Risk Management in Construction

Industry

1
Outline
 Construction Industry overview
 What is Risk and Risk Management
 Risk management Frame work and processes

 The Need for Risk Management Strategy

 RiskManagement Practice in the Road Sector
 Perspective of Risk Management

 Allocation of risk through Contracts

 Improvement Initiatives
2
Construction Industry Overview

Construction is:

One of the ancient and it is a future

Backbone of economic development

Serve even as a tool to regulate the

Macro-economic trend of a country
3
Construction Industry Overview

One of the huge industries:

Involve huge money ≈ Contributes 10% of the World’s GDP
(4-6% in our case)

Employment ≈ 7% of the total employed person

It consumes ≈ 2/3 of the World energy (fuel and electric

city)

It consumes ≈ 50% the total World Resource

ECONONY WATCH
4
Construction Industry Overview

 It is exportable

 It is said to be marginally profitable

 It is Risky but Attractive

5
Challenges : Construction Industry
 Scarce resource verses infinite human
needs
 Entails complex process
 Longdevelopment period attached with
contract (with nonnegotiable terms)
 Finance intensive

 Entry and exit barrier

6
Challenges : Construction Industry
 It is Complex

◦ Uncertainty ………. (unpredictable socio-economic environment,

Change in legislation/law)

◦ Interdependency…. (resources, activities, deliveries of stake)

 It Is Chaotic

◦ It is dynamic…(Highly competitive, lots of changes: design, staff

turnover, technology, attitude, value)

◦ Non uniform environment ( one-off product, loosely coupled supply

chain, geological and other technical factors)

7
Challenges : In the Road Sector
The Country is in fast development track
less cost,
On time and
quality delivery

It is attracting more participants

Limited resources of all kind

Developing financial and insurance sector

Recently the Industry accepts the importance of Advanced

Risk management ….than intuition and judgment.

8
What is Risk
Definitions:
 Risk is the difference b/n what was expected

and happened.
 Risks are simply the future issues which can
be mitigated, rather than present problems
that must be immediately addressed
 Risk is a state of uncertainty where some of
the possibilities involve a loss, catastrophe,
or other undesirable out come

9
What is Risk...
What is the difference b/n Risk, Uncertainty and Hazard?
 Hazard is defined as the potential that have adverse

consequence, whereas, risk is defined as the

combination of hazard and its probability of
occurrence(Edwards, 1995).
 Risk is not always related to the potential result in loss
and gain. There is no pure risk (loss) or pure gain
(benefit)
 Sometimes risks are seen as an opportunity for the
party who has knowledge and experience how to
handle it

10
Risk Management
 Risk management is the systematic process of
identifying, analyzing, and responding to project risk.
 The main objective of risk management is to seek out
means to avoid risk likelihood of occurrence or reduce
its impact
 It includes maximizing the probability and consequences
of positive events and minimizing the probability and
consequences of adverse events to project objectives.
 Project risk is an uncertain event or condition that, if it
occurs, …… has a positive or a negative effect on a
project objective (cost , time and performance).
11
Risk Management framework
There are five stages in the risk management
framework
1. Risk identification
2. Risk classification
3. Risk Analysis
4. Risk Response
5. Risk Monitoring and control

12
Stage 1. Risk identification
Risk identification: the potential risks of the project can be
identified. The process include the identification of the
source and type of risks
 it
is required to identify as many as possible risks which the
project could be exposed in order to increase the efficiency
of the risk management of the project.
 Theprocess of identification and analysis of risk should be
continues process from concept to operation phase of the
project to maximize the risk control mechanism of the
project and ensure the completion of the project on time
and budget.
 Theresult of this process will be recorded in the risk
register for subsequent identification process.
13
Stage 1. Risk identification ...
Tools and Techniques for Risk Identification
1. Documentation reviews: Performing a structured review of
project plans and assumptions, both at the total project and
detailed scope levels, prior project files, and other information.

2 Information-gathering techniques: Examples of information-

gathering techniques used in risk identification can include
brainstorming; Delphi; interviewing; and SWOT analysis (strengths,
weaknesses, opportunities, and threats ).

