Every project has uncertainties and risks. Instead of ignoring these situations, you should analyze and understand them as part of risk management for a more robust decision-making process.
In the initial phase of the project, uncertainty is high due to the limited availability of information. However, the situation becomes clear as the project progresses, and project planning improves through progressive elaboration.
Forecasting plays a key role in project planning, and a tornado diagram helps improve the confidence level in project forecasting.
A tornado diagram improves forecasting by visually showing how a change in a variable affects the output variable.
You test different scenarios and then sort the outcomes from the largest to the smallest. Because of limited resources, a project cannot address all risks. Hence, you rank them and focus resources on addressing variables with significant impact.
What is a Tornado Diagram?
A tornado diagram is a sensitivity analysis tool used to identify and visualize the impact of risks or uncertainties on a project’s outcome. Since the shape of this diagram is similar to a tornado, it is known as a tornado diagram, with the most significant factors at the top and the least significant at the bottom.
Each bar represents the variable’s range of outcomes, with longer bars indicating greater influence on the project result. By comparing these variables, you can prioritize risks, thus enabling yourself to focus on those with the highest impact.
A tornado diagram is a risk mapping tool similar to a bar chart.
Other sensitivity analysis tools include spider diagrams, correlations, critical indexes, probability Gantt charts, and schedule-impact indicators.
A project has many variables, and you must know the impact of each variable on the outcome. The outcome can be cost, project duration, or quality. You should know how sensitive the output is to a particular variable and how to prioritize it.
To analyze the impact of a value, you change one input variable at a time while keeping others at the baseline.
After drawing the diagram, you can see which variable most impacts the outcome.
For example, some of the outcomes you can review include economic indices such as the Internal Rate of Return (IRR), Net Present Value (NPV), Return on Capital Employed (ROCE), and Net Cash Return (NCR).
Tornado diagrams are also known as tornado charts, tornado plots, butterfly charts, etc.
How to Create a Tornado Diagram
You can follow the following steps to draw a tornado diagram:
Step #1: Formulate the Model
Begin by developing a model that represents the project or decision scenario. This model should include all the key variables that could impact the outcome, such as cost (IRR, NPV, etc.), time, resources, and external factors. Define the relationships between these variables and the project’s key performance indicators (KPIs).
Step #2: Assess the Range
Determine the possible range of values for each key variable in the model. This involves identifying the minimum and maximum values for each variable, based on historical data, expert judgment, or scenario analysis. These ranges represent the uncertainty in each variable.
Step #3: Select the Value Metric
Choose the value metric that you want to assess in the tornado diagram. This could be a project outcome like total cost, completion time, or return on investment. The value metric should be directly influenced by the variables identified in the model. Let’s say NPV for this illustration.
Step #4: Calculate the Value Metric’s Range
Calculate the impact of each variable’s range on the selected value metric. Adjust one variable at a time, keeping all others constant, to determine how the value metric changes across the variable’s range. Record the highest and lowest outcomes for the value metric when varying each variable.
Here, you tweak one variable while keeping other variables at baseline and examine the impact on the NPV. Record the outcomes for upside and downside, and then tabulate.
A typical case where you would study three input variables is the exchange rate, CAPEX, and sales volume.
These inputs have uncertainties, and you are examining which fluctuations will most influence the NPV.
Step #5: Draw the Tornado Chart
Create the tornado diagram by plotting horizontal bars for each variable. The bars should be sorted from longest to shortest, with the length representing the range of impact on the value metric. Place the most influential variables at the top, thus creating the “tornado” shape. This visualization can help you prioritize the variables that will have the greatest effect on the project’s outcome.
The above diagram shows the sensitivity of the NPV towards each variable. The exchange rate is the most impactful variable. You can now develop a risk response plan to manage this variable.
Tornado Diagram Benefits
- Identifies Key Variables: Tornado diagrams provide the most influential factors in a project, thus allowing you to focus on the variables that have the greatest impact on the outcomes.
- Provides Visual Clarity: Tornado diagrams show how different variables affect the project’s key metrics, thus making it easier to communicate risks to stakeholders.
- Simplifies Decision-Making: Tornado diagrams can help you prioritize risk management and resource allocation areas by ranking variables according to their impact.
- Enhances Risk Management: Tornado diagrams support more effective risk management by identifying changes in input variables, which can lead to significant outcome variations.
- Enhances Resource Utilization: Tornado diagrams can help you identify high-priority tasks and use resources optimally.
Tornado Diagram Limitations
- Assumes Linear Relationships: Tornado diagrams typically assume that variable changes have a linear effect on outcomes, which may not always be true in complex projects.
- Provides Limited Scope: Tornado diagrams feature analysis that is limited to one variable at a time, which can oversimplify situations in which multiple variables interact or compound their effects.
- Lacks Probability Information: Tornado diagrams show the potential impact of variables but do not account for the probability of those impacts occurring.
- Provides Static Analysis: Tornado diagrams provide a snapshot based on specific assumptions and ranges, which may not fully capture dynamic or evolving project conditions.
- Treats Variables Independently: Tornado diagrams treat one variable at a time, which may not align with practical situations, as these variables are interconnected. A variable may behave differently when studied alone than when combined with others.
Summary
Tornado diagrams are useful tools in project management. They show the impact of various uncertainties on project outcomes. You can prioritize risks and make informed decisions by identifying the most influential variables. Tornado diagrams enhance risk management and help you focus your resources on the factors most significantly affecting project success.
Further Readings:
- What is Sensitivity analysis?
- What is Monte Carlo Simulation?
- What is Risk Management?
- What is a Risk Management Plan?
This topic is important from a PMP exam point of view.
I am Mohammad Fahad Usmani, B.E. PMP, PMI-RMP. I have been blogging on project management topics since 2011. To date, thousands of professionals have passed the PMP exam using my resources.
