ACCA F5: Chapter 6 - Risk and Uncertainty

1 Introduction - The process of understanding and managing the risks that an organisation is inevitably subject to. - Risk: there are a number of possible outcomes and the probability of each outcome is known - Uncertainty: there are a number of possible outcomes but the probability of each outcome is not known

2 The use of research techniques to reduce uncertainty 1) Desk research (secondary research) 2) Field research (primary research). This includes: motivational and measurement research 3) Focus groups

2 The use of research techniques to reduce uncertainty 1) - The information is collected from secondary sources - It obtains existing data by studying published and other available sources of information. For example, press articles, published accounts, census information - It can often eliminate the need for extensive field work 2) - It may not be exactly what the researcher wants and may not be totally up to date or accurate - However, it is quicker and cheaper than field research

2 The use of research techniques to reduce uncertainty 1) Economic intelligence - information relating to economic environment within which a company operates. Concerned with gross national product (GNP), investment, expenditure, population, employment, productivity and trade. Provides organisation with a picture of past & future trends in environment and an indication of the company’s position in economy as a whole. Information is freely available from sources such as government ministries, the nationalised industries, universities and organisations such as the OECD. 2) Market intelligence - information about company’s present/possible future markets. Both commercial and technical, e.g. sales of competitors’ products recorded by the Business Monitor or Census of Production; product range offered by existing/potential competitors; number of outlets forming the distribution network for a company’s products; structure network by size, location and relation to end user; best overseas markets for a company. 3) Internal company data - most neglected source of marketing information. Companies record their sales information for accountancy purposes or for management of the sales force. Many companies, especially blue-chips/public services, can often be seen to produce reams of data for no apparent reason, or because 'we always have done'. Rarely is the information collected in a form in which it can readily be used by marketing management.

2 The use of research techniques to reduce uncertainty - Information is collected from primary sources by direct contact with a targeted group - Although it is more expensive and time consuming than desk research the results should be more accurate, relevant and up to date - Motivational research and measurement research

2 The use of research techniques to reduce uncertainty 1) to understand factors that influence why consumers do or do not buy particular products 2) - Depth interviewing – trained person who is able to appreciate conscious and unconscious associations and motivations and their significance - Group interviewing – between six and ten people are asked to consider the relevant subject (object) under trained supervision. - Word association testing –given a word by the interviewer, the first word that comes into the mind of the person being tested is noted - Triad testing – people are asked which out of three items they prefer. If three are brands of a given type of product (or three similar types), replies may show a great deal about which features of a product most influence the buying decision

2 The use of research techniques to reduce uncertainty 1) To build on the motivation research by trying to quantify the issues involved. Sample surveys find out how many people buy the product, quantity type of buyer purchases, where/when the product is bought 2) - Random sampling– each person in the target population has an equal chance of being selected. Samples likely to be representative - predictions more reliable. The technique may be unfeasible in practice. - Quota sampling– designed to be representative with respect to pre-selected criteria. Main disadvantage samples may still be biased for non-selected criteria - Panelling– sample is kept for subsequent investigations, trends are easier to spot. - Surveying by post– the mail shot method. Sample becomes self-selecting and so may be biased. - Observation– e.g. through the use of cameras within supermarkets to examine how long customers spend on reading the nutritional information on food packaging.

2 The use of research techniques to reduce uncertainty Common market research tool involving small groups (8-10 people) selected from broader population. Group interviewed through facilitator-led discussions in an informal environment to gather opinions/reactions to a particular subject.

2 The use of research techniques to reduce uncertainty - Results are qualitative - Small sample size means results may not be representative - Individuals may feel under pressure to agree with other members or to give a 'right' answer - Cost and logistical complexity is frequently cited as a barrier, especially for smaller companies. On-line focus groups are becoming more popular and help to address this issue.

4 Simulation Modelling technique that shows the effect of more than one variable changing at the same time. Often used in capital investment appraisal.

4 Simulation - Uses random numbers and probability statistics. Can include all random events that might affect the success/failure of a proposed project( eg changes in material prices, labour rates, market size, selling price, investment costs or inflation.) - Identifies key variables in a decision. Random numbers are assigned to each variable in a proportion in accordance with the underlying probability distribution. e.g if the most likely outcomes are thought to have a 50% probability, optimistic outcomes a 30% probability and pessimistic outcomes a 20% probability, random numbers, representing those attributes, can be assigned to costs and revenues in those proportions. - powerful computer is then used to repeat the decision many times and give management a view of the likely range and level of outcomes. Depending on the management's attitude to risk, a more informed decision can be taken. - This helps to model one-off decision using many possible repetitions. It is only of any real value if the underlying probability distribution can be estimated with some degree of confidence.

4 Simulation - It is not a technique for making a decision, only for obtaining more information about the possible outcomes - Models can become extremely complex. - The time and costs involved in their construction can be more than is gained from the improved decisions - Probability distributions may be difficult to formulate

5 Expected values (EVs) - a weighted average of all possible outcomes - It is calculated by multiplying the value of each possible outcome (x), by the probability of that outcome (p), and summing the results - EV = Σpx

5 Expected values (EVs) - Takes risk into account by considering the probability of each possible outcome and using this information to calculate an expected value. - The information is reduced to a single number resulting in easier decisions - Calculations are relatively simple

5 Expected values (EVs) - The probabilities used are usually very subjective - The EV is merely a weighted average and therefore has little meaning for a one-off project - The EV gives no indication of the dispersion of possible outcomes about the EV, i.e. the risk. - The EV may not correspond to any of the actual possible outcomes