3. Checklists: Checklists for risk identification can be developed

based on historical information and knowledge that has been
accumulated from previous similar projects and from other
sources of information. The advantage of using a check list is that
risk identification is quick and simple.

 Care should be taken to explore items that do not appear on a

standard checklist if they seem relevant to the specific project.
14
Stage 2. Risk classification
 Risk Classification : having identified as many risks as
possible, it is necessary to classify and categories risks
so that more efficient analysis and management can be
achieved.
 Risks can be classified based on their types,
consequence, and source
 Risks can also be classified based on the project
phases; pre contract stage and post contract stage

 Risks can be classified based on their source such as

physical, environmental, political, design, logistics,
financial, construction and operation.
15
Examples of Project risks Identified and classif
ied….

I. Design and tender related risks

◦ Defective design
◦ Deficiencies in drawings and specifications
◦ Drawings and documents are not issued on time
◦ Poor definition of scope of work
◦ Change of design required by owners
◦ Owners’ unreasonably imposed tight schedule
◦ Lack or departure of qualified staff
◦ Poor cost estimate
◦ Unfairness in tendering
◦ Lack of appropriate technology

16
Examples of Project risks Identified and
classified….
II. Construction related risks
◦ Poor Quality of work
◦ Accident in construction
◦ Failure to identify defects
◦ Inadequate management and planning
◦ Feasibility of construction method
◦ Delay of drawing supply
◦ Poor coordination
◦ Incompetence of contractor
◦ Delays in approvals
◦ Delays in obtaining site access and right of way
◦ Lack or departure of qualified staff
◦ Unpredicted technical problems in construction
◦ Unforeseen site conditions
◦ Material quality
◦ Low productivity of labor
◦ Low productivity of equipment
◦ Shortage of skills/techniques
◦ Owners’ improper intervention
◦ High quantity variation
◦ In appropriate organizational interface
17
Examples of Project risks Identified and classif
ied….
III. Legal and contract related risks
◦ Claims and disputes
◦ Conflicts in documents
◦ Owners’ breach of contracts and disputes
◦ Contractors' breach of contracts and disputes
◦ Delays in resolving contractual issues and disputes
◦ Stakeholders disputes
◦ Labour strikes and disputes
◦ customs and duty problems
 IV. Financial related risks
◦ Availability of funds
◦ Cash flow problem
◦ Owners’ delayed payment to contractors
◦ Owners’ sudden bankruptcy
◦ Inflation
◦ Exchange rate fluctuation
◦ Shortage in foreign currency

18
Examples of Project risks Identified and classif
ied….
V. Political and Logistic related risks
◦ War threats and political instability
◦ Corruption and bribes
◦ Changes in laws and regulations
◦ Shortage in material supply
◦ Shortage in manpower supply
◦ Shortage in equipment supply
◦ loss or damage in transportation
VI. Physical, Natural, Operation and Environment related risks
◦ Unexpected inclement weather
◦ Earth quack, landslide and flood
◦ loss or damage by fire
◦ Ecological damage and pollution
◦ Fluctuation in market demand
◦ Safety in operation

19
Examples of Project risks Identified and classif
ied….
Risks Classification based on stages of project
1. Risk associated with feasibility stages
◦ Owner’s choice of professional team & advisers
◦ Choice of construction site
◦ Adequacy of soil investigation
◦ Adequacy of finance & related calculation
2. Risks associated with design stages
◦ Inappropriate choice of design
◦ Negligence and lack of care
◦ Lack knowledge, inadequate checking
◦ Lack of safety precaution
◦ Choice of contractor and nominated sub contractor

20
Examples of Project risks Identified and classif
ied….
3. Risks during construction stage
◦ Risks associates with site of the project and its location
◦ Political risks
◦ Financial stability & economic risks
◦ Act of God – flooding , adverse geological underground
characteristics (clause 12.1)
◦ Extended duration of construction
◦ Defective design, workmanship and quality control
◦ Inadequate site management
◦ Ground movement – land slides
◦ Riot and civil commotion
◦ Labour stick

21
Examples of Project risks Identified and classif
ied….
4. Risks post construction stages
◦ Risks associated with safety
◦ Risks associated with serviceability
◦ Risks associated with natural hazards
◦ Risks associated with fitness for purpose
◦ Risks associated with project operation

22
Stage 3. Risk Analysis
 Risk Analysis: Risk analysis is involves
quantifying the impact and the probability of
occurrence of risks.
 The purpose of risk analysis is to measure the
impact of the identified risks on a project.

