Risk, Value, Finance and Decision Making
The concepts of risk, value, finance, and decision-making can be found in many sections of the ISO 55000 standard. An organization must define and understand the risks it might be exposed to and agree on its tolerance level for these risks. Assets are acquired and operated to create value, so each organization must define what “value” means, both in financial terms but also in less tangible terms, such as levels of service, reputation, environmental stewardship, etc.
Both risk and value are key concepts because they drive decision making. The risk of an asset failing and the value generated by an asset are related: if an asset fails, it cannot generate value and can trigger negative effects such as repair costs, damages to corporate reputation, or even human loss of life. An asset failure risk is therefore a potential negative value. This explains why many investment decisions are driven by risk avoidance.
Organizations also invest to improve operational efficiency, expand production capacity, adopt new technologies, and many other reasons—most of which will allow an organization to generate more value from its assets. Since the organization’s financial and human resources are limited, it cannot undertake all the projects it has in mind—which means difficult trade-off decisions must be made. To make the best possible decisions, it’s important to compare the value and costs of every project. This is why modern asset management calls for the development of a value framework, allowing organizations to evaluate all potential benefits (risk mitigation, efficiency improvements, capacity increases, enhanced customer satisfaction, environmental improvements, etc.) on a common economic scale.
Value Frameworks
Increasingly, organizations are monetizing all risks and value elements, meaning that a financial weight is attached to every element of the value framework. Some metrics are easy to monetize: an improvement in production efficiency can be measured in dollars per hour quite simply. Other metrics might be more difficult: customer satisfaction for instance can be a blend of financial and less tangible elements. Thankfully, there is a growing list of references and models already used by similar organizations that can help you quickly quantify most value measures. The diagram in this brochure highlights a variety of measures that can be incorporated in a value framework to ensure investment decisions support your organization’s Environmental, Social, Governance (ESG) and financial goals.
It’s important to quantify all measures because any project can impact many value measures. For instance, replacing a hydropower turbine with a newer model might improve its efficiency, reduce noise levels, require less maintenance, produce more stable power, etc. The same is true for risks: if the turbine fails, it will lead to a loss of revenue, it might affect the flow of the river and create environmental issues, it could force the power distribution company to buy more expensive electricity elsewhere, and it might harm workers near the asset at the time of the failure. If an organization wants to determine which projects have the highest value, it should take into consideration all these factors and ensure they are properly quantified on a common scale so that all projects can be properly compared.
Investment Portfolios
The most difficult decisions in asset management are generally related to investments—where large amounts of money and labor are in play, such as the refurbishment or replacement of existing assets, or the acquisition of new assets. Best practice tells us to group such investments in portfolios and to use rigorous criteria to establish which investments should be approved by comparing the value each project brings to the organization. Many organizations use “cut line” techniques to determine which projects to fund: rank the projects by value, then start adding up the costs of the projects while going down the list and stop when all money available has been allocated. This is a very basic technique which generally is not the most efficient use of money or resources .
Better techniques are available to help asset managers solve this challenge. They fall into the category of multi-criteria decision analysis and are used in the more advanced Asset Investment Planning and Management (AIPM) solutions. Such solutions take into consideration multiple strategic objectives and constraints, and determine which projects will deliver the highest possible value to the organization while honoring all targets and constraints (financial, resources, risk tolerances, timing, dependencies, etc.).
Stay tuned for my next article, where we’ll dive into AIPM, a strategic asset management practice that helps organizations focus their available resources on doing the right things at the right time.
Check out Boudewijn’s series to learn more about the core concepts of ISO 55000.