CONSTRUCTION PROJECTS
by
A.DEVIPRASADH
A thesis report submitted to the
FACULTY OF CIVIL ENGINEERING
In partial fulfillment of the requirement for the award of the degree
of
MASTER OF ENGINEERING
IN
CONSTRUCTION ENGINEERING AND MANAGEMENT
DEPARTMENT OF CIVIL ENGINEERING,
COLLEGE OF ENGINEERING GUINDY CAMPUS,
ANNA UNIVERSITY
CHENNAI – 6000 25
BONAFIDE CERTIFICATE
Certified that this project report titled
“
RISK ASSESSMENT AND MANAGEMENT IN CONSTRUCTION PROJECTS”
is the bonafide work of Mr.A.DEVIPRASADH, who carried out the research under my supervision. Certified further, that to the best of my knowledge the work reported herein does not form part of any other project report or dissertation on the basis of which a degree or award was conferred on an earlier occasion on this or any other candidate.Dr.A.M.THIRUMURTHY Dr.M.SEKAR
Professor and Head, Professor and Dean,
Department of Civil Engineering, College of Engineering, Guindy College of Engineering, Guindy Anna University,
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COLLEGE OF ENGINEERING GUINDY CAMPUS,
ANNA UNIVERSITY
CHENNAI 600 025.
ABSTRACT OF THE PROJECT WORK
Degree and Branch : M.E CONSTRUCTION ENGINEERING AND MANAGEMENT
Month and Year of Submission : June 2007
Title of the Project : RISK ASSESSMENT AND MANAGEMENT OF CONSTRUCTION PROJECTS
Name of the Student : A.DEVIPRASADH Roll Number : 200511840
Name and Designation of supervisor : Dr.M.SEKAR
PROFESSOR & DEAN
COLLEGE OF ENGINEERING - GUINDY ANNA UNIVERSITY
CHENNAI-600025
Construction projects are initiated in complex and dynamic environments resulting in circumstances of high uncertainty and risk, which are compounded by demanding time constraints.
Construction industry has changed significantly over the past several years. It is an industry driven primarily by private investors; the presence of securitized real estate has increased considerably. It is vulnerable to the numerous technical & business risks that often represent greater exposures than those that are traditional. Thus risk assessment need arises. Risk
assessment is a tool to identify those risks in a project and manage it accordingly with proper treatment. Risk assessment is defined in this study as a technique that aims to identify and estimate risks to personnel and property impacted upon by a project.
The general methodology of this study relies largely on the survey questionnaire which was collected from the local building contractors of different sizes by mail or by personnel meeting. A thorough literature review is initially conducted to identify the risk factors that affect the performance of construction industry as a whole. The survey questionnaire is designed to probe the cross-sectional behavioural pattern of construction risks construction industry.
The questionnaire prepared for the pilot survey was formulated by seeing the relevant literatures in the area of construction risk management. Totally for seventy five companies the questionnaires were given, out of which forty five had an effective reply and two were rejected due to improper answering. Thus the response rate is 60% which is considered a good response in this type of survey. This research seeks to identify and assess the risks and to develop a risk management framework which the investors/ developers/ contractors can adopt when contracting construction work in India.
Place: Chennai
Date:
(A.Deviprasadh)
ACKNOWLEDGEMENT
The author expresses his sincere and heartfelt gratitude to Dr.M.SEKAR, Professor & Dean, College of Engineering, Guindy, Anna University for his expert guidance and valuable suggestions throughout the project work.
The author also expresses his sincere thanks to Dr.A.M.THIRUMURTHY, Professor and Head, Department of Civil Engineering, for his kind permission to undertake this project.
The author would also like to thank all the Faculty & Staff members of the Structural Engineering Division for their constant help and encouragement throughout the project work.
Finally the author thank all other people who helped directly or indirectly during the course of the project work
TABLE OF CONTENTS
CHAPTER NO: TITLE PAGE NO:
ABSTRACT iii
ACKNOWLEDGEMENT vii
TABLE OF CONTENTS viii
LIST OF TABLES xi
LIST OF FIGURES xii
LIST OF SYMBOLS xiii
1. INTRODUCTION 1
1.1 INTRODUCTION 1
1.2 RISK IN REAL ESTATE AND CONSTRUCTION INDUSTRY 2
1.3 ORGANISATION OF THESIS
3
2. CONCEPTS OF RISK AND RISK MANAGEMENT 4
2.1 RISK CONCEPTS 4
2.2 PROJECT RISK MANAGEMENT 6
2.3 RISK ASSESSMENT 7
2.4 DETERMINATION OF RISK 8
2.5 RISK EXPOSURE 8
2.6 GENERAL TYPES OF RISKS 9
2.7 SOURCES OF RISK IN CONSTRUCTION PROJECTS 14
2.8 OVERVIEW RISK MANAGEMENT 14
2.9 MAJOR PROCESSES OF PROJECT RISK MANAGEMENT 15
2.9.1 Risk Identification 16
2.9.1.1 Tools and Techniques for Risk Identification 16
2.9.2 Risk quantification 16
2.9.2.1 Tools and Techniques for Risk Quantification 17
2.9.3 Risk response development 18
2.9.3.1 Tools and Techniques for Risk Response Development 19
2.9.4 Risk response and control 19
2.10 RESPONSE TO RISK 20
2.11 ADVANTAGES OF RISK MANAGEMENT 22
2.12 LIMITATIONS OF RISK MANAGEMENT 22
3. OBJECTIVE OF THE STUDY 23
3.1 PURPOSE & SCOPE OF STUDY 23
4.2 OBJECTIVE 24
4. LITERATURE REVIEW 26
4.1 LITERATURE REVIEW 26
4.2 PAST RESEARCH ON RISK ASSESSMENT AND MANAGEMENT 26
5. METHODOLOGY 38 5.1 METHODOLOGY 38 5.2 METHOD OF SURVEYING 38 5.3 QUESTIONNAIRE STRUCTURE 39 5.4 QUESTIONNAIRE DESIGN 39 5.5 RISK RATING 40 5.6 DESIGN OF SURVEY 40
5.7 ANALYSIS OF SURVEY RESULTS 41
5.8 PILOT STUDY 41 6. RESULTS OF SURVEY 43 6.1 GENERAL ANALYSIS 45 6.2 FINANCIAL RISK 46 6.3 MANAGEMENT RISK 48 6.4 MARKET RISK 50 6.5 TECHNICAL RISK 51 6.6 LEGAL RISK 53 6.7 POLITICAL RISK 54 6.8 ENVIRONMENTAL RISK 55
7. CONCLUSION 58
7.1 SUGGESTIONS FOR FUTURE WORK 61
REFERENCES 62
LIST OF TABLES PAGE NO:
1. Table 6.1 Results of Survey 44
2. Table 6.2 Ranking of Financial risks 47
3. Table 6.3 Ranking of Management risks 48
4. Table 6.4 Ranking of Market risks 50