 There are two steps of risk analysis:

Qualitative

Quantitative

23
a. Qualitative Risk Analysis
Qualitative Risk Analysis: involves assessment of risks
using risk matrix to determine their likelihood and
potential effect on the project objectives.
 is the process of assessing the impact and likelihood of identified
risks.
 This process prioritizes risks according to their potential effect on
project objectives.

 After analyzing the risk matrix, risks can be classified as

those will require detail consideration and those do not
need to go beyond the stage by qualitative analysis.

 Risk probability and risk consequences may be described in

qualitative terms such as very high, high, moderate, low, and very
low.

The Risk Matrix … 24

a. Qualitative Assessment
H Consider
action Immediate
 Probability and impact /Contingency action
assessed based on plan
Perceptions, Judgment
and expectation
Residual risks Consider
L action

L H
I
P

25
a. Qualitative analysis..
 The output of the qualitative analysis
includes:
◦ The severity of a risk;
◦ An order of priority;
◦ Grouping of risks;
◦ Risks requiring urgent responses;
◦ A list of low priority risks to be monitored; and
◦ Risks that require further assessment.

26
Top Ten highly significant risks
 According to the practitioners’ perspective constituted from
the three parties, the following are the top ten highly
significant risks (out of 58 identified risks) influencing
projects to achieve their objectives in Ethiopia road
construction industry;
1. Defective design (c1) (t1)
2. High quantity variation (c3) (t3)
3. Inadequate management and planning (c2) (t2)
4. Shortage in foreign currency
5. Inflation (c5)
6. Cash flow problem (t5)
7. Delay in obtaining site access and right of way
8. Claims and disputes
9. Exchange rate fluctuation (c4)
10. Low productivity of equipment (t4)

By categories ... Construction and finance related risks are high

significant in the road construction industry 27
b. Quantitative Risk Analysis..
 Measuring the probability and consequences of risks and estimating
their implications for project objectives numerically (Birr/dollar)
 Quantitative risk analysis is the most sophisticated technique and involves
determination of the level of impact and probability of occurrence of
projects risks.
 The quantitative analysis is required for risks that analyzed in qualitative
analysis and have significant effect. The quantitative analysis usually uses
the project program and cost estimates to quantify the effect of risks on
time and cost constraints of the project.
 There are number quantitative techniques used to analyze the impact and
probability of occurrence of risk which includes;
 sensitivity analysis,
 probability analysis,
 Monte Carlo Simulation,
 Decision Tree Analysis and etc .

28
b. Quantitative Risk Analysis..
 The output of the quantitative analysis includes the probability of achieving
the project objectives including, cost, time and quality.
 The result can be used by contractors and employers in estimating the
contingency amount that may be required to respond for the probable
risks to achieve the project objectives. It is also used in developing
appropriate risk management strategy .

 The analysis of the project risk must include the overall impact of the risks
on the whole life of the project and this can be achieved by computing the
net present value (NPV) of each possible combination of risk impacts using
computer based analysis such as Monte Carlo simulation .
 In this process the majority of the significant risks managed and the result
will be recorded in the risk register for successive analysis.

 risk analysis techniques are not widely used in the construction industry
with the exception of decision makers’ intuitive and subjective judgment

29
Example of Quantitative analysis
Decision tree analysis:
 is a diagram that describes a decision under

consideration
 It incorporates probabilities of risks and the costs
or rewards of each logical path of events and
future decisions from the available alternatives.
 Solving the decision tree indicates which decision
yields the greatest expected value when all the
uncertain implications, costs, rewards, and
subsequent decisions are quantified.

