SELECTED ASPECTS OF RISK MANAGEMENT IN CONSTRUCTION ENTERPRISES

Transcription

1 SELECTED ASPECTS OF RISK MANAGEMENT IN CONSTRUCTION ENTERPRISES Piotr TWOREK 617 Introduction Risk always accompanies any investment process. It s omnipresent and, by principle, occurs in every field of economy. P.F. Drucker stresses the fact that almost each field of industry is lumbered with the relevant, specific type of risk 618, that ought to be taken in order to continue the operation 619. In the construction industry, the significance of risk is quite particular. Each project executed, to lesser or greater extent is lumbered with risk. Depending on the type of the enterprise, i.e. whether the project is executed under road construction, in hydro-engineering or, for instance, in tunnel construction, the risk level observed can vary. On the whole, the risk in the construction industry is defined as the likelihood of the on-site damage occurrence 620. However, the risk of the contractor itself is the likelihood of failure to execute the project in accordance with the quality requirements, to complete the task meeting the deadline as well as at the costs agreed upon. Any deviations in these areas ought to be treated as components of the contractor s global risk. This paper aims at discussing the risk issues typical for the construction enterprises activity. In particular, my intention is elaborate on the risk management subject as the process that supports the company complete management. 617 Department of Investments, The Karol Adamiecki University of Economics in Katowice, Poland 618 P.F. Drucker: Skuteczne zarządzanie: zadania ekonomiczne a decyzje związane z ryzykiem. Państwowe Wydawnictwo Naukowe PWN, Warszawa 1976, p Ibid., p A. Kosecki, A. Madyda: Kierowanie ryzykiem w przedsiębiorstwie budowlanym. W: Technologia w budownictwie teoria i praktyka. Instytut Budownictwa Politechniki Wrocławskiej, Towarzystwo Naukowe Inżynierii Procesów Budowlanych, Wrocław-Polanica Zdrój 1996, p

2 1. Risk in investment-construction process In professional literature, risk is defined in many different ways 621. For example, P.S. Godfrey and W. Halcrow defined it in the following manner 622 : impact of risk = likelihood consequence In the paper published by the Project Management Institute, USA, risk is comprehended as an uncertain event or circumstance that in case of its occurrence may have positive or negative impact on the project objectives 623. Personally, I define risk in the most general manner as a universal, dynamic phenomena, connected to the threat of a loss occurrence, characteristic of the occurrence intensity (usually of wide impact spectrum) and also taking place in time 624. In turn, D. Kuchta defines risk as a potential, undesirable event that may result in failure to reach the project objectives 625. So as to understand risk, it s essential to differentiate it from the notion of uncertainty. These are generally comprehended as two notion categories used interchangeably. However, at the academic level, the two ought to be differentiated. It s generally assumed that uncertainty is a wider notion than risk and that it implies the condition in which we do not know the likelihood of certain results occurrence in future 626. On the contrary, in case of risk, such likelihoods are known to us, which in turn makes it a completely measurable category 627. Apart from uncertainty and risk, there is also a third category, i.e. certainty. Certainty means the state in which all the results possible to achieve in future are certain and thus they are described by one hundred percent certainty that they will occur. 621 See e.g.: M. Aba-Bulgu, S.M.N. Islam: Corporate crisis and risk management. Modelling, strategies and SME application. International Business and Management. Oxford 2007, p P.S. Godfrey, W. Halcrow: Control of Risk. A Guide to the Systematic Management of Risk from Construction. Construction Industry Research and Information Association CIRIA, London 1996, p. 9. See also: J. Zeng, M. An, N.J. Smith: Application of a fuzzy based decision making methodology to construction project risk management. International Journal of Project Management August 2007, Vol. 25, No. 6, p Kompendium wiedzy o zarządzaniu projektami (A Guide to the Project Management Body of Knowledge). Project Management Institute, Inc., PMBOK Guide 2000 Edition, p P. Tworek: Ryzyko w działalności inwestycyjno-budowlanej wybrane aspekty teoretyczne. W: Decyzje w działalności inwestycyjnej uwarunkowania, metody, efekty. Akademia Ekonomiczna im. K. Adamieckiego w Katowicach, Katowice 2007, p D. Kuchta: Zarządzanie czasem i ryzykiem projektów nauka a praktyka. W: Modelowanie preferencji a ryzyko 08. Praca zbiorowa pod red. nauk. T. Trzaskalika. Akademia Ekonomiczna im. K. Adamieckiego w Katowicach, Katowice 2008, p S. Heilpern: Dynamika i niepewność w modelowaniu ekonomicznym. Wydawnictwo Akademii Ekonomicznej im. O. Langego we Wrocławiu, Wrocław 1998, p. 13. See more: J.A. Langlo, A. Johannes, N. Olsson: Uncertainty management in a project owner perspective; Case studies from Governmental projects in Norway. W: Project Management Essential Reality for Business and Government. Editors: J. A. Kisielnicki, S. Sroka. 21 st IPMA World Congress, Cracow 2007, p. 115 and the subsequent. 627 S. Heilpern: Dynamika i niepewność op., cit., s

