RISK MANAGEMENT IN CONSTRUCTION PROJECTS

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1 International Journal of Advances in Applied Science and Engineering (IJAEAS) ISSN (P): ; ISSN (E): X Vol-1, Iss.-3, JUNE 2014, IIST RISK MANAGEMENT IN CONSTRUCTION PROJECTS SUDARSHAN N ASHAN, PROF RAKESH SAKALE 1 M Tech Sem IV, Dept of Civil Engg, Patel Institute of Technology, Bhopal 2 HOD, Dept of Civil Engg, Patel Institute of Technology,Bhopal sudarshanashan11@gmail.com, rakesh_sakale@rediffmail.com ABSTRACT The paper provides a preliminary research to the basics of risk analysis and its implementation in construction industry. Risk and Uncertainty, are terms frequently used and therefore have been explained in detail. Different Risks on Construction project have been considered and the various methods of Analysis that are adopted are discussed. General Internal and External Sources of risk in Construction Projects have been dealt with. KEYWORDS Assessment of Risk, Evaluation of Risk, Risk, Risk Management, Uncertainty I. INTRODUCTION The nature of the construction projects makes the industry unique as in construction projects, the manufacturing facility or plant must move to the construction site (Hinze, 2001). There are many different descriptions of the construction industry, drawn from different specialist disciplines. The vagueness is compounded by the fact that the construction involves such a wide range of activity that the industry's external boundaries are also unclear (Murdoch and Hughes, 2000). Construction is sensitive to economic cycles and involves diverse professionals, specialists and suppliers. It has a strong impact of the external environments and its frequently changing nature. The many variables and the their complex relationships needs sound consideration, precise business practices and decision making during the process of building a construction project. Different types of labor skills, materials and equipment need to be coordinated and implemented for the construction and will require appropriate application of business practices so as to ensure effective utilization of available resources. External factors like the frequently changing labor practices and the government policies also have a substantial impact on the construction project. II. THE PRESENT SCENARIO FOR MANAGEMENT IN CONSTRUCTION INDUSTRY Construction contractors have been slow in applying proper management methods in construction projects. A majority of project failures are attributed to the slow, sluggish and nebulous response to the changing environment. Raftery (1994) has given an explanation for the failure of the construction industry in responding to changing conditions that; Construction projects are unique Construction projects involve many skills largely nonrepetitive in nature Projects are constructed under local conditions of weather, location, transportation and labor that are more or less beyond the contractor's control. Mainly construction firms are small operations, with the management decisions being made by one or two persons. There are special problems in construction. The future cannot be forecast. Construction is a high-risk business. Construction Industry brings together many players from multiple disciplines during the various stages of a single project. Construction projects are complex and long term undertakings. The structure must be designed in accordance with applicable codes and standards. Drawings and specifications describing the work in sufficient details must be made available for constructing the structure on the field. RISK AND UNCERTAINTY When a decision is based on assumptions, expectations, estimates, and forecasts of future events it brings in an 162