5. Table 6.5 Ranking of Technical risks 51
6. Table 6.6 Ranking of Legal risks 53
7. Table 6.7 Ranking of Political risks 54
8. Table 6.8 Ranking of Environmental risks 55
9. Table 6.9 For project costing more than 50 crores top ten risks 56 10.Table 6.10 For project costing less than 50 crores top ten risks 57
LIST OF FIGURES PAGE NO: 1. Figure 2.1 Hierarchical risks involved in a project 5 2. Figure 2.1 Graphical representation of risk ratings 7 3. Figure 2.1 Overview Risk Management 15 4. Figure 3.1 Risk Management as an Integral Element of Project Management 24
5. Figure 6.1 Bar chart for Financial risks 47
6. Figure 6.2 Bar chart for Management risks 49
7. Figure 6.3 Pie chart for Market risks 51
8. Figure 6.4 Bar chart for Technical risks 52
9. Figure 6.5 Pie chart for Legal risks 53
10.Figure 6.6 Pie chart for Political risks 54 11.Figure 6.7 Pie chart for Environmental risks 55 12.Figure 6.8 Bar chart for project costing more than 50 crores - Top ten risks 56 13.Figure 6.9 Bar chart for project costing less than 50 crores - Top ten risks 57
LIST OF SYMBOLS 1. α the probability level of the risk occurrence
2. β the degree of impact or the level of loss if the risk occurs 3. ∑ Summation
CHAPTER 1
INTRODUCTION
1.1INTRODUCTION
Project management is the application of knowledge, skills, tools, and techniques to project activities in order to meet or exceed stakeholder needs and expectations from a project. Project risk management includes the processes concerned with identifying, analyzing, and responding to project risk. It includes maximizing the results of positive events and minimizing the consequences of adverse events.
Generally, risk is a choice in an environment rather than a fate. BS 6079 (British Standard Institution 1996) defines risk as ‘It is the uncertainty inherent in plans and possibility of something happening that can affect the prospects of achieving, business or project goals’. The word ‘‘risk’’ was known in the English language in the 17th century. It is believed that the word was originally a sailor’s term that came from the Spanish and meant ‘‘to run into danger or to go against a rock.’’ The money spent to fund shipments overseas was the first example of risk business in the early days of travel. Each and every activity we do involve risk, only the amount of risk varies.
Prof. Kent Miller of Purdue University defines risk as “Unpredictability in corporations/businesses outcome variables”. About Uncertainty he defines as “Unpredictability of environmental and organizational variables that impact the corporations/businesses performance.”
Consequences of uncertainty and its exposure in a project, is risk. In a project context, it is the chance of something happening that will have an impact upon objectives. It includes the possibility of loss or gain, or variation from a desired or planned outcome,
as a consequence of the uncertainty associated with following a particular course of action. Risk thus has two elements: the likelihood or probability of something happening, and the consequences or impacts if it does. Managing risk is an integral part of good management, and fundamental to achieving good business and project outcomes and the effective procurement of goods and services. Risk management provides a structured way of assessing and dealing with future uncertainty.
Project risk management includes the processes concerned with identifying, analyzing, and responding to project risk. It includes maximizing the results of positive events and minimizing the consequences of adverse events.
1.2RISK IN REAL ESTATE AND CONSTRUCTION INDUSTRY
The real estate and construction industry has changed significantly over the past several years. It is an industry driven primarily by private investors; the presence of securitized real estate has increased considerably.
Not unexpectedly, the influence of institutional investors on the real estate industry is formidable. They are beginning to experience a higher degree of scrutiny by investors, consultants and analysts, and are expected to deliver "best in class" service in all areas - from property management to risk management. To be successful in this environment, where our collective "performance bar" is being raised significantly, the real estate industry will have to dedicate more resources and develop a higher degree of operational sophistication
Real estate is vulnerable to the numerous other business risks that often represent greater exposures than those that are traditionally insurable. For example, there are regulatory and legislative risks, professional, contractual, competitive and human resource/cultural risks, reputational, strategic, customer, operational, political, legal, financial, and technological risks.
The recent move by the Indian government to introduce risk-rating system at the pre-bid stage has evoked a positive response from industry. The rating agencies have come up with detailed analysis of the various risk parameters such as identification, availability of land and project related infrastructure; status of statutory clearances; resettlement and rehabilitation requirements or status; accessibility to site and other site related infrastructure; availability and pricing of inputs; technology risk; off-take arrangement and market risk and credit risk of off-taker; and payment security mechanism envisaged. The grading of a project at the pre-bid stage would essentially be a comment on the risks involved in undertaking the project. Credit rating agencies like Crisil, Fitch Ratings have been asked to develop a grading methodology for risk-rating the projects. But some industry experts feel that a risk rating system will discourage private participation in rural development projects on a large scale. Most of the rural development projects are likely to get lower ratings which may drive away private investors and financiers from participating in such projects.