3 In the investment-construction process, risk has its own and unique profile. It results mainly from the nature of the works that need to be taken up in the investment execution phase. Risk is chiefly taken by the contractor; the contractor s global risk is formed four basic sub-categories, such as: risk of the project execution time, quality risk, price (costs) risk and the project execution safety risk 628. E.L. Abbott recognises the following types of risk characteristic of the contractor s activity: risk of not making a profit on the project or even losing the contractor s own capital on the project through underestimating the complexity of the work, i.e., underestimating the effort required to complete the work; risk of damage to adjacent property due to construction work activities, especially construction means and methods; risk of construction delays, causing the owner to impose liquidated damages for late completion; risk of injury to workers due to construction activities or job site conditions; risk of the impact of the unknowns, especially those relating to subsurface conditions on the project, or the risk of incompletely or inaccurately assessing the cost or time impact of certain events (e.g., differing site conditions), especially in the absence of contract provisions allowing for equitable adjustment; risk of negative recommendations and associated reputational damage (and consequent loss of revenue and possibly bonding capacity) in the event of adverse project experience due to claims, disputes, and associated litigation 629. Regardless of the source of the risk origin, one should always remember that the risk final effects are of financial nature. It s any of the investment process participants that beard the additional costs associated with the project execution and thus this party takes the risk. Table 1 presents the sources of risk origin during the relevant phases of the project lifecycle. 628 A lot of entities take part in the investment process. The basic participants of this process are the investor (principal), contractor and the designer. The risk that refers to them is a specific one and separate for each entity. Thus, there are risk relevant to the contractor, investor (principal) and designer. See more: C. Boothroyd, J. Emmett: Risk Management. A Practical Guide for Construction Professionals. Witherby & Co. Ltd., London 1996, p See also: L. Edwards: Practical risk management in the construction industry. Thomas Telford, London 1995, p ; R.M. Wideman: Project & Risk Management. A Guide to Managing Project Risks & Opportunities. Project Management Institute, Newtown Square1992, p. V-6; N.G. Bunni: Risk and Insurance in Construction. Spon Press, London 2003, p E.L. Abbott: Preparation of Contract Documents for Subsurface Projects. W: Subsurface Conditions. Risk Management for Design and Construction Management Professionals. Edited by D.J. Hatem. John Wiley & Sons, Inc., New York 1998, p

