Risk Management

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 What is Risk?
• A dictionary definition of risk is “the
possibility of loss or injury”
• Project risk involves understanding
potential problems that might occur on
the project and how they might impede
project success
• Risk management is like a form of
insurance; it is an investment

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 Speculative risk
A speculative risk is a risk that accompanies
the possibility of earning a profit.
 Most business decisions, such as the
decision to market a new product, involve
speculative risks.
 If the new product succeeds in the
marketplace, there are profits; if it fails, there
are losses.

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 Pure risk
A pure risk is a risk that involves only the
possibility of loss, with no potential for gain.
 The possibility of damage resulting from
hurricane, fire, or auto accident is a pure risk.
 In the above examples, there is no gain or
profit if such damage does not occur.

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Why Take Risks? Because of
Opportunities!

Try to balance risks and opportunities

Risks Opportunities
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 Risks and Uncertainties –
Basic concepts
 Risks and uncertainties are associated with specific
events/activities which can be individually identified.
 A risk event has a range of outcome and each
outcome has a probability of occurrence
 Some risks only has adverse consequences (loss);
e.g. structural collapse, bankruptcy: low/high
probability but high impact
 Common risk in construction offer either loss or gain
prospect; productivity, variation, inflation: typically
high probability with low or high impact

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 Costs of Risks
Any risk entails two types of costs.
 The first is the cost that will be incurred if a
potential loss becomes an actual loss.
 The second consists of the costs of reducing
or eliminating the risk of potential loss.
 These two types of costs must be balanced
against each other if risk management is to
be effective.

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 Risk management
   Risk management is the process of
evaluating the risks faced by a firm or
an individual and then minimizing the
costs involved with those risks.

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 The Importance of Project
Risk Management
• Project risk management is the art and
science of identifying, assigning, and
responding to risk throughout the life of a
project and in the best interests of meeting
project objectives
• Risk management is often overlooked on
projects, but it can help improve project
success by helping select good projects,
determining project scope, and developing
realistic estimates
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 Risk Management
 Requires that we accept that uncertainty exists
 Generate a structured response of risk in term of
alternative plans, solutions and contingencies
 Is a thinking process requiring imagination and
ingenuity
 Generates a realistic (and sometimes different)
attitude in project staff by preparing them for risk
events rather than being taken by surprise when
they arise

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 Risk Management
• The goal of project risk management is to
minimize potential risks while maximizing
potential opportunities. Major processes
include
– Risk identification: determining which risks are
likely to affect a project
– Risk analysis: evaluating risks to assess the
range of possible project outcomes
– Risk response development: taking steps to
enhance opportunities and developing responses
to threats
– Risk response control: responding to risks over
the course of the project
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 Risk Identification
HIGH
RARE PROBABLE
CATASTROPHE DISASTER

IMPACT

LIKELY & FREQUENT/

MINOR TRIVIAL
LOW
HIGH LIKELIHOOD LOW
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 Time, Financial, and
Technology Risk
• Time risk: Will the new project complete
according to schedule? What is the effect of
delay to this project?
• Financial risk: Can the organization afford to
undertake the project? Is this project the best
way to use the company’s financial
resources?
• Design/Technology risk: Is the project
technically feasible? Could the project design
accommodate future changes?

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 Potential Risk Conditions Construction
Project
Risk Conditions
Integration   Inadequate planning; poor resource allocation; poor integration 
management; lack of post -project review  
Scope   Poor definition of scope or work packages; incomplete definition 
of quality requirements; inadequate  scope control  
Time   Errors in estimating time or resource availability; poor allocation 
and management of float; early release of competitive products  
Cost   Estimating errors; inadequate productivity, cost, change, or 
contingency control; poor maintenance,  security, purchasing, etc.  
Quality   Poor attitude toward quality; substandard 
  design/materials/workmanship; inadequate quality assurance 
program  
Human Resources   Poor conflict management; poor project organization and 
definition of responsibilities; abse nce of leadership  
Communications   Carelessness in planning or communicating; lack of consultation 
with key stakeholders  
Risk   Ignoring risk; unclear assignment of risk; poor insurance 
management  
Procurement   Unenforceable conditions or contract clauses; ad
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 Primary sources of risk
Physical Loss or damage by fire, earthquake, flood, accident,
landslide