30
Expected Monetary Value (EMV)
Example

31
 Example for Project Risk Management
Example 1
 Suppose you are leading a construction project.

Weather, cost of construction material, and labor

turmoil are key project risks found in most
construction projects:
 Project Risks 1 - Weather: There is a 25% chance of
excessive snow fall that will delay the construction for
two weeks which will, in turn, cost the project
$80,000.
 Project Risks 2 - Cost of Construction Material: There
is a 10% probability of the price of construction
material dropping, which will save the project
$100,000.
32
 Project Risks 3 - Labor Turmoil: There is a 5%
probability of construction coming to a halt if the
workers go on strike. The impact would lead to a loss
of $150,000.
 Note that in some parts of the world where unions are
strong, strikes are very common and hence would
have a higher probability.

 In this Expected Monetary Value example, we have two

negative project risks (Weather and Labor Turmoil) and
a positive project risks (Cost of Construction Material).
The Expected Monetary Value for the project risks:

33
 Hence, if the project risk occurs, the project loses:
◦ Weather: 25/100 * (-$80,000) = - $ 20,000
◦ Cost of Construction Material: 10/100 * ($100,000) = $
10,000
◦ Labor Turmoil: 5/100 * (-$150,000) = - $7,500
 Note: Though the highest impact is caused by the Labor
Turmoil project risk, the Expected Monetary Value is
the lowest. This is because the probability of it
occurring is very low.
 The project’s Expected Monetary Value based on these
project risks is:
=-($20,000) + ($10,000) – ($7,500) = - $17,500
 Therefore, if all risks occur in the construction project,
the project would lose $17,500. In this scenario, the
project manager can add $17,500 to the budget to
compensate for this.
34
Multiplication of probabilities
ANNUAL SAVINGS
0.05

INTEREST RATE $5000

$8000 0.85
0.1

12% $10000 0.10 $5000 0.05

$8000 0.85
10% 0.7
$10000
0.10
7% 0.05
$5000
0.2 $8000 0.85

$10000
0.10
Contd….

 The probability of interest rate 10% and

annual saving of $8000= 0.7 x 0.85 = 0.595
 The probability of interest rate 7% and annual

saving $10,000 = 0.20 x 0.10 = 0.020

36
Expected Rate of Return =

E( X )= å
=1
X i P ( X i )
i

 Where Xi = Variable
 P(Xi )= Probability of occurrence of that return
 Expected value is simply a weighted average

of all values where weights being the

probabilities.
Expected value computations
 For the previous example,
 The expected value of interest rate = 12 x

0.1 + 10 x 0.7 + 7 x 0.2 = 9.6

 The expected value of annual savings = 5000

x 0.05 + 8000 x 0.85 + 10000 x 0.10 =

8050

38
Example 2
Present investment = $ 6000
Discount rate = 10%
Year 1 Year 2 Year 3
Cash Probability Cash Probability Cash Probability
flow ($) flow ($) flow ($)

1500 0.25 1500 0.50 1500 0.25

3000 0.50 3000 0.25 3000 0.25
4000 0.25 4000 0.25 4000 0.50
1500: P 1500: P 1500: P
=0.25 =0.50 =0.25
3000: P 3000: P 3000: P
=0.50 =0.25 =0.25
4000: P 4000: P 4000: P
=0.25 =0.25 =0.50

3125
2875

2500

1 3
6000

2
 1500  0.25  3000  0.5  4000  0.25
NPV   6000 
1.10
1500  0.50  3000  0.25  4000  0.25
 2
1.10
1500  0.25  3000  0.25  4000  0.50

1.103
2875 2500 3125
  6000   2
 3
)
1.10 1.10 1.10
 1027.58
 Example 3
Year 2
0.2

Year 1
40000
0.3 100,000 0.6

80,000 150,000 0.2 130000 0.3

150000 0.4
110,000 0.4
160000
-200000 0.3

0.1
160000
150,000
0.3 200000 0.8

240000
0.1
NPV   200,000 
80,000 0.2  40,000  0.6  100,000  0.2 150,000
0.3(  1.12 2
)
1.12
110,000 0.3 130,000  0.4 150,000  0.3 160,000
 0.4(  1.12 2
)
1.12
150,000 0.1160,000  0.8  200,000  0.1 240,000
 0.3(  1.12 2
)
1.12
  200,000  44,866.07  86,160.71  88,010.20
 19,036.98
Stage 4. Risk Response
 Risk Response: Once the risks of the project have been
identified and analyzed appropriate risk response strategy
must be adopted in order to take the necessary steps to
minimize the negative effects of risk on project objectives.

