Biasing, censoring and confusion in risk approaches

This conversation between a client and Riskope illustrates common biasing, censoring and confusion in risk approaches.

We always warn our clients against biasing, censoring to avoid corporate blunders and make them aware of common practice costly confusion. We hope this example will help fostering good understanding of some issues.

An interesting conversation with a agro-industrial client

During a kick-off discussion with an agro-industrial client interested in risk management, they stated: “As to the risk management issue, we will focus on the three major risks which challenge our agro-industrial business, i.e. pricing, foreign currency and credit control.”

At Riskope, we are accustomed to this type of statements, common when a client looks for the first time to risk management. In this case:

• arbitrary censoring reality to three “risks”,
• biasing by considering them as major without any proof of it, and finally
• confusing risks and hazards.

Biasing, censoring and confusion in risk approaches

Calling risks the hazards lurking on their businesses is a very common mistake clients make. It may seem we are splitting hair in four, but experience shows this a source of:

• major blunders in risk management,
• misallocation of funds, and finally
• waste of capital and management time.

Indeed pricing (variations), currency (swings) and credit (rules) are hazards.

They all have a certain likelihood of going out of the “business as usual” range. The same occurs, for example with rain. It is a hazard, but only once it goes out of the “business as usual” range. Once hazards get to a magnitude beyond “business as usual”, they have a certain chance of generating (unpleasant) multidimensional consequences. By multidimensional we mean for example a hazard could bring simultaneously a reputation and financial hit. Risks are evaluated once both the hazard and its consequences are simultaneously taken into account. By the way, when a hazard gets to “unbelievable” magnitude, hopefully with a very low probability, contracts generally foresee invoking Force Majeure clauses.

One can find “hazard specialists” that know their respective hazard subject matter.

However those individuals will neither be able to perform a proper risk assessment nor to deliver a risk prioritization, simply because that’s not their job. Past experience has shown they will be great a estimating probabilities and magnitudes but likely will not know how to measure multidimensional interdependent consequences. A proper risk assessment should have a horizontal overview of all the hazards and all their consequences. It is the deed of a risk specialist, not of a hazard specialist.

Back to our clients and as a proof of the above, they seemed to forget at least one hazard their business is exposed to, as they do not own, or 100% control, their production sites. That’s another classic mistake managers make, i.e. censoring and biasing their approach by refusing to start with a proper holistic approach.

Working with hazard specialists

Obviously, in order to serve this client we will need to seek pricing/currency/credit hazard specialists. They will deliver the data we need to present the client an unbiased holistic view of his risks. The assessment will include an evaluation of the uncertainties on the hazards and the potential consequences.

Finally, the prioritization of the risks will include those uncertainties. But more importantly biases or censoring will not taint the risk assessment. Additionally it will most certainly include some hazards the client is not thinking about, such as for example land ownership, climate change, etc.

Closing remarks

In conclusions, we could certainly help this client well beyond what he can imagine, using the support of hazard specialists we will liaise with.

We know by experience that clients need specific risk management support in order to avoid money squandering and corporate blunders.

Tagged with: Biasing, censoring

Category: Consequences, Risk analysis