2 element of taking risks. Risk is an abstract concept, difficult to define and also impossible to measure with any precision except in some cases. Considering the economics and management of construction projects, an acceptable definition of risk and uncertainty would be: risk and uncertainty are a part of the situations in which the actual outcome for a particular event or activity is likely to deviate from the estimate or forecast value (Chapman & Ward, 1997; Ward & Chapman, 2003). Any uncertain event or condition, as and when it occurs, will have an effect, which could be either positive or negative to the objectives of the project. Thus risk has a cause and a consequent effect if and when it occurs. Jaffari (2001) defined risk, as the exposure to loss/gain, or the probability of occurrence of loss/gain multiplied by its respective magnitude. An event is said to be certain if it has a 100% probability of occurrence and totally uncertain if the probability of occurrence is 0%. When a number of possibilities exist and one is not sure as to which one of these possibilities will occur, then the event is said to be an uncertainty. Risks and uncertainties characterize all activities in production, services and exchange, affecting all the fundamental variables that determine planning, implementation, monitoring, adjustment, behavior and lead to decisions. Every definition of risk is likely to carry an element of subjectivity, depending upon the nature of the risk and to what it is applied. Risk exists when a decision is expressed in terms of range of possible outcomes and when known probabilities can be attached to the outcomes. Uncertainty exists when there is more than one possible outcome of a course of action but the probability of each outcome is unknown. Flanagan & Norman (1993) differentiated between risk and uncertainty. Accordingly Risk has place in calculus of probability, and lends itself to quantitative expression. Uncertainty, by contrast, might be defined as a situation in which there is no historical data or a precedent related to the situation that is being considered by the decision maker. Risk may be dynamic or static. Dynamic risk is concerned with making opportunities in which there will be potential gains as well as losses. Dynamic risk is risking the loss of something certain, for gain of something uncertain (Flanagan & Norman, 1993), (NAO, 2001). Static risk related only to the potential losses where people are concerned with minimizing losses by risk aversion (Flanagan & Norman, 1993). The unsystematic and arbitrary management of risks can endanger the success of the project since most risks are very dynamic throughout the project lifetime (Baloi & Price, 2003). Risk has both an upside and a downside, that is, the outcome may be better (upside) or worse (downside) than originally expected. Risk and uncertainty will apply to the forecast price or time for the entire project and for any operations within it. An element of risk and uncertainty will also be associated with the assumptions about external factors like weather, inflation, strikes, riots, etc. All these are likely to affect the economic and financial loss or gain, cause physical damage or injury, or end up in delay of the project schedule. Uncertainty was used to describe situations in which it was not possible to attach a probability to the likelihood of occurrence of an event. All business decisions may not be statistically repeatable. But a few may have full statistical support in the form of detailed historical data relevant to the current decision. Such decisions are matters of judgment supported by factual data. Risk analysis attempts to enhance the value of these judgments by enabling decision-makers to make use of the full extent of their knowledge and experience through formal consideration of risk and uncertainty (Raftery, 1994; Chapman & Ward, 1997). Risk in business decisions can be categorized mainly into four categories, namely, (a) high probability high impact; (b) low probability high impact; (c) high probability low impact; and (d) low probability low impact (Raftery, 1994). The impacts may be positive or negative, favorable or unfavorable. Low probability low impact risk may be given least priority but it has to be assessed keeping in view its potential to push non-critical operations into the critical path in a construction project. Hence, it is pertinent that in a formal risk analysis, all risks should be considered at the initial stage and thereafter the decision to eliminate the low impact risks of both the low and high probability may be taken if its impact is found to be inconsequential. The exposure to risk is the probability of the event multiplied by the extent of the potential loss/gain (Chapman & Ward, 1997). It is commonly perceived that economic progress cannot take place without taking risks. People are categorized as Risk Neutral, Risk Seeking and Risk Averse (Watson, 1997). Empirical studies have shown that business decisionmakers are highly risk averse, and they actually spend much 163

3 time and effort minimizing the risks that they do take. Similarly, professional gamblers are regarded as risk takers; in fact, some professional gamblers are also very risk averse spending large amounts of effort calculating and minimizing their risk (Watson, 1997). RISKS IN CONSTRUCTION PROJECT The construction industry has the dubious distinction for time and cost overruns (Raftery, 1997). This is due to many reasons. One of them being that the construction industry is one of riskiest of all business types (Clough and Sears, 1994). Some of the typical risks in Construction Contract are Physical works, Damage and injury to persons and property, Payment, Direction and supervision, Delay and disputes, Law and arbitration, External factors. Likewise for Construction projects the typical risks can be, Occurrence of accidents to operatives on site causing physical injury, Failure to complete within the stipulated design and construction time, Failure to obtain the expected outline planning, detailed planning or building code/regulation approvals within the time allowed in the design program, Unforeseen adverse ground conditions delaying the project, Unexpected rises for labor and materials, Force majeure, Failure to complete the project within the client's budget. It is important to distinguish the sources of risk from their effects. Ultimately, all risk encountered on a project is related to one or more of the following Failure to keep within the cost budget/forecast/estimate/tender etc. Failure to keep within the time stipulated for the approvals, design, construction and occupancy. Failure to meet the required technical standards for quality, functions, fitness for purpose, safety and environment preservation. The effect of adverse events will be financial loss. The task of professional advisors, contractors and suppliers is to identify the discrete sources of risk which are the root cause for failure to occur, and then develop a Risk Management strategy that provides for the most appropriate organizations to carry that risk (Flanagan & Norman, 1993). III. METHODOLOGY METHODS OF ANALYSIS Risk analysis could be either quantitative or qualitative in nature based on the amount of information available about it. (APM, 2000) Qualitative analysis focuses on identification together with assessment of risk, and quantitative analysis focuses on the evaluation of risk (Chapman, 2001). Sometimes the data for certain risk may be inadequate for conducting the analysis. Various risk analysis techniques, adapted from (Ward and Chapman, 1997) QUALITATIVE QUANTITATIVE a. Direct judgment d. Descriptive analysis b. Ranking options e. Probability analysis c. Comparing options f. Sensitivity analysis g. Scenario analysis h. Simulation analysis A. QUALITATIVE RISK ANALYSIS Lowe (2002) introduced a definition for the qualitative assessment of risk, it involves the identification of a hierarchy of risks, their scope, factors that cause them to occur and potential dependencies. This hierarchy was arrived at, based on the probability of the event and its likely impact on the project. In Qualitative risk analysis, the risks are first identified and based on their importance a priority list is brought up, which is further subjected to analysis and or mitigation. Then an assessment of each of the identified risk is done, for its probability of occurrence and its impact on the project objectives. Components of risk analysis were introduced by Kindinger and Darby (2000): List the activities, tasks and or elements that make up the project. Identify applicable risk factors. Develop risk-ranking scale for each risk factor. Rank risk for each activity for each risk activity. Document the results and identify potential risk-reduction actions. For the Qualitative risk ranking, documentation of each qualitative risk factor identified has to be done to perform consistent evaluation across different project activities. To make this possible, qualitative definitions of risk factors are defined for three categories of risk (none/low, medium, and high). According to Kindinger and 164