 Risk response is an action or a series of actions designed

to deal with the presence of risk.
 There are four strategies typically used for addressing risks
including;
 risk retention,
 risk avoidance,
 risk transfer and
 risk mitigation.
44
Stage 4. Risk Response ...
1. Risk mitigation: it involves the activities used to reduce the
probability or impact of the risk.

Risk reduction can be achieved through taking proactive action to

reduce the negative effects of risk.

The process of risk reduction should be continuous from early

stage of the project to completion.

2. Risk avoidance: it involves activities to avoid the impact of risk on

the project objectives.

This can be achieved through activities including using suitable

procurement option, change the method of execution and etc.

However, total avoidance of risk is not practical as it may lead to

inflate the project cost to be uneconomical .

The most effective option of risk response is risk avoidance and

risk mitigation.
45
Stage 4. Risk Response ...
3. Risk transfer: it involves shifting the responsibility to respond for
risk to another party who is in the better position to deal with it.

Risk transfer is not aimed to eliminate or reduce risk. If more risk is

allocated to the contractor, the greater the project cost as inflated
amount of contingency budgeted for risk response. Thus,
transferring all the project risk to other party is not economical.

The transfer of risk can be achieved by using the relationship

between client, contractor, subcontractor and insurer. Risk also
shared b/n contracting parties.

4. Risk retention: it involves activities used to absorb the effect of

risk. Risks that have no significant effect and are repetitive can be
effectively managed through retaining the responsibility by the
owner of the project.
If the opportunity for risk reduction or avoidance is limited, the
opportunity remain is risk transfer and retain.

46
Stage 5. Risk Monitoring and Control
 Risk monitoring is the final stage of risk management cycle.
 The major role risk monitoring is to ensure the effectiveness
of the risk management system including identification,
analysis and response are applied to the project
 Those risks remaining after the risk response measures taken are so
called residual risks. Attention to Residual risks -to check they
remain non-significant.

 The residual risks will be considered in the subsequent analysis as

new identified risk.
 The result of the same will be recorded in the risk register for
successive analysis.

47
Fundamentals in Risk management
Risk Management:
 Refers to the culture, processes, and

structures that are directed toward

effective management of risks.

 Is the identification, measurement and

impact control of risks

48
 Identify
Assessment Effective
Risk
managemen
Respond t
Monitor/
Control

49
Risk Management Planning
 It is the process of deciding how to approach
and plan the risk management activities for a
project.
 The risk management plan may include the
following:
o Budgeting: Establishes a budget for risk management for
the project.
o Timing: Defines how often the risk management process
will be performed throughout the project life cycle.
o Reporting formats: Describes the content and format of
the risk response plan.

50
Risk management in construction industry
 The construction industry by its nature is more
susceptible to risk and uncertainty (Flanagan and
Norman, 1993).
 This is because of the size, nature, location of the
project and uniqueness of the product, usually use
temporary team and etc.
 It is not difficult to anticipate the typical and common
risks of the project based on the previous experience,
but it requires analysis to determine the significance
of the risk on the project objectives and to take
proactive actions to minimize risk effect.
 Risks affect projects to achieve its targets including
time, cost, quality and performance.
51
Risk management cont.
 The application of effective risk management to the
project facilitates the achievement of project objectives
and at same time for the project success.
 Risk management in the construction site is like
turning on the light in a dark room to see the
difficulties and obstacles hindering movement in the
room (Reid, 2005). Any activity in the darkness could
be difficult and hazardous. Hence, the application of
risk management to construction site helps
practitioners to visualize the hazard and risk of the
project and to take appropriate decisions to mitigate
their negative effects.

52
Risk management cont.
 If the project risks are identified and defined,
it will no longer be risks but the manager’s
task (Flanagan and Norman, 1993).
 The major role of risk management is to
reduce the negative effect of as many risks as
possible but not to remove all the project risks
since it is not practical to remove all risks.
 The availability of efficient risk management in
the project management plays crucial role for
the success of the project.
53
Risk management cont.
 The benefits of risk management includes reduction of
cost, reduction time and increase in value, increase
profitability, competitiveness of the company and used to
develop optimum markup during preparation of tender
and reduce dispute b/n employer and contractor.

