Friday, February 11, 2022

The principle of 'calculated risk' (updated)

"In carrying out the task assigned .... you will be governed by the principle of calculated risk ... which you shall interpret as avoidance of [risk] exposure ... without good prospect ... as a result of such exposure ...  of greater [benefit]" (*)

Admiral Chester Nimitz
to his subordinate admirals,
Battle of Midway, June, 1942

"You will be governed by the principle of calculated risk"
What does that really mean?

"You will be governed ..." means you've been handed the governance task; there has been a passing of (command) authority and decision-making. Whatever the strategic and most far reaching business and project considerations there are, and whomever has the responsibility for articulating the strategic vision, all that has been compressed into an instruction to "you". "You" have the authority to assess cost and benefit in the moment, and pull the trigger ... so to speak ... to take a risk or not.

"Calculated risk" is intended to convey a defensive tactic to protect a scarce or endangered asset or outcome; unless the loss of that asset begets a larger offsetting advantage. To that end, there are these constituents:

  • First, a risk assessment based upon what it means for the loss of a scarce asset or a debilitating outcome vs the benefit or advantage of a favorable outcome. Call this a cost-benefit analysis and calculation
  • Second, the quality of your knowledge base, assumptions of knowledge accuracy and timeliness, and a heads-up that there may be knowledge gaps. This is really the epistemic component of the risk: how much can the risk be mitigated by better knowledge?
  • Next, doctrine, ideology, or rules-of-thumb are made subordinate to the calculation. Now to walk away from doctrine for a calculated risk takes some intellectual flexibility and maturity, to say nothing of walking out on the limb.
  • If there is an adversary or nemesis, game-theory may be useful to estimate reactions (walk a mile in their shoes, etc .... )
  • And last, if there is no scarcity which requires the protection of a risk calculation, then the principle is unnecessary.

Fair enough

What happens when it comes to actually facing the risk in a real project situation?

  • Intellectual flexibility may be required. 
  • Cool heads will be needed; emotion will be left at the door, hopefully
  • Random effects will almost certainly intervene and perturb the knowledge-base calculations. You probably can't do much about the randomness; that's the nature of the it ... more knowledge doesn't help.
  • Updates to game theory assumptions we be needed along the way.
  • And, revisits to the knowledge base to update the risk calculation (the calculation may be rather dynamic in the doing ...) will be needed. (**) 

Plan B:

In spite of cool calculations, in the heat of the moment managers may blunder through the guardrails. Then what?

There should be a framework for Plan B on the shelf. Facts at the time will fill in the framework.

Ah, but who's in charge of Plan B? 

Someone should always be hanging back to grasp the strategic picture while tacticians deal with the here-and-now. And, that someone should have supreme executive authority to step in and make corrections.


(*) A Naval War College essay dissecting the Nimitz principle of calculated risk is found here.

(**) This idea of revision in the face of new information is the Bayesian approach risk calculations. That is: you have a hypothesis, "A", based on your going-in knowledge; then there's a change or there is observed evidence "B". Now you know more, and so the likelihood changes ("likelihood" being the probability that the observed evidence will support the original hypothesis, P(B/A)


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