1.3 ORGANISATION OF THESIS
The thesis is organized into seven chapters. The first chapter gives an introduction to the present study. The second chapter gives detail concepts of risk management. The third chapter presents the objective of this investigation. Literature survey is explained in the chapter four. Research methodology is given in the chapter five. The analysis of results is in chapter six. Chapter seven gives the conclusion drawn from this investigation and suggestions for future work. Finally the bibliographic references are given at the end.
CHAPTER 2
CONCEPTS OF RISK ANALYSIS AND MANAGEMENT
2.1 RISK CONCEPTS
Risk is a multi-facet concept. In the context of construction industry, it could be the likelihood of the occurrence of a definite event/factor or combination of events/factors which occur during the whole process of construction to the detriment of the project a lack of predictability about structure outcome or consequences in a decision or planning situation, the uncertainty associated with estimates of outcomes – there is a chance that results could be better than expected as well as worse than expected etc. In addition to the different definitions of risk, there are various ways for categorizing risk for different purposes too. Some categorize risks in construction projects broadly into external risks and internal risks while others classify risk in more detailed categories of political risk, financial risk, market risk, intellectual property risk, social risk, safety risk, etc. The classification is shown in the figure 2.1. The typology of the risks seems to depend mainly upon whether the project is local (domestic) or international. The internal risks are relevant to all projects irrespective of whether they are local or international. International projects tend to be subjected to the external risk such as unawareness of the social conditions, economic and political scenarios, unknown and new procedural formalities, regulatory framework and governing authority, etc.
Risk is inherent and difficult to deal with, and this requires a proper management framework both of theoretical and practical meanings. Risk management is a formal and orderly process of systematically identifying, analysing, and responding to risks throughout the life-cycle of a project to obtain the optimum degree of risk elimination, mitigation and/or control. Significant improvement to construction project management performance may be achieved from adopting the process of risk management.
The types of exposure to risk that an organization is faced with are wide-ranging and vary from one organization to another. These exposures could be the risk of business failure, the risk of project financial losses, the occurrences of major construction accidents, default of business associates and dispute and organization risks. It is desirable to understand and identify the risks as early as possible, so that suitable strategy can be implemented to retain particular risks or to transfer them to minimize any likely negative aspect they may have.
Figure 2.1 Hierarchical risks involved in a project
The risk management process begins with the initial identification of the relevant and potential risks associated with the construction project. It is of considerable importance since the process of risk analysis and response management may only be performed on identified potential risks. Risk analysis and evaluation is the intermediate process between risk identification and management. It incorporates uncertainty in a quantitative and qualitative manner to evaluate the potential impact of risk. The evaluation should generally concentrate on risks with high probabilities, high financial consequences or combinations there of which yield a substantial financial impact. Once the risks of a project have been identified and analysed, an appropriate method of treating risk must be
adopted. Within a framework of risk management, contractors also should decide how to handle or treat each risk and formulate suitable risk treatment strategies or mitigation measures. These mitigation measures are generally based on the nature and potential consequences of the risk. The main objective is to remove as much as possible the potential impact and to increase the level of control of risk. More the control of one mitigation measure on one risk, the more effective the measure is. The process of risk management does not aim to remove completely all risks from a project. Its objective is to develop an organized framework to assist decision makers to manage the risks, especially the critical ones, effectively and efficiently.
2.2PROJECT RISK MANAGEMENT
Risk management in a project encompasses identifying influencing factors that could potentially negatively impact a project’s cost schedule or quality baselines; quantifying the associated potential impact of the identified risk; and implementing measures to manage and mitigate the potential impact.
The riskier the activity is, the costlier the consequences if the wrong decision is made. Businesses would like to quantify risk for many reasons. Knowing how much risk is involved will help decide if costly measures to reduce the level of risk are justifiable. It can also help to decide if sharing the risk with an insurance company is justified. Some risks, such as natural disasters, are virtually unavoidable and affect many people. All choices in life involve risk. Risks cannot be totally avoided, but the choice can be made so that risk is minimized.
Risk = Probability of an event × Consequence of loss due to that event Per event
Graphical representation of risk ratings can be made by plotting graph between probability and seriousness, Figure 2.2 explains this.
Figure 2.2 Graphical representations of risk rating
2.3RISK ASSESSMENT
Risk assessment is defined in this study as a technique that aims to identify and estimate risks to personnel and property impacted upon by a project. Traditional risk assessment for construction has been synonymous with probabilistic analysis. Such approaches require events to be mutually exclusive, exhaustive, and conditionally independent. However, construction involves many variables, and it is often difficult to determine causality, dependence and correlations. As a result, subjective analytical methods that rely on historical information and the experiences of individuals and companies have been used to assess the impact of construction risk and uncertainty.
2.4DETERMINATION OF RISK
There are mainly two methods to determine risk, namely the quantitative and the qualitative approach. The quantitative approach relies on statistical calculation to determine risk, its probability of occurrence, and its impact on a project. A common example of the quantitative approach is decision tree analysis, applying probabilities to two or more outcomes. Another approach is the Monte Carlo simulation, which generates a value from a probability distribution and other factors.
The qualitative approach relies on judgments, using criteria to determine outcome. A common qualitative approach is a precedence diagramming method, which uses ordinal numbers to determine priorities and outcomes. An example of a qualitative approach is to list in descending order specific processes of a project, the risk or risks associated with each process, and the control or controls that may or should exist for each risk.
2.5RISK EXPOSURE
Several factors can expose projects to higher than normal risk.
• Team size - The larger the team, the higher the probability of a problem arising. For example, communications can be more difficult as the number of participants increases. The number of interactions among people increases and thus they require greater coordination.
• History - Newer projects are riskier because the processes have not been refined. The more times a project of a similar nature has been done, the greater the likelihood of success.
• Staff expertise and experience - If the staff lacks direct experience and knowledge of the subject, people will struggle to learn as they go along, robbing the project of time and possibly introducing errors.
• Complexity - The more sophisticated a project, there is a greater the opportunity of a mistake or problem.
• Management stability - Management stability implies unity of direction, which in turn means reaching goals. Management irritability can lead to unrealistic scheduling and inefficient use of resources.
