- claimplan.org -
- Page S1 RA1 -

Risk Management in Construction.

The skills used in construction are not exact and only partly computable.

Those involved in projects often have to cope with a large amount of risk.

Uncertainty breeds risk.

A system of managing risk has to be both pragmatic and cost effective.

The management of risk uses prudence, analysis, acumen, foresight, experience and a preparedness to use an orderly approach.

Development of a Project :-  Outline Stages.

Demand gives rise to the following stages of :-
Concept, Studies, Reports, Policies, Permits & Licences, Financing, Land Acquisition and the Design & Engineering Stage.

Purpose governs demand and may be controlled by one or Multiple Parties where there are Multi-functions or Disciplines with varied Skills & Expertise giving rise to Interfaces which require Co-ordination which may develop Conflicting Interests.

The Contracting Phase is basically composed of :-
Enquiries, Tenders, Contracts, Performance and Completion followed by the Commissioning.
The Project can then be put to its Proposed Usage when Benefits and Returns are generated.
However, at all Phases and Stages there is the Possibility of RISK.

Positive Elements – Estimating Cost.

From the Enquiry Documents it is possible to determine the Finite Issues.
The Finite Issues will generate a Defined Work Scope from Quantities, Specifications and the Application.
A Time Schedule can be generated at the same time which will incorporate the Terms and Conditions from which Certainty will allow Rates to be defined.

Risk (Uncertainty) – Review Exposure.

From the Enquiry Documents it is also possible to identify the Conceptual Issues which can be Classified to say:-
Resource Availability, Performance, Location and Access, the Environment; Political, Commercial and Climatic influences and Legal, Geophysical, Market and Financial considerations which all make for Uncertainty leading to a consideration of the Probability that any or all of these factors will have on a Project.

Risk Reviewed by the Main Parties to a Contract.

The Risk in a Project can be allocated to the Employer, the Contractor and his Sub-contractors.

For the Employer these are generally composed of :-
Long Term Targets and a Complete Project Overview, these generate the Main Targets which are a Timeous Project and Use from Investment.
The Employer’s main Interests must therefore centre on Financial Soundness and Quality.
He is exposed to all the Risks.
He can maximise risk off-lay by :-
The Scope of the Works, Ensuring Performance from all Parties, Sound Commercial Control, consider All Types of Resources necessary, the Logistics required to perform the works and its warranties and any other options available.

The Main Contractor has to face two ways, to the Client and to his Sub-contractors and are more limited :-
The MC has Short Term Targets, mainly the life of the Project and an Overview restricted to the Project. His main Targets must be to Earn a Profit and ensure his Cash Recovery and Cash Flow.
The MC’s Main Interests will focus on :-
Adequate Performance, Timely Completion, Maximum Recovery with Minimum Costs and a sound basis of Financing.
He must - Minimise Risks and Lay Off Residual Risks where benficial.

The Sub-contractors have limited Short Term Targets, mainly the Project life with no proper project overview.
Their Main Objectives must also be to Earn a Profit and ensure their Cash Recovery and Cash Flows.
The SC’s Main Interests will also focus on :-
Adequate Performance, Maximum Recovery with Minimum Costs.

It should be noted that the Short Term Targets for the Main Contractor and Sub-contractor are not necessarily restricted to the project life they may also be looking to gaining further work with the same client hence performance would be a criterian. But in terms of the “Project” itself they are restricted.

Tender Prices Build Up & Development.

All contracts start for a contractor with the receipt of the “Enquiry Documents”. After reviewing these it should be possible to identify what are :-
Defined Issues, namely those works that are clear in their content and scope, and
Conceptual Issues, namely those works although they are defined by content and scope raise special questions concerning their construction.

For the ‘Defined Issues’ the Documents will or should leave no doubts on how they are to be constructed. The quality of the documents will govern this issue and for these works rates can be calculated in the normal manner from standard practises to arrive at a base cost giving rise to the base price.

