1. 2/13/2014 1 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Topic 2 Risk and the Return on Investment Paul D. Collopy Economics Technical Committee

2. 2/13/2014 2 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Two Messages Managers: Embrace Risk –Eliminate unnecessary downside risk –Know what you are signing up for –Use strategies like hedging to improve risk+return Analysts: Dont lose sight of the Fundamentals –E[NPV] is the basic metric (return) –Adjust for risk aversion when > 4% Equity otherwise never trade E[NPV] for

3. 2/13/2014 3 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Risk Mitigation Great idea, if there is no cost –in product performance –in development time Risk free development Sunset Industry Performance > SoA = Technical Risk Everybody lovesbut

4. 2/13/2014 4 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development What is Risk? Risk = Uncertainty 400500600 Risk Combat Range 400500600 Combat Range Low Risk Program

5. 2/13/2014 5 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Military Aerospace Development 05101520 Years Concept Studies Tech Development Dem / Val E & MD Production Entry into Service Careful Risk Mitigation ensures the system will achieve obsolescence and military irrelevance upon entry into service

6. 2/13/2014 6 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Venture Star

7. 2/13/2014 7 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Caveats Choose your Battles Hope for Success / Plan for Failure Do not Bet the Company

8. 2/13/2014 8 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Choose your Battles Risks Interact: ~ 5 Technical Risks can be managed at once Use Spiral Development for more ambitious programs 0 1 Average Probability of Failure Development Cost or Schedule Diseconomy of Scale

9. 2/13/2014 9 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Hope for Success / Plan for Failure Quote expected performance Plan backup designs –Low risk Prepare to take a performance hit There is always next time

10. 2/13/2014 10 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Betting the Company 0% 4% 8% 12% 16% 20% 0%4%8%12%16%20% % of Equity Value / Equity Typical Business Value of Money Neutral Attitude to Risk 16 u$. 0 e $. 1 016 Risks < 4% equity: value = avg. return For Risk = 20% eq. business is strongly risk averse

11. 2/13/2014 11 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Using the Value of Money Curve 0% 4% 8% 12% 16% 20% 0%4%8%12%16%20% % of Equity Value / Equity p 1 - p - 8% + 8% Arbitrary Base Point Downside Upside = 3% Downside =5% Value of deal = 3%p + 5%(1-p) Upside

12. 2/13/2014 12 Engineering & Technology Management Group Engineering Technology Management Tracking the Constant of Change Management History Society Legal Aspects LogisticsSupply Chain Systems Engineering Economics Risk Technical Information Multidiscipline Design Product Development Summary Risk has upside and downside Risk-free designs condemn the industry to mediocrity Good risks need to be managed not mitigated