Forecasting and Management of Technology, Second Edition

10.3 Accounting for Risk and Uncertainty

Thus far, discussions have assumed that the costs and benefits of alternative projects are known with certainty. However, managers never have perfect foresight. At best, they have a somewhat subjective, probabilistic assessment of the likelihood of various outcomes. Obviously, introducing risk can change the choice among alternative projects. For instance, if the expected present values of two projects are equal, the one that is more likely to succeed is preferable. Depending upon the risk preferences of the decision maker, projects with high risk may be rejected in favor of others for which profits will almost surely be lower but losses are unlikely. The following distinction between risk and uncertainty is important:

• Risk: An action can result in more than one outcome with different probabilities of occurrence (e.g., every weather forecaster in town agrees that there is a 50% risk of rain tomorrow).
• Uncertainty: An action can result in more than one outcome, depending on external conditions of unknown probability or for which there is very little confidence in the probability estimate (e.g., one weather forecaster predicts that there is a 50% chance of rain a week from tomorrow).

10.3.1 Accounting for Risk within Organizations

Efforts to implement new technologies involve both risk and uncertainty. If the innovation is a minor change that will lead to lower production costs for an established product, then both the risk and the uncertainty ...