Where conceptual issues are concerned these will have to be identified and assessed for risks from the documents again. Having determined the risks a decision has to be taken whether they are excluded, or included and insured for where possible. Where it is accepted means to lay off should be looked for. It is then possible to price this risk and feed it into the base price which, with an amount for profit added will constitute the final price for the works or part thereof.

The Operation of Risk Management.

At tender or Pre-Contract stages there are still uncertainties and these have got to be managed. Initially the risk has to be identified and their probabilities assessed. It is the possible to define a strategy to deal with these risks mainly by assessing their control features. The risks can then be quantified and costed. The next stage in this process is to plan the works adequately.

Once the work has been planned and the tender is accepted the contractor is obliged to complete his obligations and execute the contract during which he has to change uncertainty into certainty and maintain the contractual risk allocation and where possible convert the budget allowance into profit and avoid the risk reducing the profit which will involve locating changes and controlling their effects on the contract by Working the Plan.

However, at all phases and stages the contractor must clearly communicate internally in his own organisation upward through the company organisation , downward to the site team so that all levels of responsibility understand what is required of them in the performance of the contract.

Market Conditions – Possible Effects.

In almost all markets there is competition and construction is a prime example. Companies that compete for contracts are in one of two conditions either they have an over capacity of work or insufficient work in hand. Whatever their status it may be in the company’s interests to actively seek work and they may be driven by market changes or a change in projects criteria that they are looking to carry out.

Whether they are over or under capacity Project Financing is a critical factor in their considerations and this will control the schedule pressure and the contract conditions.

However, Risk is present in all these factors which will give rise to a degree of uncertainty which can be kept or offlayed, either way it is managed and allowed for. It can then be priced and the contract carried out which should generate a profit that is the purpose in the end.

Taking Risks – The Basics.

For every risk there should be a reward but it should be proportional.
The Party that takes the risks should be the party that can best manage the risks.

If there is doubt that a Party cannot manage the risk do not pas on or take the risk. If a risk is passed to a non competent party it is possible to increase the exposure to further risk and the divesting party still has the original risk.

However, it should be noted that whilst off loading risks reduces exposure it can also lead to a reduction in revenue.

Assessment of Risk – Main Considerations.

The parties to a contract are generally the employer and his consultants, the Contractor, Subcontractors, where used, and the Suppliers, particularly where warranties are involved. The main concern is that the role that the party plays in the project should be normal to the party’s business. If this is the case then the parties are in a position to adequately assess the extent of the proposed risk.

As the parties are experienced in their fields they should be able to assess the philosophy of the risks and should look to minimise their exposure. However, once the risk is acceptede the parties should be quite clear on what risks they are accepting and the degree of exposure involved.

It should, thus, be axiomatic that a high degree of risk will generate a high price tag, and where a supplier is involved if he receives an order he is accepting the risks that he has recognised and assessed.

The final main area of consideration should be concern for the resources available for a project, this applies to both human, permanent and temporary materials. Are there sufficient resources for the work and to cover the assessed risk. If resources are NOT available a review should be carried out to determine how the liability will be discharged.

The Outline Management of Risk.

In managing the inherent risk it is necessary to identify the features which will control the risk It should then be possible to reduce or mitigate the risk to some degree and this will generate some form of profit and at the same time should limit costs which should improve the profit.

The Components of Risk Management.

The basic steps in any risk management exercise are similar to normal contract / project management, namely :-
Identify the risk, develop a strategy to deal with the risk, incorporate the risk into the planning for the project and this should demonstrate that how the risk will be controlled and how it will be executed in the performance of the project.

However communication is of paramount importance at all stages.
(The elements of communication will be demonstrated later in the draft.).

The Definition of Control.

The basic requirements for any form of control are to understand what the objectives are and how they will be achieved namely by adequate planning. Thus it is necessary to know what is required to meet the objectives, when the objectives are to be met who is to meet them and how are the objectives to be met.