• Time compression - If a schedule is highly compressed, then the risks are magnified. Having more time means greater flexibility and the opportunity to prevent or mitigate the impact of errors.
• Resource availability - The more resources that are available, the greater the ability to respond to problems as they arise. For example, more money brings greater ability to secure equipment or people when needed. Plentiful resources, of course, do not guarantee protection from risk; however they do provide the means to respond to it.
2.6GENERAL TYPES OF RISKS
Risks can be viewed as business, technical, or operational. A technical risk is the inability to build the product that will satisfy requirements. An operational risk is the inability of the customer to work with core team members. Risks are either acceptable or unacceptable. An acceptable risk is one that negatively affects a task on the non-critical path. An unacceptable risk is one that negatively affects the critical path. Risks are either short or long term. A short-term risk has an immediate impact, such as changing the requirements for a deliverable. A long-term risk has an impact sometime in the distant future, such as releasing a product without adequate testing. Risks are viewed as either manageable or unmanageable. A manageable risk is one you can live with, such as a minor requirement change. An unmanageable risk is impossible to accommodate, such as a huge turnover of core team members. Finally, risks are either internal or external. An internal risk is peculiar to a project, such as the inability to get the parts of a product to
work. An external risk originates from outside the scope of the project, such as when senior management arbitrarily cuts funding by 20 percent.
• Delivery/operation risk
The ability to overcome the risk of delivering and operating the project as conceived. This risk factor involves issues or concerns associated with actual engineering, procurement, construction execution, and operation of the project, including non-traditional approaches such as a public owner’s use of design-build contracts.
• Technology risk
The ability to overcome the technological risks of the project. This risk factor involves issues or concerns associated with the technologies involved in the execution methods and operational technology of the project.
• Financial risk
The ability to overcome the financial risk of the project through to final completion and operation. This risk factor involves issues or concerns associated with the financing of the project, including the execution period and operations or equity financing.
• Procurement-contractual risk
The ability to overcome the risks associated with the procurement of, or contracting for, the execution and operation of the project. This risk factor involves issues or concerns associated with the contractual and procurement approaches-systems-processes used for both project execution and operation.
• Political risk
The ability to overcome the political risk of the project, including local, state, and national political opposition and code and regulatory impediments. This risk
factor involves issues or concerns associated with the local, regional, and national political and regulatory situation confronting the project.
• Environmental risk
The ability to overcome the environmental risks of the project. This risk factor involves issues or concerns associated with the environmental problems, concerns, and activities confronting the project during the project execution and the project operation.
• Social risk
The ability to overcome the social risks of the project. This risk factor involves issues or concerns associated with the social and cultural impacts of the project to the community and region within which it is to be located.
• Economic risk
The ability to overcome the economic impact risks of the project. This risk factor involves issues or concerns associated with the macroeconomic impact of the project to the community and region within which it is to be located.
• Reserves risk - an operations risk factor
Addresses the extent of reserves and contingency to be transported, and not only the anchor field, but also reserve risk associated with the prospects and discoveries in the area.
• Credit risk - a financial risk factor
Customer credit risk is a new risk issue stemming from the large inflow of small capital independents and the formation of many Limited Liability Corporations without any real assets.
• Engineering risk- a technology risk factor
The exploration and production requirements are continuously pushing the deepwater envelope. A large risk consideration is that the meteorological-ocean data current and waves is empirical and is changing with new measurement information becoming available every year.
• Materials risks - a procurement risk factor
The huge costs of projects are driving the search for the cheapest material that meets specifications which is to be fabricated in a location that has the least cost-often in different countries.
• Weather risks - an environmental risk factor
Wave currents (storm risks) are plaguing many off-shore projects, yet are increasingly uninsurable.
• Insurance risks - an economic risk factor
The global reinsurance market currently has severe capital restrictions that are restricting access to project insurance.
• People risks - a social risk factor
Changing social relationships and forced cultural changes of linear projects, like pipe- lines, are destabilizing local support and long term operability conditions.
• Interface risks - a delivery risk factor
The risk that several different contractors working on different segments of a project are not being managed in the design phase, as more work must be executed on a fast track basis under design-build delivery methods.
• Underground risks - a technology risk factor
The unknowns underground will always be a source of risk that affects execution resources and methodologies.
• Joint venture risks - a financial risk factor
Projects requires many stakeholders to be joint ventures to spread financial risk, which is also forcing differing institutional approaches and cultures to clash and increasing, not diminishing, financial risk sharing, although such risk issues are not fundamentally analyzed when joint ventures are established .
• Design-build risks - a procurement/contractual risk factor
Execution management practices that are not accustomed to design-build stakeholder expectations and industry practices are reducing design-build benefits and exacerbating impacts of risks as they emerge during project execution, especially because many of the key “players” are over-committed.
• Security risks - a political risk factor
Projects of all types are required in many unstable parts of the world, but the militant and terrorist threat and sophistication is well beyond that heretofore experienced.
• “Green” risks - an environmental risk factor:
Projects experience increased environmental concerns in developed, developing, and underdeveloped countries with equal ferocity, which impacts acceptable construction methodologies and resource use.
• Right of way risks - a social risk factor
Right of way issues are increasingly causing delay as through indigenous populations experiencing broader democratic approaches are asserting rights to extract social improvement with consequently larger cost to projects.
• Payment risks - an economic risk factor
In both developing and underdeveloped countries, projects are financed privately through concessions that require payment for the commodity
transported, which requires both a risky impact on the economy and a culture shift from the perception of having to pay for what is considered a right.
2.7SOURCES OF RISK IN CONSTRUCTION PROJECTS
The common sources of risk in construction projects are listed below: • Misunderstanding of contract terms and conditions.
