The element of uncertainty can be considered in almost every area of human activity. In fact, this is the environment in which various relations are formed, and economic activity also proceeds.
Uncertainty is an integral characteristic of real business conditions. After all, an entrepreneur, in spite of his experience and professionalism, cannot influence every really existing socio-economic process or foresee absolutely all possible situations accompanying the adoption of his decisions and their implementation.
The concept of uncertainty and risk
Thinking about entrepreneurial activity, about the organization of a company, company or private business, a person should understand that economic uncertainty will always be his main companion. Its manifestations are especially noticeable in the process of making important decisions, when the entrepreneur collects and analyzes the information available to him. This concept illustrates the limited capabilities of the leader, because you cannot get complete information about the studied object or situation. The entrepreneur has to be content with the data that is available to him, and make decisions based on the available facts.
As a result, at the implementation stage, the project may experience the impact of unforeseen factors, that is, there is a real risk that threatens its successful implementation.
Since uncertainty is an unrecoverable environment for economic activity, it should be noted that the value of risk cannot be zero. For the same reason, one cannot speak of absolute certainty in the implementation of the selected solutions: any goal is not realized to one degree or another.
Why does uncertainty arise
Speaking about its sources, first of all, it should be mentioned the incompleteness and insufficiency of human knowledge relating to the world around us in general and the economic sphere in particular. Such uncertainty is the oldest and formidable opponent of the entrepreneur, since ignorance of the laws of nature has long been a serious obstacle to the conduct of production activities and the economy.
Another source is the phenomenon of chance. This is the name of events whose course cannot be predicted, since under the same conditions they can occur in different ways. Planning each situation is not possible. Sharp equipment breakdowns, sudden fluctuations in product demand indicators, and unpredictable supply problems are recognized as accidental.
The third reason influencing the conditions of uncertainty is opposition. It manifests itself when suppliers violate contractual obligations, there is uncertainty in the demand for the product, and there are also difficulties in marketing it.
The difference between the terms “uncertainty” and “risk”
Despite the apparent similarity of these concepts, each of them determines a very specific situation.
The essence of the uncertainty is that a person does not have enough information about what may happen in the future. Risk is also ignorance of upcoming events, but the existence of the possibility of predicting the onset of a particular outcome.
Uncertainty cannot be measured, while risk is a measurable quantity, a quantitative measure of which is called the probability of a favorable or unfavorable outcome.
Types of uncertainty and their features
There are two main types of this concept:
- External (exogenous).
- Internal (endogenous).
External sources of uncertainty cannot be reduced by any economic system, since they do not depend on it (consumer preferences, technological development in this area, weather conditions). However, entrepreneurs can mitigate their consequences by resorting to insurance.
Internal uncertainty manifests itself as a factor of uncertainty when the buyer evaluates the purchase volume or as a lack of clarity regarding the conclusion of a transaction between partners. Entrepreneurial uncertainty also falls into this category (arises when there are several alternative options). This situation can be corrected by a managerial employee or the manager himself.
In addition to the above, there are also several synthetic types, they combine the signs of endogenous and exogenous types.
Examples of different types of uncertainty
The difference between external economic uncertainty and internal uncertainty is the fact that certain external forces exert not just influence, but even pressure on the economic agent making the decision. He cannot resist them and is forced to build his activities in the light of new conditions. In conditions of internal uncertainty, the decisive decisive role belongs to the economic agent, and he makes the final decision. Normal economic activity is affected by both types.
A good example of the exogenous and endogenous uncertainties, as well as their differences from each other, is the dam. Being built by man, it is exposed to elemental and natural forces.
Dam destruction can occur if the designer made a mistake during the design process, there was a marriage in the materials or negligence of the workers (endogenous uncertainty). Along with this, the structure may suffer from a storm (exogenous uncertainty).
The person managing the project leads the construction process, focusing on endogenous (proper selection of personnel and material) and exogenous conditions (taking into account the possibility of severe storms, laying additional parameters in the calculations).
Political uncertainty is a separate category of exogenous. It manifests itself as the impossibility of predicting the impact of political decisions on the state of the economy in the country. Government policy decisions affect taxation, interest rates, and the production of common goods.
Uncertainty Analysis Features
Both concepts, both uncertainty and risk, are extremely important for the development of a real and feasible course of development of an organization. Their ignoring is impossible, since in fact it is a contradiction between what is planned and what actually exists.
The conditions of uncertainty that an entrepreneur has to adapt to are the impossibility of predicting a large number of variables:
- The activities of transporters, suppliers, workers.
- Market situation (changing social needs and consumer demand, introducing a technically and technologically more advanced product).
