There are very few industries where risk and uncertainty are extremely prevalent than the construction industry. The complexities of projects that start from initial investments to completion are time consuming from the design to the production processes. In addition, projects require skilled people of all types and interests and the coordination of numerous interrelated activities. Furthermore, there are external factors that are uncontrollable that just add onto to the already complicated process of completing a project. Poor reputation in dealing with risks is what the construction industry is known for which include many projects that fail to meet deadlines and budgets. Because of poor risk management in this industry, contractors, clients, and the public have suffered in their bottom line.
Risk Management Concept
Risk management concepts are extremely important to understand the magnitude of risk involved when implementing a plan. We consider the following risk management concepts throughout the paper in detail.
Risk: the possibility of suffering a loss (harm) and the impact that loss has on the parties involved. On the other hand, is an unrealized future loss arising from a present action or in-action. Therefore, it is crucial that an organization understands and can quantify the risks that it faces.
Opportunity: the possibility of realizing a favorable outcome and the impact this outcome has on the involved party. Opportunity is positive risk and can be identified and managed in a similar way.
Uncertainty: the gap between the information required to estimate an outcome and the information already possessed by the decision maker (CII 1989). The most important point here is that outcomes of uncertainty cannot be quantified or measured and is the reason for the difference between risk and uncertainty (ACCA Text, 2008/09)
Risk Analysis: this is the second phase of risk management process after risk identification. It involves the evaluation or assessment of risk according to the likelihood of occurrence and impact on the organization. Once we identify potential risks, the next major task is to assess them by using two variables; the probability (or likelihood) of risk realized and the impact or hazard (what would happen if risk were realized). These two intersecting continua can be used to create a probability/impact grid on to which individual risks could be theoretically plotted (Campbell, 2009)
Low Likelihood High
Fig. Risk Grid
Risk Mitigation: this involves the process of developing plans to respond or deal with risk on a project. Risk mitigation is determined by the level of risk appetite of an organization, that is the amount of risk they are willing to accept to fulfill their business strategy. This risk appetite is in turn determined by risk capacity (i.e. the amount or risk organization can bear) and risk attitude (i.e. the overall approach to risk in terms of the management being risk adverse or risk seeking)
Strategies for managing or mitigating risk use the following approach: (1) transference (i.e. Risk transferred wholly or in part to third party, so that if an adverse event occurs, the third party suffers all or most of the loss). (2) Avoidance (i.e an organization might choose to avoid it risks completely by not investing or withdrawing from the business). (3) Reduction (i.e. strategy to reduce risk in the organization). (4) Acceptance (this approach is appropriate where adverse effect is minimal).
Construction risk: Construction risk are any event or circumstance that is uncertain at the execution of the contract that will have a financial impact on one or more of the parties. Every construction project must accept that it has risks that cannot be eliminated. For instance, no one can eliminate the possibility that it will rain at the project site all day during planned site work operations. Some types of risks are predictable or readily identifiable while others are sometimes totally unforeseen in the construction process.
We classify construction risks into six categories:
– Design-related risks, (defective design)
– Physical risks (labor injuries, fire, damage to equipment
– Acts of God (floods, hurricanes)
– Political and environmental risks ( changes in rules and regulations, political uncertainty)
– Construction related risks ( change orders, labor productivity)
– Financial and economical risks (inflation, unavailability of funds)
In the construction industry, there are three main crucial effects of risks as follows: (1) Failure to stay within the cost budget, (2) Failure to attain the required completion date, and (3) Failure to attain the required quality and operational requirements.
Risk Analysis and Mitigation in a construction Company- the Case of Balfour Beatty
Balfour Beatty plc is world-class engineering, construction, service and investment business. They are involved in developing and taken care of essential assets such as hospitals, schools, road, rail, utility system and major structures. They work in partnership with customers who value the highest level of quality, safety and technical expertise. Balfour Beatty main aim is to deliver reliable, responsible growth over long-term period.
Balfour Beatty adopts the following risk management process: (1) business objectives defined. (2) Opportunities and risks identified. (3) Benefits and risks assessed and quantified. (4) Action plans developed to mitigate risk. (5) Risk mitigation delivery reviewed on an ongoing basis and (6) periodic reviews up to board level.
Balfour Beatty faces certain potential business risk and they develop ways to mitigate the keys risks. These risks classification is as follows:
– External: this includes economic environment, increased customer expectations, commercial counterparty solvency, legal/regulation etc.
– Strategic: includes bidding, joint venture, acquisition, and investment
– Organization and management: includes growth, people, business conduct, information technology and information security
– Financial and treasury risk: includes treasury risk management, finance and liquidity, treasury counterparty, contract bonds, currency, interest rate and pension.
– Delivery and operational: includes performance, supply chain, health, safety and environmental.
For clarity and understanding, I have decided to consider particular business risk faced by this construction company for more detail discussion (with emphasis) on how Balfour Beatty mitigates such risks.
– Economic environment: The current economic environment causes some customers to delay (or postponed) their capital investment and asset maintenance plan which can affect the company. They mitigate risks through their broad exposure to infrastructure markets.
– Increased customer expectations: customers demand an integrated approach to the delivery of infrastructure project. They mitigate this risk by using their specialist operating service to support cross activities and provide customers with management of the delivery.
– Commercial counterparty solvency: financial exposed to major customers, subcontractors and suppliers. Company mitigates risk by rigorous checks before signing contracts.
– Bidding: company bids selectively for a large number of contracts each year and a limited number of concession opportunities. Tenders developed in accordance with proper processes for estimating and risk identification and assessment with particular attention to new characteristics.
Organization and management risk
– People: the company faces challenges on retention and recruitment of staff. They implement defined recruitment and remuneration processes, which are centrally coordinated to ensure competitive advantage.
– Business conduct: company expects highest standards of integrity and conduct from its employees in their dealings with customers, suppliers, and other stakeholders. They develop Business Conduct Guidelines and Stakeholder Codes of Practice to set out framework of expected behavior.
Financial and treasury risk
– Interest rate risk: the company has no significant borrowings (excluding PPP non-recourse term loan). The company policy is for PPP concession to use interest rate swaps to swap floating rate borrowings to fixed rates to mitigate the risk of changing interest rates.
– Treasury counterparty risk: this risk is monitored regularly and mitigated by limiting deposits in value and duration to reflect credit rating of the counterparty.
Delivery and operational risk
– Performance: company procedures embrace regular and frequent reviews with agenda centered on health, safety and environmental performance, issues affecting delivery and the impact on costs to completion and forecast revenue. They may also provide services or manages the delivery of such services on behave of clients.
ACCA Text (2008/09): Professional Accountant (PA). Kaplan publishing; Berkshire
Campbell, D. (March 2009): Risk and Environmental Auditing. Student Accountant, ACCA Magazine for trainees, pp. 46-48
Phillips, J (2006): Project Management Professional Study Guide. Second Edition, McGraw-Hill Professional: USA
http://www.investis.com/bby/investors/reports/2008rep/anreport08/anreport2008.pdf Retrieved on 28/04/09: Balfour Beatty Directors Report and Account 2008.