4 Darby(2000), the results of the qualitative risk analysis can be used in three important ways. : The qualitative risk analysis factor rankings for each project activity provide a first-order prioritization of project risks before the application of risk reduction actions. The more meaningful, result from conducting a qualitative risk analysis is the identification of possible risk-reduction actions responding to the identified risk factors. It is much easier and straight forward to make the Risk reduction recommendations if the risk issue has been identified properly. The final use of the qualitative risk analysis is the development of input distributions for both qualitative and quantitative risk modeling and coming up with a integrated risk analysis model. B. QUANTITATIVE RISK ANALYSIS The numerical estimation of the probability that the project will meet its cost and time objectives is termed as Quantitative risk analysis. It is based on the simultaneous evaluation of the impact of all identified and quantified risks. Quantitative methods rely on probability distribution of risks and hence they are expected to give more objective results than the qualitative methods provided we have sufficient relevant data for analysis. In contrast qualitative methods depend on personal judgment and the previous experiences of the analyst, thus adding an element of variation in results from person to person within a range. Thus quantitative methods are more preferred over qualitative methods. Quantitative risk analysis involves statistical techniques which can be used with specialized software (Office of Project Management Process Improvement, 2003). According to Abu izk, 2002, Quantitative risk analysis is in fact assigning probabilities or likelihood to the various factors and also a value for the impact, thus identifying the severity of that factor. Kuismanen, 2001 suggested that when a thorough quantitative analysis is required the following two approaches can be adopted: 1. Risks can be quantified as individual entities while looking at the big picture. This can include the cumulative effects (to certain accuracy) into each individual risk and thus make more accurate estimations of the net value of the risks. 2. Alternatively modeling the mathematical properties of the interrelations from the bottom up can be started and then calculate the net impact of each risk including the effects of inter relations. The aim of risk analysis is to determine how likely an adverse event is to occur and the consequences, if it does occur. Quantitative Risk Analysis involves describing the risk in numerical terms. METHODS OF QUANTITATIVE RISK ANALYSIS Any specific risk analysis technique is going to require a strategy. It is best to begin by providing a way of thinking about risk analysis that is applicable to any specific tool might be used. Probability Analysis is a tool in investigating problems which do not have a single value solution, Monte Carlo Simulation is the most easily used form of probability analysis. Sensitivity Analysis is a tool that has been used to a great extent by most risk analysts at some time or the other. Breakeven Analysis is an application of a sensitivity analysis. It can be used to measure the key variables which show a project to be attractive or unattractive. Scenario Analysis is also a derivative of sensitivity analysis technique which tests alternative scenarios; the aim is to consider various scenarios as options. Decision Trees are diagrams used to both formulate the problem as well as evaluate it. Sensitivity analysis is a deterministic modeling technique used to test the impact of a change in the value of an independent variable vis-à-vis on the dependent variable. It pinpoints exactly where the variation in the expected value of a cost parameter changes a decision. Though not useful in quantifying the risk, it certainly helps in identifying the factors which are risk sensitivity. It helps to test components which may have the greatest impact on the results. Sensitivity analysis has the advantage of allowing specific scenarios of interest to be tested and well described. It helps in estimating the maximum or minimum possible costs. Simulation is a probability-based technique where all uncertainties are assumed to follow the characteristics of random uncertainty. When the outcome of any process is strictly a matter of chance it is said to be a random process. The Monte Carlo process is a technique for generating random values and transforming them into values of interest. Different values of risk variables are combined in a Monte Carlo simulation. The frequency of occurrence of a particular value of any one of the variables is determined by 165