When all these factors are determined and planned for and the work is being implemented it is vital to monitor or audit the performance(s).

The audit should show where there is non conformance with the plan and possibly why and the impact can be reviewed and assessed. In the normal course of events suitable corrective action can be put in place. The circle will again operate.

The Components of Control.

With what should be a normal pro-active management the necessary control methods and documentation will already be in place and would, in all probability contain means of auditing / monitoring cost, time (schedule) and documents for the project. The audit process can be facilitated by having a user friendly or familiar systems in place for record keeping and monitoring. The net criterion to observe is that the auditing records are accurate. This point must be hammered home to all levels of responsibility and reporting. Without accurate audit response the whole system falls down as it is not possible to develop meaningful and reliable trends and forecasts which aide the identifying of performance shortfalls and the resultant problems which can negate sensible and positive actions being taken where necessary.

Change – The Impact on Risk.

When a change is instructed there could be an immediate affect on the contracted balance of risk. It may increase, or decrease (which is rarely the case), the eposure to the contracting parties who are responsible for performance. It, the change, may even impact on supplier warranties and guarantees and in any review the long as well as short term affects should be carefully considered from three main aspects, engineering, procurement and construction. Are the project variables affected if so what are the affects on time and resources.

Any affect to balance, exposure or to the variables will impact on the costs knocking on to the price and ultimately will cause a change to the anticipated profit.

The Influence and Control of Change.

With any change there are two main features, what do they affect or influence and how are they controlled.

Change has an impact internally to organisations, resource availabilities, objectives, technologies and methods used which will influence productivity and determine the skills and experience required for the works.

It can also impact externally on the client and may involve government departments & authorities, particularly if licences, permits or notices are involved. Change can also be affected by the environment and location of the works, particularly where sensitive industrial and commercial projects may be concerned say, and finally third parties can be drawn in where they were not involved before depending on the nature of the works and the changes instructed.

The major control features available stem from the level and experience of the project management skills available at the time and how the contract has been initially contracted through the documents governing the administration of the contract. These can influence and be influenced by the techniques employed to deal with the change and known or established procedures and practises which can be brought into use or are being used by the performing party or as directed by the client.

The Control Process of Change.

The steps involved in controlling change arestraightforward and follow a logical path :-
The change is identified and can be evaluated and quantified.At the same time action options can be considered and assessed for impact on the current planning and a course of action determined, this can then be fed back into the cost process and the current planning should be adjusted, if required. These steps are all necessary before any action can be implemented and the resultant performance audited and assessed.

However, there must be accurate and up to date information available at all stages of this chain of actions. The accuracy and completeness of review assessment and audit information cannot be emphasised too much the follow up results can be critical to any decision making process required at say later stages and inaccurate information may have disastrous affects on the final financial situation of the project or resources under consideration.

Communication Whilst Managing the Risk.

The main objectives of any contract or project are :-
Minimum commitment and / or minimum investment cost, delivery on schedule, to a specified quality, within budget price, so that the project can be put to its intended purpose.
For these processes to be effective and effected the main catalyst to each objective of the project is COMMUNICATION. ***Quote examples.

The Communications Breakdown (or Build Up ?).

There are two parties to any communication the Originator and/or Issuer and the Recipient(s).

The Contracting Parties instruct and raise questions, confirm actions and give answers. The instructions can be for information, action or record. The questions may be to request information, serve notices or convey information. They can also involvele third parties in the resulting chains of exchanges.

Communication can be internal or eternal to the parties, and the method used is either Oral or written.

The resultant circular format shown in the impact sketches is only one way of portraying the process, but it is the core of any successful communication process.

Classification of Communications.

Basically, on any contract or project communication falls into five (5) main groups. These are :-
Contractual / Legal. This should cover, but not be restricted to :-
Enquiry documents, Tenders, Contracts and amendments, Change Orders / Variations, Notices, Bonds & Guarantees, Insurance Policies, Certificates, claims and Instructions.

