MCM4433 Project Risk Management Chapter 1: Introduction to Risk Management

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Chapter 1: Introduction to Risk Management

1.0 Nature of Construction Industry

The construction industry is undeniably one of the most dynamic, risky, and
challenging sectors. Unfortunately, it has garnered a poor reputation for its handling
of risks, with numerous major projects failing to meet their deadlines and cost
projections. Several factors contribute to this, including the unpredictable influence
of weather, fluctuations in labor and equipment productivity, and variations in the
quality of construction materials.

Regrettably, risks are frequently either disregarded or addressed in an arbitrary

manner. The common practice of simply adding a 10% contingency to the estimated
project cost often proves insufficient in a complex field like construction. This
approach frequently leads to costly delays, legal disputes, and, in extreme cases,
bankruptcy.

In reality, risk management is a vital component of the decision-making process for

construction companies. Both risk and uncertainty can pose significant threats to
construction projects, potentially affecting productivity, performance, quality, and the
project's budget. It's essential to recognize that risk cannot be entirely eliminated,
but it can be mitigated, transferred, or accepted to some extent.

The construction industry is inherently complex with a multitude of factors at play. It

necessitates a more sophisticated and comprehensive approach to risk
management. Proactive risk management strategies are vital to ensure the
successful and cost-effective completion of construction projects in this challenging
and dynamic field.

2.0 Definition of Risk Management

In the context of risk management, it's essential to define risk management as “the
systematic process of identifying, analyzing, assessing, and mitigating risks to
achieve project objectives effectively and efficiently”. In the construction industry,
this involves recognizing the intricate interplay of factors, adopting proactive
strategies to address potential risks, and continuously monitoring and adapting the
risk management plan to ensure successful project outcomes. Ultimately, risk
management in construction aims to minimize uncertainties and enhance the overall
project's chances of success in this challenging and dynamic field.

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3.0 Risk Assessment, Analysis and Management

Risk assessment, analysis, and management are fundamental components of the

risk management process. They play critical roles in identifying, understanding, and
mitigating risks in various domains, including business, finance, and, as in this
context, construction. Let's explore these components in the context of risk
management:

3.1 Risk Assessment:

Identification of Risks: The first step in risk assessment is to identify potential risks
that could impact a construction project. These risks can be internal (related to the
project itself) or external (related to external factors like weather or regulatory
changes).

Risk Categorization: Risks are typically categorized into different types, such as
financial risks, operational risks, safety risks, or legal risks. Categorization helps in
understanding the nature of each risk.

3.2 Risk Analysis:

Quantitative Analysis: In quantitative risk analysis, numerical data and probabilistic

models are used to assess the impact and likelihood of each identified risk. This
analysis helps assign values to risks, such as estimating potential cost overruns or
delays.

Qualitative Analysis: Qualitative risk analysis involves a more subjective

assessment of risks. It focuses on understanding the nature and characteristics of
risks, often using tools like risk matrices or risk heat maps.

3.3 Risk Management:

Risk Mitigation: After assessing and analyzing risks, the next step is to develop risk
mitigation strategies. This involves identifying actions that can be taken to reduce
the impact or likelihood of risks. For example, if a project is susceptible to weather-
related delays, contingency plans can be developed to manage such risks.

Risk Transfer: In some cases, risks can be transferred to third parties through
contracts, insurance, or other means. For instance, construction companies might
purchase insurance policies to mitigate financial risks associated with accidents or
damage to property.

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Risk Acceptance: Not all risks can be eliminated or transferred. Some risks may
need to be accepted, meaning the project team acknowledges them and has plans
in place to respond if they materialize. This is often the case with certain market or
economic risks.

In the context of construction industry, risk assessment, analysis, and management

are essential due to the unique challenges faced by construction projects. These
challenges include weather-related disruptions, labor issues, material shortages,
regulatory changes, and more. By systematically identifying, analyzing, and
managing risks, construction professionals can make informed decisions, allocate
resources effectively, and increase the likelihood of successful project completion
within budget and on schedule.

In summary, risk assessment involves identifying and categorizing risks, risk

analysis quantifies and qualifies these risks, and risk management encompasses
strategies to mitigate, transfer, or accept risks to achieve project objectives while
minimizing potential negative impacts. These three components together form a
comprehensive risk management framework crucial in the construction industry and
various other sectors.

4.0 Risk and Opportunity

The construction industry is inherently complex, and both risks and opportunities
abound at every stage of a project which have a significant impact on project
outcomes.

4.1 Risks in the Construction Industry:

Financial Risks: Construction projects often involve substantial financial

investments. Cost overruns, budget constraints, or unexpected expenses can pose
significant financial risks. Economic downturns can also affect project financing and
profitability.

