What is Risk-Reward Analysis?
A very useful technique to assess and evaluate different courses of action (options) is to perform a Risk-Reward Analysis.
This can be achieved by constructing a simple 3x3 matrix of each possible option with the XY axes showing:
- Risk associated with the option (high, medium or low)
- Costs associated with the option (high, medium or low)
Options in the top right part side of the diagram are “High Risk – High Cost” which makes them less attractive. Options in the bottom left part of the diagram are “Low Risk – Low Cost” which makes them more attractive.
When you consider Risks there are two key dimensions which you need to consider in reaching a judgement of “High” Risk - Impact and Likelihood. For more on this see our Risk Mapping Tool.
When you consider Costs there are two key dimensions which you need to consider in reaching a judgement of “High” Cost - on-going costs (OPEX) and once-off costs (CAPEX). Under on-going costs you might also wish to differentiate between Internal and External costs.
However you do not yet have enough information to decide between these options.
The third dimension of the diagram is “Rewards” (or Benefits or Value) associated with each option. This is also high, medium or low.
As part of the analysis you should, of course, agree what you mean by “High, Medium and Low” for Risk, Costs and Rewards.
To decide on the best option you should focus initially only on those options with High Rewards - otherwise why would you do them?
Then for the group of High Rewards options try and find those with the lowest combination of risk and cost depending on which of these two aspects is more important to you.
If you cannot find a suitable High Reward option with the Risk/Cost profile you like then you should turn your attention to the Medium reward options.
It is also important than you assess “Do nothing” alongside any other proactive options as this establishes your baseline and in some cases may be the best decision.
For more on Risk and Reward see: A Systematic Guide to Project Management.
OR if you need help using this tool please contact us.