Commercial, covering, but not restricted to :-
Invoices both Inward & Outward, Payments both In & Out, Shipping Documents, Goods Received and Final Accounts.

Controls, which could cover, but not restricted to :-
Time & Resource schedules and planning, Resourcing, Progress Monitoring / Auditing, Budgets & Costs Reports, Cash Flows, Document Registers and Transmittals.

Technical subjects such as :-
Drawings, Specifications, Enquiries, Tenders, Bills of Quantity, Instructions, Approvals, QA/QC, Manuals, Queries & Clarifications.

Administration, which could cover areas such as :-
Reports, All Correspondence (at least one main file containing one copy of all correspondence concerning the project), Transmittals, Minutes of Meetings, Management Accounts.

As with any company, contract or project the contents of the groups will vary, unless an international SBS system is employed. It can be argued that Bo Q’s are commercial etc. The purpose is to establish a clarification on any project for the system employed. The only reasonable pre-requisite is that, for any project, there is one main file which contains the original copy of all outgoing, incoming and interdepartmental piece of paper raised an used or referred to during the administration and performance of the contract and any post contract communications.

The Management of Communication.

As with any process communication has to be managed.

For any communication there is an originator and a recipient who will distribute the item to any personnel or departments that may be involved which will, of course, include the actionee(s).

Generally the recipient of the communication, particularly if it is written, will be to the head source of the contracting or client party or the recipient party’s nominee who represents the party for the purpose of the contract. The nominee will generally have the necessary authority, accountability and responsibility in the organisation’s lines of reporting, communication and responsibilityfor the initiation of the process.

Likewise for any response raised this will normally be generated by the actionee, if a response is required and the reverse process of the chain will be activated.

Where oral communication is made it is sometimes usual for the orality to be transposed to document format at some stage and this will follow the reverse chain action process.

The Essentials of Communication.

There must be clear lines of communication at all times and these must be apparent to all contracting parties.

The Originator and Recipient must either be specified under the contract or have agreed authority to act in either capacity.

The language of the communication should be as per the contract but in the case of oral communications this can vary depending on the location of the contract and the particular parties to the oral communication.

The purpose of the communication has already been classified in a previous section

The distribution of the communication can be varied, it may be as per contract, as per the parties established procedures or as previously discussed, or on a need to know basis.

The methods of communication can be written, on paper or e-mail, or oral say by telephone or at a meeting. The style can be diagramatic, prose or vocal. It should be clear, precise and accurate with no room for ambiguity.

Poor Communication.

Poor communication will result in all or some of the following ;-
Uncertainty, confusion, errors, conflicts, duplication, inconsistency or indecision.

Any one or a combination of any of the foregoing may lead to a loss of control. This could cause either delay or increased cost or increased risk or a combination of these which would inevitably erode the financial risk allowance impacting on profits and could give rise to disputes and claims.

Claims and Risk.

There are two major approaches to managing both claims and risks, either in a reactive manner or by a pre-emptive approach.

If we examine the reactive approach nothing is effected or done until there is a causal action. This may cause actual costs an / or delays (which can also attract costs of their own), and, depending on their time window, there may no opportunity to eliminate or mitigate their effects. Thus recovery of costs and time are a necessity.

It then becomes necessary to research the causes, determine the responsibility, gather evidence and develop a case for a claim. This will inevitably incur the expenditure of time and resources (human), probably involving management and specialist which may result in unrecoverable costs.

In a possible settlement this may be affected by or better action to mitigate losses. Counterclaims may result and there is a lengthy chain of action formed. There is no leverage to mitigate or recover losses and very often the final course of action is arbitration or litigation.

