Definition: Risk tolerance defines how much risk an individual or organization can withstand. It is the range of specified results. A high tolerance means the organization is willing to take greater risks, and low tolerance means they are unwilling to take high risks.
Risk tolerance shows the risk attitude of stakeholders in measurable units. It indicates how sensitive stakeholders and organizations are towards risks.
Risk tolerance is dynamic and changes over time, and the project manager must keep monitoring it and how it may influence stakeholders. It is a key part of project risk management, and it helps prioritize risk and get resources to manage risks.
Factors Affecting Risk Tolerance
Three key stakeholders affect the risk tolerance for a project. These stakeholders are the organization, the project manager, and the project owner or client.
Risk assessment and perception are subjective matters. Mostly, these stakeholders have different opinions about any risk.
The organization’s risk tolerance depends on its financial conditions and the effect of the risk on customer satisfaction. A financially stable organization can have a high-risk tolerance.
The risk tolerance of the project manager and project management team depends on the organizational culture and their job security. However, generally, these groups are risk-averse.
The project owners’ risk tolerance depends on the importance of the project. If the project is critical to the organization’s success, then the client will have a high-risk tolerance; otherwise, the tolerance will be low.
If the project is internal to the organization and is critical to achieving organizational goals, the organization can take risks. In this case, the organization’s tolerance will be high.
However, the organization may not want to take risks for unimportant projects.
Risk Tolerance Example
A project manager is bidding for a contract whose budget is 1,000,000 USD. The management agreed, but they instructed they cannot go over 5% of this amount.
This 5% is the risk tolerance limit of the organization.
A well-documented risk tolerance helps organizations be more informed and confident in taking appropriate levels of risks aligning with the organization’s strategic objectives. It helps them allocate efficient, risk-adjusted resource allocation.
NB: This topic is important from a PMP and PMI-RMP exam point of view.