Do You Know the Difference Between Risk Appetite, Risk Tolerance and Risk Threshold?

he Difference Between Risk Appetite, Risk Tolerance and Risk Threshold

If you deal with risk management in projects or in the company, then sooner or later you will encounter the terms Risk Attitude, Risk Appetite, Risk Tolerance and Risk Threshold. Do you know what we are talking about here? No? No problem, you won’t be alone. I’m sure this brief introduction will expand your knowledge. Read on and learn more!

What is Your Risk Attitude?

Organizations and project participants are willing to take risks to varying degrees, depending on their attitude towards risk. This risk attitude is driven by perception, tolerance and other inclinations, which should be clear whenever possible. The behavior with regard to risks reflects a perceived balance in the organization between risk appetite and risk avoidance. Risk attitude can be influenced by a number of factors. According to PMBOK®, these can be divided into the following three topics:

Risk Appetite is the degree of uncertainty that an organization is willing to take in anticipation of a corresponding benefit.

Risk Tolerance is the degree, amount or value of risk that an organization or individual will withstand.

Risk Threshold refers to a specific threshold to which stakeholders express an interest in accepting an uncertainty or impact. Below this risk threshold, the organization will accept the risk; above it, it will not be tolerated.

We don’t encounter these terms every day, and they are most often used in an environment where risk is a daily topic, such as in risk management departments. But if you want to do the PMI PMP certification, for example, you should be familiar with these terms.

Are You Risk-Averse or Risk-Seeking?

When I wrote the first edition of my project risk management book we were in the midst of a major financial crisis in 2008-2010. Things were chaotic in the financial world at the time, and no one knew exactly what was to come. The risks will be big in the future as well and some risks will probably happen. Not only in the financial world but also in the Middle East political risks are looming, the demographic change of our society brings risks even in our latitudes. We often forget that our projects are also carried out in an environment full of uncertainties.

Managers, politicians and project managers must therefore ask themselves, “What should we do in this environment of constant uncertainty?” The answers probably often depend on whether we are still around when something “happens” or whether we have a “after me, the deluge” attitude. But you will agree, most of the time proactive action is better than reacting when something does happen. We must therefore prepare ourselves appropriately for the challenging future. But what does appropriate mean?

Attitudes toward risk vary from person to person. The spectrum ranges from risk-averse (unease with uncertainties) to risk-tolerant (no specific reaction) to risk-seeking (uncertainty is welcomed).

The risk attitude spectrum in Risk Management
The Risk Attitude Spectrum

There are four ways we can adapt to risk as a person or organization:

Risk-averse: Being averse to risks. Uncomfortable with uncertainties. This is where you focus on taking as few risks as possible, avoiding risks and protecting yourself, or preventing risks.

Risk-tolerant: Risk-tolerant organizations are reasonably comfortable with most uncertainties and accept risk as a normal feature of daily life, business and projects. They are rather casual about risk. Risks do not have an obvious or significant impact on their behavior.

Risk-neutral: Risk-neutral organizations are willing to deliberately take reasonable risks for a short period of time in order to generate long-term benefits. This is a clear trade-off between risk and reward.

Risk-seeking: Being willing to take risks. Uncertainty is welcomed. Risks are consciously taken—often in the hope that they will not occur and that the corresponding action will generate large profits.

So which of these risk attitudes is appropriate for projects? Each can make sense, of course, depending on your project goal and the uncertainties and potential opportunities present. On the one hand, our behavior depends on our personal attitude toward risk; on the other hand, the choice is highly dependent on the situation at hand and how we think the uncertainties will affect the defined objectives. Attitudes toward risk have a significant influence on risk management activities. A risk-averse product innovation team is no more good than a risk-seeking nuclear safety inspector.

Risk Appetite – How Hungry Are You?

In the past, the term “risk appetite” was really only used by academics. Since the financial and sovereign debt crisis of 2008, however, we have been confronted with it more often. But what is the difference between “risk appetite” and “risk attitude”? There is often confusion about this and it is not uncommon for them to be used as synonyms. Let’s get away from the risk terminology for a moment. Appetite is an inner desire, a feeling that is hard to measure and manifests as hunger, hunger for food. How can you quantify Appetite? High, Medium, Low or I could devour a horse, or rather just a salad which is a measure of Appetite.

So appetite is something that comes from within. Attitude is something else. Here it is about positioning oneself. Here you have the free choice in which direction you position yourself. If you are on a diet and you are hungry, then you will rather choose a salad.

You can also find more on these topics in the following articles:

What is the Difference Between Uncertainty and Risk?

How to Successfully Manage Reducible and Irreducible Risk.

What Does Resilience in Projects Have to Do With Risk Management?

Here You Can Find More Knowledge

ere You Can Find More KnowledgeWould you like to learn more about how to make your projects more successful with Project Risk Management? My book Project Risk Management – Practical Guide takes you an important step further!

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Posted in Risk Management.