• Design changes and errors • Poorly coordinated work • Poor estimates
• Poorly defined roles and responsibilities • Unskilled staff
• Natural hazards
• Political and legal problems
2.8OVERVIEW OF RISK MANAGEMENT
Project Risk Management includes the processes concerned with identifying, analyzing, and responding to project risk. It includes maximizing the results of positive events and minimizing the consequences of adverse events. Figure 2.3 provides an overview of the following major processes:
Figure2.3 Overview Risk Management
The processes shown in figure 2.3 interact with each other and with the processes in the other knowledge areas as well. Each process may involve effort from one or more individuals or groups of individuals based on the needs of the project. Each process generally occurs at least once in every project phase. Risk identification and risk quantification are sometimes treated as a single process, and the combined process may be called risk analysis or risk assessment. Risk response development is sometimes called response planning or risk mitigation. Risk response development and risk response control are sometimes treated as a single process, and the combined process may be called risk management (PMI 1996).
2.9 MAJOR PROCESSES OF PROJECT RISK MANAGEMENT
Risk management involves four processes, namely 1. Risk Identification
Determining which risks are likely to affect the project and documenting the characteristics of each.
2. Risk Quantification
Evaluating risks and risk interactions to assess the range of possible project outcomes. 3. Risk Response Development
Defining enhancement steps for opportunities and responses to threats. 4. Risk Response Control
Responding to changes in risk over the course of the project.
2.9.1 Risk identification
Risk identification consists of determining which risks are likely to affect the project and documenting the characteristics of each. Risk identification is not a onetime event; it should be performed on a regular basis throughout the project. Risk identification should address both internal and external risks. Internal risks are things that the project team can control or influence, such as staff assignments and cost estimates. External risks are things beyond the control or influence of the project team, such as market shifts or government action. Risk involves only the possibility of suffering harm or loss. In the project context, however, risk identification is also concerned with opportunities (positive outcomes) as well as threats (negative outcomes).
2.9.1.1 Tools and techniques for risk identification
Risk can be identified by the following methods: (A.K.Garg 2005) 1. Brainstorming
2. Workshops 3. Interviews
4. Questionnaire survey
5. Feed back from similar projects 6. Use of specialists
7. Previous experience
2.9.2 Risk quantification
Risk quantification involves evaluating risks and risk interactions to assess the range of possible project outcomes. It is primarily concerned with determining which risk
events warrant response. It is complicated by a number of factors including, but not limited to:
• Opportunities and threats can interact in unanticipated ways (e.g., schedule delays may force consideration of a new strategy that reduces overall project duration).
• A single risk event can cause multiple effects, as when late delivery of a key component produces cost overruns, schedule delays, penalty payments, and a lower-quality product. • Opportunities for one stakeholder (reduced cost) may be threats to another (reduced profits).
• The mathematical techniques used can create a false impression of precision and reliability.
2.9.2.1 Tools and techniques for risk quantification • Expected monetary value.
Expected monetary value, as a tool for risk quantification, is the product of two numbers: • Risk event probability-an estimate of the probability that a given risk event will occur.
• Risk event value-an estimate of the gain or loss that will be incurred if the risk event does occur. Distort the result by equating a small loss with a high probability to a large loss with a small probability.
The expected monetary value is generally used as input to further analysis (e.g., in a decision tree) since risk events can occur individually or in groups, in parallel or in sequence.
• Statistical sums.
Statistical sums can be used to calculate a range of total project costs from the cost estimates for individual work items. (Calculating a range of probable project completion dates from the activity duration estimates requires simulation)
The range of total project costs can be used to quantify the relative risk of alternative project budgets or proposal prices.
• Simulation.
Simulation uses a representation or model of a system to analyze the behaviour or performance of the system. The most common form of simulation on a project is
schedule simulation using the project network as the model of the project. Most schedule simulations are based on some form of Monte Carlo analysis. This technique, adapted from general management, “performs” the project many times to provide a statistical distribution of the calculated results. The results of a schedule simulation may be used to quantify the risk of various schedule alternatives, different project strategies, different paths through the network, or individual activities.
Schedule simulation should be used on any large or complex project since traditional mathematical analysis techniques such as the Critical Path Method (CPM) and the Program Evaluation and Review Technique (PERT) do not account for path convergence and thus tend to underestimate project durations. Monte Carlo analysis and other forms of simulation can also be used to assess the range of possible cost outcomes.
• Decision trees.
A decision tree is a diagram that depicts key interactions among decisions and associated chance events as they are understood by the decision maker. The branches of the tree represent either decisions or chance events are examples of a decision tree.
• Expert judgment.
Expert judgment can often be applied in lieu of or in addition to the mathematical techniques. For example, risk events could be described as having a high, medium, or low probability of occurrence and a severe, moderate, or limited impact.
2.9.3 Risk response development
Risk response development involves defining enhancement steps for opportunities and responses to threats. Responses to threats generally fall into one of three categories: • Avoidance-eliminating a specific threat, usually by eliminating the cause. The project management team can never eliminate all risk, but specific risk events can often be eliminated.
• Mitigation-reducing the expected monetary value of a risk event by reducing the probability of occurrence (e.g., using proven technology to lessen the probability that the product of the project will not work), reducing the risk event value (e.g., buying insurance), or both.
• Acceptance-accepting the consequences. Acceptance can be active (e.g., by developing a contingency plan to execute should the risk event occur) or passive (e.g., by accepting a lower profit if some activities overrun).
2.9.3.1 Tools and techniques for risk response development 1. Procurement.
Procurement, acquiring goods or services from outside the immediate project organization, is often an appropriate response to some types of risk. For example, risks associated with using a particular technology may be mitigated by contracting with an organization that has experience with that technology.
Procurement often involves exchanging one risk for another. For example, mitigating cost risk with a fixed price contract may create schedule risk if the seller is unable to perform. In similar fashion, trying to transfer all technical risk to the seller may result in an unacceptably high cost proposal.
2. Contingency planning.
Contingency planning involves defining action steps to be taken if an identified risk event should occur
3. Alternative strategies.
Risk events can often be prevented or avoided by changing the planned approach. For example, additional design work may decrease the number of changes which must be handled during the implementation or construction phase. Many application areas have a substantial body of literature on the potential value of various alternative strategies.
4. Insurance.
Insurance or an insurance-like arrangement such as bonding is often available to deal with some categories of risk. The type of coverage available and the cost of coverage vary by application area.
