Comparing Projects by Using Riskope’s CDA/ESM (Comparative Decision Analysis/ Economic Safety Margin)

Comparing Projects by Using Riskope’s CDA/ESM (Comparative Decision Analysis/ Economic Safety Margin)

Jul 17th, 2009


The aim of the CDA/ESM methodology is to enable communities, governments, design groups, corporations etc. to compare and evaluate projects in a transparent and objective way.

The ultimate goal is of course to limit the chances of poor decisions, ruinous choices and industrial fiascoes when comparing projects or alternatives.

Projects whose comparison/evaluation is amenable to the proposed methodology include, but are not limited to:

  • Industrial processes (including information, IT & IP protection etc.)
  • Civil infrastructure (buildings underground, above ground)
  • Transport infrastructures (railroads, highways, airports, harbors etc.)
  • Linear facilities (power lines, pipelines, channels etc.)
  • Civil protection work (tsunamis, typhoons, earthquakes, avalanches, rockfalls etc.)
  • Natural resources (mining (open pits and underground), oil, gas, hydro, forest etc.)
  • Environmental protection (clean-up, rehabilitation, restoration, reclamation, encapsulation, decontamination, demining, dumping, waste management, recycling etc.)
  • Terrorism and criminality, including Information Warfare (IW).

A Brief Review of Alternative Comparison Methods

Comparing Projects risks Using Riskope's CDA/ESM

Figure 1. For each analysis: min, max, average of the cumulative cost at fourty years

Various ways of comparing projects have been proposed in the past in various industries and environments at strategic or tactical level.

At strategic level, sophisticated methods that use the so called “utility functions” (UF) can be applied to compare alternatives and projects. It has been argued the use of UFs may be more appropriate than the use of monetary values when comparing alternatives at strategic level. Modern UF methodologies encompass options identification, outcome identification, likelihood evaluation, value evaluation and probabilistic calculations to estimate the UF of each alternative. Other more appropriate strategic level approaches encompass specific tools to be used in identifying objectives, including wish lists and goals, constraints and guidelines leading to a value focused judgment and generation of possible paths.

However, economic factors, capital expenditures and other “money” considerations remains a factor of choice in most business decisions, even at strategic level and most certainly at tactical level. Tactical level decisions are often driven by comparison of expected financial performances, balance sheet forecasts, and “generalized cost”. Generally, however, discount cash methods such as the Net Present Value (NPV) are used.

When using NPV, some authors have proposed to add to the annual cost of a facility (or project, or operation) its annual “risk cost”. However, this type of analyses developed deterministically, only in terms of expected cost, may result in severe errors and poor decisions. That happens because that procedure cannot fully capture failure effects related to loss of life, environmental attributes, criminal sanctions, or the corporate future. These results can indeed at best be evaluated as widely scattered stochastic variables, and reasonable estimates of their compounded effect can only be achieved if these scatters are taken into account.

Comparing Alternatives with CDA/ESM

In order to solve the problem posed by the approaches discussed above more sophisticated techniques have recently been introduced. These modern techniques allow the probabilistic determination of the costs and risk costs of complex facilities, but are too detailed to be applied at a preliminary level.

Riskope‘s CDA/ESM methodology stems out of the modern probabilistic techniques and is geared towards allowing comparison of projects at tactical level, in a simplified preliminary way, and still capture the uncertainties and stochastic aspects of reality along the life span of each alternative.
With the CDA/ESM, the evaluation of projects is carried out by evaluating their Economic Safety Margin (ESM). As the ESM includes life long expected gains, implementation costs and total risks, the proposed methodology encompasses and requires a simplified and preliminary Life Cycle Risk Assessment for Projects (LCRAP).

Like for structural reliability, a large safety margin indicates a strong and robust application. Like for structural reliability, ESM has to be evaluated in probabilistic terms, as all its terms are indeed stochastic, and the probability of the ESM<0 indicates the probability of economic failure of the project.

This approach significantly differs from a classic “provisional balance sheet” approach because risks and uncertainties are explicitly taken into account, as well as the stochastic nature of the costs.

Example of CDA/ESM Use

Let’s examine two alternative for the protection of a railroad segment in the Canadian Rockies. This example is oversimplified and only the expected values are discussed (albeit the method used is fully probabilistic).

Alternative 1: Rockfall Protection Net

In order to protect the railroad from rock-falls a net system is foreseen (life span 20years) at a cost of 200,000$.
A derailment could cost 2M$ in that area, and the yearly probability of occurrence has been defined by geological and rock mechanics studies.
The average ESM of this alternative is evaluated at +1.7M$ over the life span of the rock-fall net system after taking into account the expected return (i.e. the avoidance of derailments) and all the risks of the alternative, from cradle to grave. Desoite the uncertainties and scatter of all the driving paramters of this analysis such large expected ESM means that the probability of a financial fiasco of this alternative is low.

Alternative 2: Rockfall Protection Shed

The construction of a shed to cover the same segment is evaluated at 2M$ with identical derailment potential consequences and cradle to grave risks pertinent with this alternative.
With an yearly probability of occurrence of a rock-fall identical to the one of Alternative 1 the ESM is evaluated at -480,000$, indicating an extreme likelihood of a financial fiasco of this alternative

Comparison Between The Net And The Shed

Quite obviously the Net System is to be preferred to the Shed, as the ESM of the net is widely positive, whereas the ESM of the shed is almost half a million negative.

Before making the final decision, however the following conditions should be considered:

Condition 1:
Is it possible that the expected return was underestimated by as much as half a million? In other words: are there reasons to believe that a 2.5M$ derailment is possible? Or: can we imagine that the yearly probability was grossly underestimated?
Condition 2:
Is it possible that the magnitude of the expected rockfall was severely underestimated and therefore the risks are way larger than estimated?

The brief discussion above illustrate how CDA/ESM can actually help transparent and easy discussions also in the case of public interest cases, when painful decisions have to be taken in full transparency with respect to various stakeholders.

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Category: Crisis management, Hazard, Risk analysis, Risk management, Tolerance/Acceptability

2 responses to “Comparing Projects by Using Riskope’s CDA/ESM (Comparative Decision Analysis/ Economic Safety Margin)”

  1. […] be deemed negligent only if Mitigative moneys spent (per annum) are less than the annualized risks. Clearly transparency and rationality constitute a strong a priori defence in case something would go […]

  2. […] be deemed negligent only if Mitigative moneys spent (per annum) are less than the annualized risks. Clearly transparency and rationality constitute a strong a priori defence in case something would go […]

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