Risk Programming

The other night, I had the opportunity to watch a free webcast titled “Use of @RISK for Probabilistic Decision Analysis of a Manufacturing Forecast in an Environment of High Uncertainty”. This presentation was extremely timely, since many companies are struggling to survive in these challenging economic times. Dr. Jose Briones did an excellent job discussing and illustrating how profitability projections in a manufacturing environment are directly tied to how the sales forecast fits with the capability of the operation, and how different manufacturing capacities and productions rates impact the output of the plant and the allocation of the fixed cost of production.

In the example he presents, a company is trying to decide how best to balance the sales of certain families of products to maximize revenue, maintain a diverse product line, and properly price each individual product based on the impact to the manufacturing schedule and fixed cost allocation.

He spends an appropriate amount of time discussing different input distributions such as the Triangular, Normal, Pert and Gamma distributions as well as sharing his recommendations on when to use them. He also shares his expertise on fixed cost allocation by product and the dangers in using the common method of dividing the fixed cost by the total production, and recommends doing so by allocating the fixed costs based on the projected run time of each product family. Lastly, he spends some time discussing the interpretation of the results, which I feel does a great job wrapping up the information presented in the webcast.
 

Dr. Jose A. Briones is currently the Director of Operations for SpyroTek Performance Solutions, a diversified supplier of specialty materials, BPM software and innovation consulting services. Dr. Briones has a PhD in Chemical Engineering from Clemson University and is a graduate of the Business Administration Program of Wharton Business School. If you have any questions about the webcast, you can contact Jose at Brioneja@SpyroTek.com or through Jameson Romeo-Hall at Palisade Corporation.
 

One of the criticisms leveled at the risk assessment models blamed for many of the recent failures in the finance world is that they allowed too much room for error--that the models themselves were inaccurate.  My argument is that it was not the models but operator error--sloppiness or excessive optimism--in dealing with probabilities.  

Theoretical probability, a branch of mathematics that attempts to reconcile likelihood with random phenomena, is the basis of statistical analysis and other forms of quantitative analysis of large bodies of data.  Most models have to accomplish the same reconciliation. Most Monte Carlo software, for instance, calls for user input of probability functions.  Obviously, the models that result are only as accurate as the probability functions incorporated in them.

There have been questions raised about how appropriately the Wall Street risk analysis models used by hedge funds and banks  accounted for real-world time horizons.  According to at least one commentator, most of these models tried to account for very limited time horizons, weeks instead of years.  Obviously, the shorter the time period a financial organization is exposed to risk, the less probability of a cataclysmic event.  And the probability of the same devastating event occurring over a period of a decade or two is much greater.  Unusual events are just that: they don't occur very often. 

There is no reason why the risk analysis programs that turn out Wall Street's models could not be tweaked to account for longer time periods--unless the person doing the modeling wants--consciously or unconsciously--to develop an irrationally sunny scenario.

Just a couple of months ago when gas cost over $4/gallon, Americans were scrambling maximize their fuel economy and buying hybrid electric vehicles to save money, cut our dependency on foreign oil, and to save the earth. At that time, a very wise friend said, “Wait and see, gas prices will come back down and we (Americans) will forget all about it.” What happened over the next few months is exactly as he predicted. If it were not for the domestic automakers being on the brink of economic collapse, there would not have been any recent talk of innovation, reform, or the need for more efficient automobiles.

As we all know and feel, the gas crunch as been replaced by a much larger and serious worldwide economic down turn that threatens all. There are many speculations to how we got here and even more on how we get out. Lean Six Sigma is a proven methodology to remove waste and variation from our business processes and is receiving a lot of attention to do just that. Many companies are - but many more should - be scrambling to implement a Lean Six Sigma program to save what is left of their businesses. I hope that they will be successful.

Now let’s look ahead 2, 3 maybe 5 years . . . once our economy has stabilized and “returned to normal.” Have the experiences of the past changed us for the better? We will continue to apply sound Lean Six Sigma principles and risk analysis to our business, making them stronger and more efficient. Or will this too fade as a distant memory until the next time?

I do not feel there is not a business or process that would not be benefited by applying the tools  and principles of  Lean Six Sigma in many  aspects of their businesses. Let us use this opportunity as a catalyst for business and government reform and increased efficiencies in order to provide the best products and services for our customers, and to avoid a repeat of the current state of affairs.

Last week, Palisade Corporation held its North American User Conference; it was a very successful event that brought together @RISK Users from around the world. Presentations and discussions touched on topics such as the subprime mortgage crisis, financial risk management, modeling flu, project risk management and of course, the ways to Monte Carlo simulation in Six Sigma.

It was great to see such a high level of interest in the Six Sigma related presentations and buzz they created in both the social networking opportunities as well as the feedback forms that were submitted after the conference.  This shows despite the economic difficulties and the natural tendency to eliminate all unessential spending, Six Sigma and Design for Six Sigma is rightfully viewed as part of the solution.

SigmaFlow’s president Jay Holstine, presented Process Mapping for Knowledge Transfer: Doing More with Less. A very pertinent topic in today’s economic times, which will be presented live as an ISSSP Focused Session on November 25 at 2pm EST. Please join us.

Ed Biernat from Consulting with Impact led a presentation on the use of Six Sigma in Process Industries. If you are interested in viewing his presentation, Lean Six Sigma Applicatin of @RISK Part I, it can be viewed online.  Part II will be live on December 12, 2008 at 1pm EST where he will dive deeply into the use of @RISK in this case study. Please join us.

A recent article, Executives Switch to Survival Mode, in the Wall Street Journal indicates that two of the top issues in crisis management can be managed with a strong Lean Six Sigma program, these were:

• Excellence in Execution – Whether on the shop floor or in administrative processes, there is no longer room for inaccuracies or waste.
• Speed, flexibility and adaptability to change is another area where a strong Six Sigma program mitigates the effects of crisis.