Environ- Ecological damage, pollution, waste treatment

Public enquiry
mental
Design New technology, innovative applications, reliability,safety
Detail, precision and appropriateness of specifications
Design arising from surveys, investigations
Likelihood of change
Interaction of design with method of construction

Logistic Loss or damage in the transportation of materials and

equipment
Availability of specialized resources
Access and communications
Organizational interfaces
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 Primary sources of risk
Financial Availability of funds, adequacy of insurance
Adequate provision of of cash flow
Losses due to default of contractors,suppliers
Exchange rate fluctuations, inflation, taxation

Legal Liability for acts of others, direct liabilities

Local law, legal differences between home country and
countries of suppliers, contractors, designers

Political Political risks in countries of owner and suppliers,

contractors – war, revolution, changes in law

Construc- Feasibility of construction methods, safety

Industrial relations
tion
Extent of change, Climate, Quality and availability of
management and supervision

Operational Fluctuation in market demand for product or service

Maintenance needs, Fitness for purpose
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 Risk Analysis
 Many risks are quantifiable in term of
terms of their effect on cost or time or
revenue
 Can be analysed by measuring their
effects on the parameters used to
assess project or contract viability
 Application of statistical probability

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 Risk analysis techniques
 Sensitivity analysis
 Probability analysis (e.g. Monte Carlo)
 Decision tree
 Utility theory

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 Sensitivity analysis
 SA seeks to place a value on the effect
of change of a single variable within a
project.
 Defining a likely range of of variation for
those variables which have a high
impact on cost, time or economic return
and to which the project will be most
sensitive.
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Sensitivity Analysis – Spider Diagram

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Sensitivity Analysis – Spider Diagram

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 Sensitivity diagram with
Probability contours

Aaaa

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 Probability Analysis
 Specifying a probability distribution for each
variable and then considering situations
where any or all of these variables can
change their initial values at the same time.
 Though defining probability of occurrence
may be difficult, it has proved possible to
make a tentative estimate
 Example using Monte Carlo technique

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 Decision tree
 Graphical means of bringing together the
information about investment possibilities and
a sequence of decision choices.
 It shows the present possible courses of
action and future possibilities
 It requires the decision maker to place some
degree a probability on an outcome occurring.

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 Utility theory
 Utilitytheory attempts to take into
account of the attitude of the decision
maker to risk or to the magnitude of risk
 It endeavours to assess the decision
profile of the decision maker and
formalize management’s attitude toward
risk

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 Risk Utility
• Risk utility or risk tolerance is the amount of
satisfaction or pleasure received from a
potential payoff
– Utility rises at a decreasing rate for a person who
is risk-averse
– Those who are risk-seeking have a higher
tolerance for risk and their satisfaction increases
when more payoff is at stake
– The risk neutral approach achieves a balance
between risk and payoff

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Risk Utility Function and Risk
Preference

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 Risk Responses
• Risk avoidance: eliminating a specific
threat or risk, usually by eliminating its
causes
• Risk acceptance: accepting the
consequences should a risk occur
• Risk mitigation: reducing the impact of a
risk event by reducing the probability of
its occurrence

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 Risk Avoidance
 In extreme cases, risks may have serious
consequences as to warrant a reappraisal or
even the replacement of the project by an
alternative one.
 Such an action should be determined at the
project appraisal stage
 Risks can be avoided by redesign, different
packaging of the work content or different
method of construction
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 Risk Acceptance
 An individual or firm will-and probably must-take on
certain risks as part of living or doing business.
 Risk assumption is the act of taking responsibility for
the loss or injury that may result from a risk.
 Generally, it makes sense to assume a risk when one
or more of the following conditions exist:
- The potential loss is too small to worry about.
- Effective risk management has reduced the risk.
- Insurance coverage, if available, is too expensive.
- There is no other way of protecting against a loss.

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 Risk Reduction
If a risk cannot be avoided, perhaps it can be reduced.
In general risk may be reduced by:
 Obtaining additional information
 Performing additional tests/simulations
 Allocating additional resources
 Improving communication and managing
organizational interfaces
 The risks involved in management decisions can be
reduced only through effective decision making.