2.9.4 Risk response and control
Risk response control involves executing the risk management plan in order to respond to risk events over the course of the project. When changes occur, the basic cycle of identify, quantify, and respond is repeated. It is important to understand that even the
most thorough and comprehensive analysis cannot identify all risks and probabilities correctly; control and iteration are required.
2.9.4.1 Tools and techniques for risk response control
• Workarounds. Workarounds are unplanned responses to negative risk events. Workarounds are unplanned only in the sense that the response was not defined in advance of the risk event occurring.
• Additional risk response development. If the risk event was not anticipated, or the effect is greater than expected, the planned response may not be adequate, and it will be necessary to repeat the response development process and perhaps the risk quantification process as well.
2.10 RESPONSE TO RISK
There are basically five categories of classic risk response strategies: accepting, avoiding, monitoring, transferring, and mitigating the risk (Eric Verzuh 2005).
1. Accepting the Risk
Accepting the risk means, understand the risk, its consequences, and probability, and choose to do nothing about it. If the risk occurs, the project team will react. This is a common strategy when the consequences or probability that a problem will occur are minimal. As long as the consequences are cheaper than the cure, this strategy makes sense.
2. Avoid the Risk
Avoid a risk by choosing not to do part of the project. This deletion of part of the project could affect more than the project-the business risk could also be affected. Changing the scope of the project might change the business case as well, because a scaled-down product could have smaller revenue or cost-saving opportunities. Risk/return is a popular expression in finance-high return on an investment, probably more risk is involved. Avoiding risks on projects can have the same effect-low risk, low return.
3. Monitor the Risk and Prepare Contingency Plans
Monitor a risk by choosing some predictive indicator to watch as the project nears the risk point. The risk strategy in is to monitor the risk by being part of the test team. Contingency plans are alternative courses of action prepared before the risk event occurs. The most common contingency plan is to set aside extra money, a contingency fund, to draw on in the event of unforeseen cost overruns. It’s important to make sure that this fund is used only for unforeseen cost overruns-not to make up for underestimating or substandard performance. Contingency plans can be looked on as a kind of insurance and, like insurance policies, they can be expensive.
4. Transfer the Risk
Many large projects purchase insurance for a variety of risks, ranging from theft to fire. By doing this, they have effectively transferred risk to the insurance company in that, if a disaster should occur, the insurance company will pay for it. While purchasing insurance is the most direct method of transferring risk, there are others. For example, hiring an expert to do the work can also transfer risk. A fixed-price contract states that the work will be done for an amount specified before the work begins. Fixed schedules may also be added to such a contract, with penalties for overruns. With fixed-price contracts, project managers know exactly what the cost of this part of a project will be. They have effectively transferred the cost and schedule risks from the project to the subcontracting firm; any overruns will be the responsibility of the subcontractor. The only downside to this scenario is that the subcontractor, knowing it will be held to the original bid, will probably make the bid higher to make up for the risk it is assuming. Another type of contract for service is called a reimbursable, or cost-plus, contract. Reimbursable contracts pay subcontractors based on the labour, equipment, and materials they use on a project. The risk of cost and schedule overruns is borne completely by the project on these contracts. The project is not able to transfer risk with this kind of contract, but when the work to be performed is poorly defined, or the type of service is open-ended, a reimbursable contract is the only type a subcontractor will sign. Clearly, transferring risk to another party has advantages, but it also introduces new risks.
5. Mitigate the Risk
Mitigation is a process of response to the risk after impact affects the project. Mitigation covers nearly all the actions the project team can take to overcome risks from the project environment.
2.11 ADVANTAGES OF RISK MANAGEMENT
Following are the advantages of risk management 1. Less uncertainty
2. Achievement of objectives 3. Shareholders' reliability 4. Reduction of capital cost 5. Creation of value
2.12 LIMITATIONS OF RISK MANAGEMENT
If risks are improperly assessed and prioritized, time can be wasted in dealing with risk of losses that are not likely to occur. Spending too much time assessing and managing unlikely risks can divert resources that could be used more profitably. Unlikely events do occur, but if the risk is unlikely enough to occur, it may be better to simply retain the risk, and deal with the result if the loss does in fact occur.
CHAPTER 3
OBJECTIVE OF THE STUDY
3.1 PURPOSE & SCOPE OF STUDY
The Development of infrastructure is one of the most important activities that can boost up the business of the various Industries, thereby increasing the Gross Domestic Product (GDP). Due to this fact countries stress on infrastructure development and provide finances for the same in their yearly budget. The various such projects are in themselves vast and big and involve a lot of money. This vastness of each Project leaves lot of scope for various problems from clearances to land acquisition, wastage, unforeseen delays, natural calamities etc., leading to time and cost overrun in the project. The cost overrun can be of huge magnitude in a project involving large amount of money.
The loss of services given by the project during the time by which the project overruns can be enormous if put into monetary terms. Hence, to reduce the losses efficient management of a construction project is required. Application of various project management techniques have to be made from the conception to the completion stages which includes managing the various risks associated with the project in its every stage. Risk Management can be viewed as an integral part of project management, as shown in the Figure 3.1.
Fig 3.1 Risk Management as an Integral Element of Project Management
The scope of Risk Assessment and Mitigation is limited to the construction of large building projects like IT parks, Multiplexes, Malls, Large residential townships etc.
3.2 OBJECTIVE
The construction industry, perhaps more than most, is overwhelmed by risk. Too often this risk is not dealt with satisfactorily and the industry has suffered poor performance as a result. Infrastructure projects being huge in nature and involving a large amount of money, any sort of wastage (either time, resources etc) would lead to huge monetary losses. The losses are due to various risks associated with such mega projects. Risk Management Value Management Asset Management Project Management
These risks are to be identified and mitigated to avoid the losses. This entire process of risk identification and mitigation is termed as risk management. Research on risk assessment and management has been done by various people, mostly on developed countries. In India, only few research works have been done in this area. Thus this study focuses risk assessment and management in India in field of construction.
