and Taxes
In a letter from Jacob Bernoulli to Gottfreid von
Leibniz in 1703, Bernoulli wrote, “It is strange
that we know the odds of throwing a seven
instead of an eight with a pair of dice, but we
do not know the probability that a man of 20
will outlive a man of 60.” Bernoulli wanted to
conduct an experiment where he would
compare a large number of pairs of men of
various ages to see if he could deduce the
probabilities from that evidence.
Leibniz was not impressed. He replied to Bernoulli,
“Nature has established patterns originating in the
turn of events, but only for the most part.”
We can never escape uncertainty. No mathematical
model works perfectly. Statisticians are satisfied
when a model works with only 5% probability that
its results are due to chance. But that still leaves
5% that we do not understand, cannot model, and
can cause all kinds of mischief if we mechanically
make decisions based on the model. No event is
without cause. Assigning a probability to chance is
the same as assigning a number to ignorance.
Patterns repeat themselves only for the
most part. Use risk management tools
and the art of survival when forecasts
about the unknown future turn out to be
wrong.
In the earlier example, the currency did
depreciate, even though the probabilities
were against it. The other part matters
every bit as much as the most part.
Approach #3 – Stephen Jay Gould
Gould is an American evolutionary biologist. He was
informed in his twenties that he suffered from
mesothelioma, a deadly form of cancer. The median
life expectancy was eight months. Gould faced this
diagnosis from his training in Darwinian evolution – a
reality in which causes have effects but the variety of
possible effects from any given cause is limitless.
Consequently, the effects are not entirely predictable.
“Variation stands as the fundamental reality and
calculated averages become abstractions.”
Focusing on the
mean ignores the
events in the tails
0 mo
8 mo
Infinity
Life Expectancy
All of us depend too much on measures of central
tendency – we focus on the hole rather than the
donut. Our decisions are based on trends,
correlation coefficients, normal distributions,
and above all the mean.
The essence of risk management is the recognition
of variation. Losses do not stem from average
results but rather from deviations from the
mean – the outliers of distributions.
Simplification lures us into a trap - it is
impossible without measures of central
tendency.
Gould’s Darwinian models argues that
diversity in nature is so great and every
event could lead to a large variety of
outcomes that there is no such thing in
nature that we can identify as the norm.
In risk management, normal is not a state
of nature but a state of transition and
trend is not destiny.
The positive message here is that variety is the
spice of life. Take away variety and nothing
remains but averages with zero standard
deviations and targets always on the mark.
Remove variety and we remove uncertainty.
Variety is the essence of survival. All ships don’t
skink together, all stocks don’t go up or down
at the same time, different assets have different
cyclical patterns.
Without variation, life would not only be boring,
but life would be risky. Variation makes risk
management possible. It means that there is
more than one basket in which to carry eggs.
Therefore, society is willing to assume more
risk if there are additional baskets.
Risk Management Tools
Failure Modes and Effect Analysis (FMEA)
Fault Tree Analysis
Quality Function Deployment (QFD) –
House of Quality
Failure Mode
Fail to Intent
Effect
Root Cause
Consequence
Analysis
Mitigation
Risk Assessment
Action Plans
Results
Continuous Improvement
Scope and Objective
•
•
•
•
Design Control
Risk Assessment
Risk Management
Trouble Shooting (Fault Finder)
Top Down
Failure Mode
Type 1: Failure to perform specified
function
Type 2: Something you don’t want –
something that is not supposed to be
there
Cause
Man
Machine
Method
Material
Environment
Effect
Effect means consequence or impact
• Immediate Consequence
• Consequence of the consequence
• Consequence of the consequence of the
consequence
• Cumulated Consequence = ∫Consequencen
Effect
Product
Local Effect
Process
Local Effects
Immediate effect – effect on
reviewed item or local area
Immediate effect – effect on
local process area
Next High Level Effect
Downstream Process Effects
Effects on surrounding parts
or next high level subassembly, or all effects between
local and end product
End Effect
Effect on system, or effect on
end product user
Effect on downstream process is
we cannot correct the situation
immediately and stop the
problems
End Effect
Effect on entire system or end
product user
Mitigation
Mitigation means: What are you going to
do about the situation?
1st Line of Defense
Avoid or eliminate failure causes
2nd Line of Defense
Identify or detect the failure earlier
3rd Line of Defense
Reduce the impacts/consequences of
failure
Risk Assessment
Occurrence
The likelihood that a failure occurs by a specified
cause under current control
Severity
The impact(s) of failure
Detection
How early and effectively can we detect and
correct the failure
Risk Priority Number (RPN)
The compounds of Occurrence, Severity, and
Detection
Reaction Plan
Are you satisfied with the situation? If not, do something
– mitigate again!
1.
2.
3.
How can I prove it to myself that I don’t have the problem?
Test plan – how good is this test plan? Can I find and correct
the situation? (Second line of defense)
Can I avoid it totally?
First line of defense
You bought the farm – How can I control the damage?
Third line of defense
Responsible Party
Who is going to take action?
When can they complete it?
Types of FMEA’s
• Product FMEA – also called Design FMEA
(dFMEA)
• Process FMEA – also called Manufacturing FMEA
(pFMEA)
• Application FMEA – also called User FMEA
(aFMEA)
• Supplier Quality FMEA – also called Material
FMEA (mFEMA)
• Service FMEA – also called Preventive
Maintenance FMEA (sFMEA)
• Equipment FMEA
Bottom-Up Approach
Residential Internal Painting System
Primer
Additives/Filler
Adhesive
Coating
Color Pigment Vehicle/Carrier
Resin
Top-Down Approach
Example – Paint
• Homogeneous coverage for background
• Compatible with coating and surface
• Environmental resistance (5 years)
• Easy to apply
• Quick to dry
• Color appearance (opaque)
Common Mistakes and Traps
“Fill in the blanks” only.
Don’t understand the scope and objective of FMEA
Day dreaming
Didn’t go through the self-challenge process of design
control
Couldn’t separate Failure Mode, Cause, Effect
Mixed everything together. Argument for the sake of
argument.
Common Mistakes and Traps
Repeated itself
Dog chases its own tail.
Mitigation is not truly challenged
Ranking criteria too loose
Only identifying the problems but not the solutions. Or,
couldn’t control it, even if there is a solution. Control
plan not in place.
Do once, then keep in file
Leaving Document rather than Living Document
Lack of consistency
Thank you