- Natural incidents that cannot be foreseen.
These circumstances significantly affect the setting of clear and defined goals. Also, their uncertainty interferes with conducting a full-fledged analysis and identifying the degree of their influence on achieving or not achieving the planned result.
Uncertainty Management Decision Making
The responsibility of any leader is an adequate and timely assessment of the existing and hypothetical situation, as well as the adoption of appropriate decisions.
The problem of uncertainty is that the decision-making process under such conditions often takes an urgent and urgent character, and the required actions can be fraught with risk. The problems that arise and the risks that they provoke are explicit and implicit. This is determined by the incoming information.
If there are obvious problems, the data is more specific. When there are implicit problems, the enterprise management has at its disposal inaccurate or insufficient information (it serves as a very weak signal about the approaching danger). In this case, the task of a good leader is not to ignore the signals, but to strengthen observation of how events are moving.
Decisions made under uncertainty
Taking into account the amount of information that was available to the head, the following types of decisions are distinguished:
- Taken in conditions of certainty.
- Risk-based (probabilistic certainty).
- Having the basis of uncertainty (unreliability).
Decisions taken from the standpoint of reliability (certainty) lead to an increase in the efficiency of development and a reduction in the costs associated with the selection of a suitable option. The main plus of such situations is that most of the variables necessary for the calculations are introduced by the head himself.
In practice, full certainty is a rather rare occurrence. If necessary, decision making in risk conditions (the so-called measurable uncertainty), use probable estimates. This approach reduces the negative impact of uncertainty.
The risk is that it is impossible to assess the likelihood of an event occurring for sure, there may be errors. For this reason, the manager, along with calculations, also uses his experience, intuition and managerial abilities.
The value of these qualities becomes decisive when it is necessary to make a decision in conditions of complete uncertainty (if there is no way to calculate the probability indicator of the occurrence of specific events).
How does the uncertainty analysis process go
Based on the characteristics of economic activity in the absence of reliable information, it can be concluded that the analysis of uncertainty is significant. There are two main approaches to the analysis technique:
- Studying sensitivity and scenarios.
- Conducting analysis by risk assessment. In this case, a variety of probabilistic and statistical methods are used.
Analyzing the phenomenon itself and its elements, it should be understood that these are objective concepts. It is impossible to completely exclude them from doing business and create unambiguous conditions for business, no matter how many executives would like to. However, do not perceive uncertainty as only a negative phenomenon. Implicit circumstances and the “muddy water” of a market economy can obscure the attractive opportunities that appear over time.
True, often the concept of uncertainty in the course of business is still endowed with a negative value.
Ways to Reduce Uncertainty
Given the main causes of uncertainty and the degree of its influence on the success of the enterprise (and sometimes on the fact of its existence), you understand that minimizing this impact becomes a priority for the leader.
Existing ways to reduce uncertainty and risk will not be able to completely eliminate them, however, they will allow for possible consequences and reduce losses:
- The diversification method provides for the distribution of risk between those products that have different characteristics. Due to the increased risk from the sale or purchase of one of the products, the risk of selling or buying another is reduced. An example of risk diversification is the release of products that can be used in peacetime or wartime. Regardless of the situation in the state, the company makes a profit.
- Risk pooling method. Its essence is to turn a random loss into a system of relatively small fixed costs. A good example of this method is insurance, in which the regular payment of insurance payments (fixed costs) allows you to receive compensation for negative risk in case of its occurrence.
- The method by which a reduction in uncertainty can be obtained is also the search for information. Its effectiveness is due to the effect directly on the cause that triggered the occurrence of the phenomenon (lack of reliable and complete information). The data obtained can significantly reduce the level of uncertainty. In some cases, even its transformation from immeasurable to measurable (at risk) is possible.
Among the effective ways to reduce the degree of uncertainty is also a group of methods that provide for the sharing of risk among people who can "cope" with it:
- The risk sharing method is that the assessed risk is superimposed on several participants. At the same time, the damage to everyone is small.
- Speculative activity involving the purchase of something with the intention of selling at a higher price. A person engaged in speculation becomes an intermediary between the end user and the owner of the good. He does not have guarantees that he will be able to resell the benefit more expensively, this is his risk. A speculator buys a product from a person who is not risk averse.
As for the interorganizational level, at which enterprises cooperate and conclude agreements and contracts, it is possible to note the sharing of risks in the form of certain guarantees, mutual obligations and responsibilities. Such techniques can reduce behavioral risks, increase the attractiveness of the project and protect participants from major losses.
A significant role in the process of reducing uncertainty is played by the good managerial qualities of the leader and his ability to develop relevant forecasts.