Schedule Risks: Delays in construction projects can result from various factors,
such as weather conditions, labor strikes, or unforeseen technical challenges.
Schedule overruns can lead to increased costs and client dissatisfaction.

Safety and Health Risks: The construction industry is known for inherent safety and
health risks. Accidents and injuries can disrupt project progress, result in legal
liabilities, and damage a company's reputation.

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Regulatory and Compliance Risks: Changes in regulations, zoning laws, or

permitting requirements can impact construction projects. Non-compliance can lead
to legal issues and project delays.

Quality Risks: Ensuring the quality of construction materials and workmanship is

essential. Poor quality can lead to rework, defects, and client dissatisfaction.

Environmental Risks: Construction activities can have environmental impacts.

Violations of environmental regulations can result in fines and project delays.

4.2 Opportunities in the Construction Industry:

Innovation and Technological Opportunities: Advancements in construction

technology and materials present opportunities for efficiency gains and cost savings.
Adopting innovative construction methods can differentiate a company and lead to
competitive advantages.

Sustainability Opportunities: Growing awareness of environmental sustainability

has led to opportunities for green construction practices. Companies that specialize
in eco-friendly building methods and materials can tap into a growing market.

Market Expansion: Entering new markets, both geographically and in terms of

construction sectors (e.g., residential, commercial, infrastructure), can be a
significant opportunity for growth.

Strategic Partnerships: Collaborating with other construction firms, suppliers, or

technology providers can open up opportunities for joint ventures, access to
specialized resources, and shared risk management.

Government Initiatives: Government infrastructure projects and incentives for

construction can provide a steady stream of work. Public-private partnerships (PPPs)
are also opportunities for construction companies to participate in government
projects.

Global Expansion: Expanding operations to international markets can be an

opportunity for companies with the resources and expertise to tackle projects abroad.

An effective risk management is essential to mitigate potential negative impacts on

projects, while seizing opportunities can lead to growth and success. Construction
firms often conduct risk assessments, develop risk mitigation strategies, and
continuously monitor project progress to identify and address both risks and

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opportunities throughout the project lifecycle. Balancing risk management with a

proactive approach to opportunities is key to achieving favorable project outcomes
and long-term business success in this dynamic and competitive field.

5.0 Risk and Uncertainty

The distinction and connection between uncertainty and risk can be explained as
follows: Risk represents measurable uncertainty, while uncertainty denotes
unmeasurable risk. It is the interplay of uncertainty on project objectives that gives
rise to risk. This implies that only those uncertainties which have the capacity to
impact project objectives in a meaningful way can be categorized as risks. In
essence, a risk is an uncertainty that holds significance, and its significance is
defined in relation to the specific objectives under consideration.

5.1 Nature of Risk

Risk is the probability of something bad happening in a given situation. According to

PMI (2000), risk is an uncertain event or condition that, if it occurs has a positive or
negative effect on a project’s objective. To separate it from uncertainty, we define
risk as something we can predict based on statistical probabilities. In other words,
we have some knowledge about a risky situation because we can calculate the
chances of it occurring. On the flip side, uncertainty means we have no knowledge
about what might happen. So, risk is often discussed in terms of the likelihood of a
specific undesirable event and what negative consequences or losses it might bring.

The impact of a risk can be measured as the likelihood of a specific unwanted event
and its unwanted consequences or loss:

RI = L x C,

Where: RI = risk impact;

L = likelihood; and C = consequence.

Risk factors that carry potential hazards include project complexity, construction
speed, project location, and the team's familiarity with the work. When serious risks
occur on projects the effects can be highly detrimental. In extreme cases,
unexpected delays and increased costs can transform a project that had the potential
for profitability into a loss-making endeavor.

Research indicates that cost and time targets are often missed due to unforeseen
events that even experienced project managers cannot foresee. Sometimes, these

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events are foreseeable to some extent, but their full extent remains difficult to
quantify. For example, industrial disputes, delayed decision-making, or changes in
ground conditions may be anticipated, but accurately predicting their likelihood and
impact is challenging because no two construction projects are identical. Hence, it
is crucial to identify sources of risk specific to each project. Grouping risks based on
simple assessments of their likelihood and potential impact can be helpful, allowing
focus on what truly matters and the implementation of effective risk management
measures.

Nevertheless, outcomes can be unpredictable, and sometimes costs may be lower

than expected (e.g., favorable weather conditions) or revenues may exceed
projections. Therefore, risks can occasionally be seen as advantageous, as long as
they are taken into account in project planning. Ultimately, it is the responsibility of a
construction manager to oversee risk management on behalf of the client, ensuring
that risks are appropriately addressed and managed throughout the project lifecycle.