4 Phases of generalised construction project Table 1 Project phase Sub-phase Typical risk issues Concept/feasibility Pre-project Statement of requirements Technical specification Front end design Detailed design Project Procurement Construction Commissioning Operation Maintenance Post-project Decommissioning and abandonment Note: The phasing of risk issues can vary from that stated. Political Environmental Regulatory Contractual: - procurement - design - method of construction Regulatory: - safety - public nuisance - environment Product market Operations Contamination Source: P.S. Godfrey, W. Halcrow: Control of, op. cit., s. 30. According to D. Skorupka, in the relevant phases of a construction process, risk ought to be sought in the following areas: - initial project: bad market (competitor) analysis, wrong analysis of investor preferences, overestimation of delivery cost, incorrect self-assessment; - tender: corruption, cancellation of tender, wrong calculation of project cost (determination of profitability levels), price-dumping by competition, too expensive (cheap) marketing and lobbing, customer reliability; - project work: wrong selection of designer teams, overestimating of project cost, drop of aesthetic level (knowledge of investor preferences is needed), wrong selection of technology (type of construction, used materials, etc.), wrong work schedule; - building work: protests (ecologists, local communities, etc.), wrong soil structure recognition, equipment failure, absences of workers (illnesses, strikes), qualifications of workers (efficiency), wrong resources management, materials deliveries failure, building materials quality, standards failure, inadequate controls, expansion of work scope, bad organization; 644

5 - payment settlement: political destabilisation of state, destabilisation of economic system, increase of inflation, incorrect plan of cost, slump in the market, customer reliability, trade contract precision (changes of assumptions during delivery, lack of precise initial assumption, wrong determination of work scope), compliance 630. Along with the course of any investment process, the risk sources change and so does its nature and risk management method Construction risk management selected aspects In many construction enterprises throughout the world, professional risk management has now become a must. This in particular refers to large executive enterprises that undertake to execute large and complicated projects. By managing it skilfully, a risk manager may limit significantly the losses that may arise in the enterprise in connection with the construction works execution. Essentially, risk management is a process comprising the stages under which plenty of activities are carried out and many risk management methods are applied. To simplify, the process may be divided into three fundamental stages : - risk identification, i.e. recognising risk origin sources and its basic categories, - risk analysis, i.e. its assessment and determining its impact level, - reaction to the risk selecting the right method for counteracting the risk identified and calculated beforehand. In accordance with the Project Management Institute s concept, risk management is a process comprising six phases: risk management planning, risk identification, risk qualitative analysis, risk quantitative analysis, planning a reaction to the risk, risk monitoring and control 632. Depending on the needs and for practical reasons, we are at liberty as to the expansion of the risk management process by new phases and stages. However, its foundation will always be laid taking into the stages of identification, quantification and the reaction to the risk. 630 D. Skorupka: Risk Management in Building Projects. AACE International Transactions, Morgantown 2003, p K. Marcinek: Ryzyko projektów inwestycyjnych. Akademia Ekonomiczna im. K. Adamieckiego w Katowicach, Katowice 2001, p Kompendium wiedzy o zarządzaniu, op. cit., p See also: M.F. Dallas: Value & risk management. A Guide to best practice. Blackwell Publishing Ltd., Oxford 2006, p

6 Figure 1 shows the concept of risk management in a construction enterprise. Identify hazards Assess consequences Assess probability Prioritize = risk analysis Decide metod of risk control Reduce risks - Wholly or partially eliminate or substitute - Reduce probability - Limit consequences Self finance retained risks - Fund from captive from fund (internal or external) - Non-fund use reserve use cash - Arrange external borrowings Transfer risk - Contractually - Insurance Risk financing Arrange Manage Fig. 1. Overview of risk management practices Source: L. Edwards: Practical risk management, op. cit., p. 15. Figure 1 takes into account the methodological aspects of risk management process, where in case of the reaction to the risk, a technique for the risk transfer has been allowed for by contractual arrangements and insurances 633. In business practice, these are the most effective forms of minimising risk. Due to proper provisions of the contract, risk may be transferred on the other party to the contract 634 or, by the purchase of an insurance policy, it may be transferred onto the insurer. In the area of risk management, the contractor is able to apply numerous tools and quantitative methods 633 See more: P. Tworek: Podział ryzyka w procesie realizacji przedsięwzięć inwestycyjnych w świetle badań ankietowych. W: Współczesne kierunki inwestowania formy i efekty. Praca pod red. H. Henzel. Akademia Ekonomiczna im. K. Adamieckiego w Katowicach, Katowice 2005, p See also: T.E. Glavinich: Contractor s Guide to Greek Building Construction. Management, Project delivery, documentation and risk reduction. John Wiley & Sons, Inc., Hoboken, New Jersey 2008, p See more: K.C. Lam, D. Wang, P.T.K. Lee, Y.T. Tsang: Modelling risk allocation decision in construction contracts. International Journal of Project Management July 2007, Vol. 25, No. 5, p. 485 and subsequent. 646