CHAPTER 4
LITERATURE REVIEW
4.1 LITERATURE REVIEW
An extensive review of international project risk assessment and management was conducted during the initial phase of the research effort. Previous research suggests that construction activity is particularly subject to more risks than other business activities because of its complexity; a construction project usually requires a multitude of people with different skills and interests and the coordination of a wide range of disparate, yet interrelated, activities. Such complexity is further compounded by the unique features of a project and many other external uncertainties. And also, in general, there is an absence of literature that has focused on the practices, results or development of risk assessment and management techniques for Indian construction projects.
4.2 PAST RESEARCH WORK ON RISK ASSESSMENT AND
MANAGEMENT
The subject of risk management has been influential ever since colonies of people have evolved. In Covello and Mumpower’s (1985) article, and according to Grier (1981), the first signs of risk management go back as far as 3200 BC in the Tigris-Euphrates valley with a group of people called the Asipu. One of their functions was to act as risk consultants. Their procedure would be to identify the important dimensions of the problem, propose alternative actions, and collect data on the likely outcomes. Their data sources, though, were signs from the gods. Each alternative option would be interpreted from the gods, and either a plus or a minus sign would result, whether the idea was a favorable one, or not. Then, the most favorable action would be selected from the pool of positive responses and reported to the client.
Roozbeh kangari (1995) discussed the attitude of large U.S construction firms toward risk and determined how the contractors conduct construction risk management through a survey of the top 100 contractors. The study showed that in the recent years contractors are more willing to assume risks that accompany contractual and legal problem in the form of risk sharing with the owner. The survey also found that contactors assume the risk associated with actual quantities toward the practice of defensive engineering is determined.
Akintola S Akintoye and Malcolm J MacLeod (1997) studied the construction industry's perception of risk associated with its activities and the extent to which the industry uses risk analysis and management techniques with the help of a questionnaire survey of general contractors and project managers. The authors concluded that risk management is essential to construction activities in minimizing losses and enhancing profitability. Construction risk is generally perceived as events that influence project objectives of cost, time and quality.
Risk analysis and management in construction depend mainly on intuition, judgement and experience. Formal risk analysis and management techniques are rarely used due to a lack of knowledge and to doubts on the suitability of these techniques for construction industry activities.
Shen L Y (1997) identified the most serious project delay risks and the effective actions for managing these risks. Practitioners' risk management actions and their effectiveness have been investigated through a questionnaire survey. It revealed that methods where practitioners' experience and subjective judgement are used are the most effective and important risk management action, and that methods using quantitative analytical techniques have been rarely used due to limited understanding and experience. The findings also suggest a need to promote the application and awareness of various analytical techniques for risk management in a proper context in the Hong Kong construction industry.
Thomas E Uher and A Ray Toakley (1999) studied the use of risk management in the conceptual phase of the construction project development cycle in the Australian construction industry through a survey. It was found that while most respondents were familiar with risk management; its application in the conceptual phase was relatively low, even though individuals were willing to embrace change.
Li Bing and Robert L. K. Tiong (1999) based on their study categorised the risk factors and their mitigating measures, the most effective risk mitigating measures were categorized into eight groups. Those are partner selection, agreement, employment, control, subcontracting, engineering contract, good relationship, and renegotiation. They proposed a risk management model incorporating measures. Three cases of international construction JVs were analyzed from the perspectives of the execution of these measures.
Li Bing et al (1999) identified the risk factors associated with international construction joint ventures (JVs) from and ‘‘integrated’’ perspective. The risk factors were grouped into three main groups: (1) Internal; (2) Project- specific; and (3) External. The study examined the most effective mitigating measures adopted by construction professionals in managing these risks for their construction projects in East Asia. Based on an international survey of contractors, it was found that the most critical risk factors exist in the financial aspects of JVs, government policies, economic conditions, and project relationship. When entering a foreign construction market in the formof a JV, a foreign construction company could reduce its risks if it would carefully select its local partner, ensure that a good JV agreement is drafted, choose the right staff and subcontractors, establish good project relationships, and secure a fair construction contract with its client.
Mulholland and Christian (1999) made a model in a systematic way to consider and quantify uncertainty in construction schedules. The study focused on lessons learned from past projects and describes a risk assessment process involving typical inputs and expected outputs. The model incorporates knowledge and experience acquired from many experts, project-specific information, decision
analysis techniques, and a mathematical model to estimate the amount of risk in a construction schedule at the initiation of a project. The model provides the means for sensitivity analyses for different outcomes wherein the effect of critical and significant risk factors can be evaluated.
Shou Qing Wang (1999) conducted an international survey on risk management of BOT projects in China. The overall objectives of the survey are (1) to identify the unique or critical risks associated with China’s BOT projects; (2) to evaluate the effectiveness of measures for mitigating these risks; (3) to examine the key contract clauses used in Laibin B’s concession agreement; and (4) to provide a risk management framework for investing in future BOT projects in China. The study discussed the adequacy of key contract clauses in Laibin B’s concession agreement related to the political and force majeure risks in China, from the perspective of foreign developers, lawyers, and lenders. The contract clauses discussed include changes in law, corruption, delay in approval, expropriation, and force majeure.
Sudong Ye and Robert L. K. Tiong (2000) formed a systematic classification of existing evaluation methods developed a new method—the net-present-value-at-risk (NPV-at-risk) method—by combining the weighted average cost of capital and dual risk-return methods. The evaluation of two hypothetical power projects showed that the NPV-at-risk method can provide a better decision for risk evaluation of, and investment in, privately financed infrastructure projects.
Shou Qing Wang (2000) based on their survey on risk management of build-operate-transfer (BOT) projects in developing countries, with emphasis on infrastructure projects in China, discussed specifically the criticality of the political and force majeure risks. Based on the survey, critical risks, in descending order of criticality, were identified: Chinese Parties’ reliability and creditworthiness, change in law, force majeure, delay in approval, expropriation, and corruption. The measures for mitigating each of these risks are also discussed.