5.2 Definition of Uncertainty

Uncertainty can be defined as the occurrence of an event for which the probability
distribution is truly unknown. In other words, uncertainty is associated with events
where very little is known except the possibility of their occurrence. It represents the
lack of information necessary to make a decision at a given moment. Uncertainty
arises when an action can result in multiple possible outcomes, but the probability of
each outcome is not known.

6.0 Cost and Benefit of Risk Management

Risk management is not about predicting the future, but understanding a project and
making a better decision regarding the management of that project tomorrow. In
project management terms, the most serious effects of risk can be summarized as
follows: failure to keep under the cost estimate; failure to achieve the required
completion date; and failure to reach the required quality and operational
requirements. Risk management can help stakeholders to avoid or alleviate these
failures.

The benefits of risks management can be summarized as follows:

• Project issues are identified, understood and taken into consideration from
the start. It allows robustness of projects to specific uncertainties to be
compared;

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• Enable decision making to be more systematic and less subjective. Decisions

are supported by thorough analysis;
• The definition and structure of the project are continually monitored and
controlled;
• Clearer understanding of specific risks associated with a project. It make the
relative importance of each risk immediately apparent;
• Development of historical data to help future risk management procedures;
• It gives an improved understanding of the project through identifying the risk
and thinking through response scenarios;
• Improve project management experience and communication. It has a
powerful impact on management by forcing a realisation that there is a range
of possible outcomes for a project.

Whereas, the cost of risks management can be summarized as follows:

• Resource Allocation: Implementing a robust risk management process

requires allocating resources, including personnel, time, and potentially
financial investments, to identify, assess, and manage risks.
• Training and Education: Organizations may need to invest in training and
educating employees and stakeholders about risk management principles
and practices.
• Technology and Tools: Utilizing risk management software and tools can be
costly, including the initial purchase or development, maintenance, and
training associated with these tools.
• Consulting Services: In some cases, organizations may seek external
expertise through consultants or risk management experts, incurring
consulting fees.
• Documentation and Reporting: Properly documenting and reporting risk
management activities can require administrative efforts and may involve
additional costs.

While there are costs associated with implementing risk management practices, the
benefits often outweigh these costs. Effective risk management not only helps
organizations avoid negative consequences but also enhances decision-making,
reduces uncertainty, and contributes to overall success and sustainability.

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7.0 Decision Making Under Certainty, Risk and Uncertainty

Risk management aids decision-makers in making well-informed decisions at every

phase of the project, allowing them to prioritize tasks and differentiate between
various courses of action. Employing the risk management process throughout the
project's lifecycle assists in shaping decisions regarding the project's feasibility, its
preferred approach, and the ultimate project design.

This approach serves as a foundation for questioning assumptions and

preconceived notions. It prompts project managers to implement measures aimed at
mitigating uncertainty concerning the organization's objectives by adjusting the
project's execution approach and the characteristics and specifications of the
ultimate deliverables.

The risk and uncertainty exists across all phases of a construction project. When
initiating a project, the client must carefully address the following inquiries:

 Is the construction of a new building truly necessary, or would expanding or

renovating the current premises suffice?
 What are the disadvantages associated with relocating to a new site?
 How much investment is warranted, and what's the expected timeframe for
realizing returns?

As the project progresses through various stages, including feasibility, strategy, pre-
construction, construction, and commissioning, a multitude of risks and uncertainties
will surface. The responsibility of evaluating and managing these risks falls upon the
risk manager or project manager.

Each 'what if ...?' scenario necessitates meticulous analysis. Risks must be identified
and documented, variables quantified to the extent possible, and the potential
ramifications of each event assessed. While an individual risk may result in minor
consequences, the combination of seemingly 'minor' risks could have significant
implications for the project. Hence, the importance of conducting a comprehensive
analysis.

By following this approach, the unexpected setbacks that often accompany

construction projects can be minimized.

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Risk management not only involves identifying risk events but also encompasses
devising strategies for prevention, avoidance, containment, or transfer. Events with
the highest degree of risk or uncertainty will likely demand the closest scrutiny,
although this determination may hinge on the event's criticality.

It is crucial to differentiate between the sources of risk and their impacts.

Nevertheless, regardless of their origins, all risks possess the potential to affect
project objectives and the key facets of time, cost, and quality.

Self-Assessment Questions
1. Risk management helps to understand a project in order to make a better
management decision. Discuss.

2. What do you understand about “risk”? Discuss its impact to a construction

project.

3. Discuss how is risk management implemented in the Malaysian construction

industry?