7 serving the purpose of risk quantification 635. By co-operating with the investor, it may, for instance, apply the sensitivity analysis that enables to define the variables (risk factors) to which the project is most sensitive 636. In turn, the risk quantification method typical for the contractor is the MERA technique, which is very effective when it comes to calculating variations that may arise while the project is being executed 637. Furthermore, the project risk identification may be carried out efficiently by using the tool called a checklist 638. Thanks to this technique, as early as at the beginning of the investment process, it s possible to identify the risk categories that pose the greatest threat in the project execution phase and then during its exploitation phase. As results from figure 1, risk management is a multi-stage and multi-action process, requiring wide knowledge and essential preparation from the individuals that deal with such evaluations. Thus, it s not an easy activity. Ideally, risk at any enterprise should be managed by an expert in this field, i.e. a risk manager 639. Conclusions Risk management may be executed both at the level of the entire construction enterprise and the specific projects to be executed. Significantly, the process ought to be executed properly as far as its essence is concerned and professionally, by using such tools as, for instance, computer technologies, which enable to calculate risk more precisely. A contractor needs to manage risk on permanent basis, taking into account the fact that the risk is a constant issue in the construction industry and that the risk 635 From among the risk quantification techniques that are most useful in a construction enterprise activity, one may specify: decision making tree analysis, some network methods (e.g. PERT), MERA technique and risk simulation. The risk simulation by means of the Monte Carlo method is note-worthy for it enables to calculate risk for an investment enterprise taking into account the occurrence of many factors at the same time. See: A. Minasowicz, P. Surowiec: Przygotowanie realizacji przedsięwzięć inwestycyjnych z uwzględnieniem ryzyka. W: Problemy realizacji inwestycji. Polski Związek Inżynierów i Techników Budownictwa, Zarząd Główny. Komitet Inżynierii Procesów Budowlanych i Inwestycyjnych. Materiały Konferencyjne, Warszawa- Puławy, 9-12 października 2002, p See also: D.M. Emiris, P.V. Siskos, D.V. Siskos: Risk evaluation and decision modeling in logistics projects using a software tool. W: Project Management Essential Reality for Business and Government. Editors: J.A. Kisielnicki, S. Sroka. 21 st IPMA World Congress, Cracow 2007, p. 337 and subsequent. 636 Owing to this method, it is possible to define in the project the difference in NPV value (net present value) of the project that has been materially achieved, as compared to the value assumed by the investor. See more: K. Marcinek: Finansowa ocena przedsięwzięć inwestycyjnych przedsiębiorstw. Akademia Ekonomiczna im. K. Adamieckiego w Katowicach, Katowice 2002, p Unknown and unused in Poland at all. More information on this method, see: C. Boothroyd, J. Emmett: Risk Management..., op. cit., p See more: Management of Project Risks and Uncertainties. Construction Industry Institute. Publication 6-8, October, Austin 1989, p See more: L. Edwards: Practical risk..., op. cit., p

8 systematically recur as well as that new factors creating risk on-site appear all the time. Furthermore, this branch is characteristic of the so-called force majeure risk associated with acts of God on which a man has no impact. 648