With a pre-emptive approach it means that risk has already been identified and control measures have been put in place and it has been communicated to responsible areas where the performance of the change and risk can be monitored and trends and forecasts suitably assessed. The responsibility for performance has been nominated and the impact can be analysed and quantified. This allows decisions to be taken to either avoid the impact of the change on the risk or mitigate it with a fair chance of financial recovery. It is then possible to attempt to eliminate the cause(s) or, say, accelerate to get back on program. In either event it is possible to reasonably claim costs or instigate a claim for recovery of costs.

With any of these actions, as the risk was catered for but the change or variation could not have been foreseen the performing party can assume a degree of control and he has some leverage to resolve the issues as they arise with the changes.

As a result there is a more efficient use of management and specialist involvement, when used, to enhance profit, succeed with claims and consequently improve revenues and cash flows.

Communication – Effective Risk Management.
The “Best Practises” Principles.

Risk is recognised prior to commitment and only accepted if it is capable of being successfully managed. This can only be accomplished if the work scope is precisely defined in terms of volume and how it is to be performed to what quality (specification). This has to fit into a predefined planned time frame of activities logically combined with all the interfaces, restraints and dependencies defined for the activities which have been adequately resourced and will be supplied by a workable procurement strategy.

The works has to have a properly structured contract with a balanced risk distribution with clearly defined duties and obligations for all the contracting parties. (If risk is unduly proportioned to one party then this must be clearly defined and the resulting prices duly accepted by the other party.).

Adequate performance can then be reasonably expected and the performing party should be able to carry out the work to the plan thereby discharging his duties and obligations under the contract. This can be controlled and audited throughout the progress of the works. If the work is proceeding adequately there should be little problem in maintaining a reasonable communications networkwhere changes are readily recognised and accepted and the necessary follow up actions for financial settlement can be invoked and followed up logically by all the parties involved.

Under these circumstances it is reasonable to :-
DO WHAT YOU ARE PAID FOR AND GET PAID FOR WHAT YOU DO.

Effective Risk Management.
The Main Phases.

The object of any contract is that one party contracts with a second party (or more), to carry out an obligation for a consideration. (That consideration is usually financial).

At pre contract stage the risks are assessed, classified and a strategy evolved to control the risks. Thus the work is Planned.

During the execution of the project work is implemented under the project plan which has acknowledged and allowed for risks and financial recovery is managed. Uncertainty is changed to certainty, changes are identified and quantified also those which affect risks are covered and formal price and time adjustments are made. Work is carried out to the plan.

Post execution if there are claims or unsettled disputes then the normal recourse actions to settle these can be implemented to ensure that all work is duly and properly paid for . In other words recover the plan.

Effective Risk Management – Summary.

The performance of a contract should be to schedule with the scope of the performance known with respect to quantity, the quality required and the way in which it is to be carried out. This includes for all risks identified. This does not allow for changes made during the performance of the contract. These will impact on the risks but uncertainties will be eliminated or mitigated as the risks were identified prior to the start of the contract.

Thus the work proceeds according to the contract and with the known budgets for the works (labour, materials, equipment etc) making up the cost for the works.

Financial recovery is made during the performance of the works or as specified in the contract. This also includes for the allowances made for risks. Risk costs may be reduced or even eliminated during the course of the execution as they should have been priced into the costs along with a normal profit allowance. Savings made on the risks will be converted into a additional profit which should increase the overall profit margin.

Overall Summary.

Market trends may lead to a high degree of competion which may enforce lower prices and resultant profits. The Egan Report has identified that in construction contracts wastage can be as high as 30 %, if efficiency and more efficient materials controls are adopted this could cut wastage and improve profit margins.

The best way forward on a contract is to avoid confrontation and attempt to base success and increased profits on mutual trust, co-operation and good communications between the parties.

Conflicts and / or disputes will, by and large, lead higher costs and questionable results. In the UK, at least, there is a marked decline (approx. 35 %) in litigation and / or arbitration.

The key factor with risk is to make realistic risk assessments and allocations which should result in sensible and acceptable final prices for works.

David T Lewis.
17 Mar 02.