5 defining the probability distribution to be applied across the given range of values. The results are shown as frequency and cumulative frequency diagrams. Decision Trees: This analysis is carried out by decision tree diagram. Decision trees are very helpful to both formulate the problem and evaluate options. In this analysis there are graphical models used to represent a project and can clearly reflect the effects of each decision taken in the project. CONCLUSION All forecasts about the future are uncertain. Practically, no construction project has ever begun with all aspects clearly known and certain. Risk analysis and management should not be viewed as a separate planning and response operation. Risk and opportunity management is a way of thinking and a philosophy that should span the entire gamut of project activities. Systematic analysis of risk exposure can lead to better and efficient allocation of resources. The process of breaking a project into its sources of risk and then examining them systematically gives the estimator a realistic feel for the project and its possible outcomes. The methods of risk analysis and management discussed here are just a preliminary research. The construction industry is ridden with risk and according to the business inclination there will be ample opportunities in risk management in most industries. Risk management would be the most sought after occupations in the future with great potentials. It is observed that Risk management technique is rarely used by the participants in construction projects. They handle the risks with an informal approach. The main reason for this is the lack of awareness and usefulness of the technique. It is also influenced by the facts that there are many who believe that the projects are unique and invariably firefighting techniques are adopted and the situation retrieved to satisfactory levels. Lack of proper documented procedures is also another reason for the failure in implementing regular Risk management techniques in construction projects. Hence, there is an intense need for documenting procedures which can help as broad guidelines in the proper implementation of the techniques. REFERENCES [1] Abu Rizk S., 2003, Risk and uncertainty in construction: an overview, a presentation. ( ysis and management-sabourizk.pdf) [2] Association for Project Management, 2000, Project Risk Analysis and Management, a guide by APM. [3] Baloi D., & Price A., 2003, Modeling global risk factors affecting construction cost performance, International Journal of Project Management 21, pp [4] Chapman RJ, 2001, The controlling influences on effective risk identification and assessment for construction design management, International Journal of Project Management 19, pp Jan [5] Chapman C. & Ward S., 1997, Project Risk Management: Processes, Techniques and Insights. John Wiley. ; Ward & Chapman, 2003 [6] Chapman, C., & Ward, S. (1997). Project Risk Management: Processes, Techniques, and Insights. New York, NY: John Wiley & Sons. [7] Clough and Sears, 1994 [8] Flanagan R. & Norman G., 1993 Risk Management and Construction, 2nd Edition. Blackwell Science. [9] Hinze, 2001 [10] Jaafari, A. (2001). Management of risks, uncertainties and opportunities on projects: Time for a fundamental shift. International Journal of Project Management, 19(2), [11] Kindinger J. & Darby J., 2000, Risk factor analysis A new qualitative risk management tool, Proceedings of the project management institute annual seminars & symposium. [12] Kuismanen O. et al, 2001, Risk interrelation management controlling the snowball effects, Proceedings of the 5th European Project Management Conference, PMI Europe. [13] Lowe J., 2002, Construction & Development Risk, Unit 4, Glasow Caledonian University. [14] Murdoch and Hughes, 2000 [15] NAO, 2001 [16] Office of Project Management Process Improvement, 2003 [17] Raftery, 1997 [18] Raftery, J. (1994). Risk Analysis in Projects. London, England: Chapman & Hall. [19] Watson,

Project Risk Management. Prof. Dr. Daning Hu Department of Informatics University of Zurich

Project Risk Management. Prof. Dr. Daning Hu Department of Informatics University of Zurich Project Risk Management Prof. Dr. Daning Hu Department of Informatics University of Zurich Learning Objectives Understand what risk is and the importance of good project risk management Discuss the elements