Makarand Hastak and Aury Shake (2000) developed a risk assessment model for international construction projects named ICRAM-1. The paper discusses some of the existing models for country risk assessment, presents potential risk indicators at the macro, market, and project levels, and explains the ICRAM-1 methodology through an applied example. Four main results are obtained from the ICRAM-1 analysis: (1) High-risk indicators; (2) impact of country environment on a specific project; (3) impact of market environment on a specific project; and (4) overall project risk.
Hastak and Shaked (2000) in their study classified all risks specific to whole construction scenario into three broad levels, i.e. country, market and project levels. Macroeconomic stability is partly linked to the stance of fiscal and monetary policy, and to a country’s vulnerability to economic shocks. Construction market level risks, for a foreign firm, include technological advantage over local competitors, availability of construction resources, complexity of regulatory processes, and attitude of local and foreign governments towards the construction industry while project level risks are specific to construction sites and include logistic constraints, improper design, site safety, improper quality control and environmental protection, etc.
Artem Aleshin (2001) studied the problem of risk management of international and joint venture projects with foreign co-operation in Russia. The author identified classified and assessed risks inherent to joint venture projects in Russia and practical recommendation for risk management.
Shen et al (2001) based on their survey, established a risk significance index to show the relative significance among the risks associated with the joint ventures in the Chinese construction procurement practice. Real cases were examined to show the risk environment faced by joint ventures.
Nabil A.Kartam and SaiedA.Kartam (2001) based of a questionnaire survey found that contractors show more willingness to accept risks that are contractual and legal related rather than other types of risks. Their research also indicated that the
application of formal risk analysis techniques is limited in the Kuwaiti construction industry.
Prashant Kapila1 and Chris Hendrickson (2001) they identified the financial risk factors associated with international construction ventures from an integrated perspective. They examined the most effective mitigation measures adopted by construction professionals in managing these risks for their construction projects and suggests other means of risk aversion.
Tarek M. Zayed (2002) made a BOT risk prototype evaluation model that provides a logical, reliable, and consistent procedure for assessing the BOT project risk. The proposed model introduced the BOT risk index (F), which relied on the actual performance of eight main BOT risk areas. Two different modeling approaches were used in constructing this index: a new developed and an adapted Dias and Ioannou model.
Darrin and Mervyn K Lewis (2002) analysed the principles involved, on practical experience of evaluating projects to form a framework for assessing the risk, with a help of waste water treatment facility in Scotland as a case study which is a typical PPP project.
Motiar rahman.M and Mohan.M.Kumaraswamy (2002) developed a basic model which conceptualized for improved project delivery through Joint risk management through a survey conducted in Hong Kong and with a case study in mainland China..
Alfredo del Can et.al (2002) presented a generic project risk management process that has been particularized for construction projects from the point of view of the owner and the consultant who may be assisting the owner. First, the authors explains a complete or generic project risk management process to be undertaken by organizations with the highest level of risk management maturity in the largest and most complex
construction projects. After that, factors influencing possible simplifications of the generic process are identified, and simplifications are proposed for some cases. Then the application to a real project is summarized. As a final validation, a Delphi analysis has been developed to assess the project risk management methodology explained here, and the results are presented. The appropriate contracting method and the contract documents for any construction project depend on the nature of the project, but an appropriate contracting method coupled with clear and equitable contract documents do not by themselves ensure project success where people work together in the face of uncertainty and complexity with diverse interests and conflicting agendas. The attitudes of the contracting parties and the co-operative relationships among the project participants are important for successful project delivery. These are examined in the light of transaction cost economics and relational contracting (RC) principles. It is found that RC may well be a useful route towards reduced transaction costs, while also fostering co-operative relationships and better teamwork that in turn facilitate joint risk management (JRM). The usefulness of the latter is reinforced by relevant observations from a recent Hong Kong-based survey, followed by a case study in Mainland China.
Thomas et al (2003) of IIT Madras, carried out risk perception analysis to evaluate the risk criticality, risk management capability, risk allocation/sharing preference, and factors influencing risk acceptance of major stakeholders in BOT projects. They surveyed various senior project participants such as government officials, promoters, lenders and consultants of Indian BOT road projects.
Eight types of risks have been identified as very critical in the Indian road sector under BOT set up with traffic revenue risk being the most critical. The study revealed that the factors and their relative influence on the risk acceptance of stakeholders are considerably different.
Wong and Hui (2003) identified the importance of risk factors by data collected in a postal questionnaire survey conducted to the building contractors in Hong Kong. Out of 60 factors identified the availability of required cash, uncertainty in costs estimates,
urgent need for work, past experience in similar projects and contract size are considered most important. The findings suggested that in the upward adjustment of tender prices, the large-size contractors are more concerned with the uncertainty in costs estimates while the medium- and small-size contractors care more about no past experience.
Shen et al (2003) established a risk significance index, based on a survey to show the relative significance among the risks associated with the joint ventures in the Chinese construction procurement practice. Real cases were examined to show the risk environment faced by joint ventures. The paper also investigated practical applications of risk management in the business of joint ventures.
Osama Ahmed Jannadi and Salman Almishari (2003) developed and computerized a risk assessor model – RAM, to determine the risk associated with a particular activity and the justification factor.
Daud Nasir et al (2003) developed a method to assist in the determination of the lower and upper activity duration values for schedule risk analysis by program evaluation and review technique analysis or Monte Carlo simulation. Probabilities for various combinations of parents for each risk variable were obtained through an expert interview survey and incorporated into the model. Finally, sensitivity analysis was performed. The model was tested using 17 case studies.
Sudong Ye and Robert L.K Tiong (2003) used Monte Carlo simulation, to evaluate the mean net present value (NPV), variance and NPV-at-risk of different concession period structures. They analysed the influence of project characteristics on concession period design to evaluate the feasibility of the design.
They concluded that a well-designed concession period structure can create a ‘win–win’ solution for both project promoter and the host government.
Hyun-Ho C.H.N Cho and J. W. Seo (2004) presented a risk assessment methodology for underground construction projects. A formalized procedure and