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 Risk Transfer
 Common route of risk transfer in construction projects
are:
- client to contractor or designer
- contractor to sub-contractor
- client, contractor,sub-contractor or designer to
insurer
- contractor or sub-contractor to surety

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 Risk Transfer
The transfer of risk should ensure the client best
interests in the project.
Factors to consider:
 The party which can best control the events which
may lead to the risk occurring
 The party which can best control the risk if it occurs
 Whether or not it is preferable for the client to retain
an involvement in the control of the risk
 The party to carry the risk if it cannot be control

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 Risk Transfer
 Whether the premium to be charged by the party to
which the risk is allocated is reasonable and
acceptable
 Whether this party is likely to be able to sustain the
consequences if the risk occurs
 Whether, if the risk is transferred, it leads to the
possibility of risks of a different nature being
transferred back to the client

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 Risk Transfer
The most commonly used method of dealing with risk is to
shift, or transfer, the risk to an insurance company.
 An insurer (or insurance company) is a firm that agrees,
for a fee, to assume financial responsibility for losses
that may result from a specific risk.
- The fee charged by an insurance company is called the
premium.
- A contract between an insurer and the person or firm
whose risk is assumed is known as an insurance policy.
 Insurance is thus the protection against loss that is
afforded by the purchase of an insurance policy.

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 Risk Management Plans,
Contingencies
• A risk management plan documents the
procedures for managing risk throughout the
project
• Contingency plans are predefined actions that
the project team will take if an identified risk
event occurs
• Contingency reserves are provisions held by
the project sponsor for possible changes in
project scope or quality that can be used to
mitigate cost and/or schedule risk
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 Contingencies
The setting of contingencies is an
essential part of project management
Three types of contingencies:
 Time (float)
 Cost (allowance in budget)
 Performance/quality (tolerance)

This requires a named person in-charged

and consistent monitoring
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 Application of
risk management
 The greatest degree of uncertainty about the
future is encountered in the appraisal stage of
a new project
 Decisions taken in this stage tend to have the
largest impact on final cost
 Change is an unavoidable characteristic of
major capital projects and its extent and
effects are frequently under-estimate during
this phase
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 Application of
risk management

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Risk decision during appraisal
 Therelated decisions or action during appraisal
stage:
- identification of all project risks
- quantification of each risk in term of time and cost where
possible
- assessment of relative impact/probability of each risk
- identification of the most serious risks for consideration
project management
- allocation of these risks to various parties, establishment
of contingency funds to protect the client against those
risk which are unavoidable and retained by him

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 Top 10 Risk Item Tracking
• Top 10 risk item tracking is a tool for
maintaining an awareness of risk throughout
the life of a project
• Establish a periodic review of the top 10
project risk items
• List the current ranking, previous ranking,
number of times the risk appears on the list
over a period of time, and a summary of
progress made in resolving the risk item
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 Example of Top 10 Risk Item
Tracking
Monthly Ranking
Risk Item This Last Number Risk Resolution
of Months Progress
Month Month
Inadequate 1 2 4 Working on revising the
planning entire project plan
Poor definition 2 3 3 Holding meetings with
of scope project customer and
sponsor to clarify scope
Absence of 3 1 2 Just assigned a new
leadership project manager to lead
the project after old one
quit
Poor cost 4 4 3 Revising cost estimates
estimates
Poor time 5 5 3 Revising schedule
estimates estimates
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 Project Manager’s roles
 An in-depth study of risk and uncertainty for
all projects
 Estimates cost and time that include specific
contingency allowance and also provide
ranges commensurate with the identified
major risks and uncertainties built in
 Proposal of ways of at least reducing effects
of risks and uncertainty
 The adoption of methods for allocating the
remaining risks to the various parties in a way
which will optimise project performance
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 Project Manager’s roles
 The recognition that risk and reward go hand-
in-hand and that the allocation of risk to a
party should be accompanied by a motivation
for good management
 An open minded approach to innovative
solutions to problems
 A regular and preferably independent review
of project proposals and conceptual design to
reduce misunderstandings and ensure that
the full spectrum of uncertainties is exposed
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 Using Software to Assist in
Project Risk Management
• Databases can keep track of risks
• Spreadsheets can aid in tracking and
quantifying risks
• More sophisticated risk management
software helps develop models and
uses simulation to analyze and respond
to various project risks
e.g. @RISK
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