 Risk management can be considered as project

management strategic tool that can assist mangers to
make better decision at all stages of the project and
increase the profitability and competitiveness of the
business

 However, the construction industry is very slow to accept

risk management as an important project management
tool that help mangers to make better decision
54
Importance of risk management
 Most projects are suffering from cost overrun and delays in
completion in road construction industry. In the worst cases, the
cost overrun of projects reached to the limit more than 50% of the
project cost and the delays reach more than 100% of the completion
period.
 Among various reasons for extensive delays and cost overrun
preventing projects to achieve their objectives, poor risk
management is on the top on list of the reasons.
 This implies that the construction industry require to implement
effective risk management in order to curb the current problems of
projects and minimize the negative effect of risks on the project
objectives.
 The impact of risks on the projects could be adversely affect the
industry and in general the economy. In the worst cases, some
projects reach to the point no longer feasible due to impact of risks
which could have been minimized through implementation of
effective risk management for the whole life of the project.
55
Importance of risk management
 usually the project risks are taken as the responsibility of the project
managers and decision makers.

 Usually decision makers use their experience gained from previous

project to identify and asses the level of impact and the likelihood of
occurrence of risks to the project in the industry. And there is no
formal system in the industry to counter risk and to take proactive
measure to minimize the negative effect of risk on project objective.

 usually professionals consider risk as a package instead of individual

risk and there is culture to add percentage of unit price as
contingency for uncertainty during preparation of tender.

 Professionals usually use their previous experience in estimating the

percentage of the unit price that to be add on the unit price for the
uncertainty without conducting analysis.

 It is required to change this culture in the industry

56
Risk Management strategy
 Risk management strategy is a means that
enables projects practitioners to visualize the
uncertainty of the project to take the necessary
steps timely to mitigate its effect
 the critical questions that should be answered in
the project’s risk management strategy include:
◦ How to package the project work,
◦ Which contract arrangements is appropriate,
◦ What is the basis for selecting contractors,
◦ Who is responsible for the design,
◦ What is the term of payment,
◦ How projects’ risk allocated to the contracting parties
and etc
57
Risk Management at Project Level

Risks to be managed during Pre-Bid

(feasibility stage)….. (more efficient)
Risks to be managed before commencement
during Mobilization (design stage)

 Risks to be managed during the construction

Phase (construction and post construction
stages)
 Risk register to be used for similar project
58
The Value of Risk Management
Contributes to project success;
 on time,
 on budget and
 on quality & performance
Recognizes uncertainty and provides
forecasts of possible outcomes;
Produces better business outcomes
through more informed decision making;
Project Management
Guidance

59
The Value of Risk Management…Cont

Offers better control –efficiency

effectiveness

Protectingand enhancing assets and

company image;

Is a positive influence on creative

thinking and innovation;
Project
Management Guidance
60
Risk Management
Becomes integral part of overall management

ISO developed Generic Guide line (ISO

31000:2009)

Risk Management Institutes are established

Consulting offices targeted this business

61
Perspectives on risk
 In general risk perception is influenced by:
 Practical experience
 The availability of information
 Educational background
 peer group influence
 Individual's cognitive characteristics like people's beliefs,
attitudes, judgments and feelings

 Risk loving decision makers may take or retain more risks and more
ready to use the opportunities. The converse will apply to risk averse
decision makers who are usually ready to transfer risk.

 Some contractors believe that risk management would involve

considerable amount of extra cost to the project. However, from
repeated research findings, it is noted that the total cost of risk
management is insignificant as compared to the cost that would be
incurred to mitigate the effect of risk in the absence of risk
management

62
Perspectives on risk
 The parties involved in the construction industry includes clients,
contractors, subcontractors and insurers. Each party has different
perspective based on their respective viewpoint, attitudes, experience and
benefits.
◦ Risks that could result in cost overrun and delay in time are the concern
of clients,
◦ contractors usually give more attention to project risks that would affect
their profit;
◦ workers usually give more attention to project risks related health and
safety and accidents;
◦ insurers may be concerned about insurable risks.

 Risk perception among the project practitioners can be maximized as they

allowed to participate in risk management activities and when they are
accountable for their work.

 Provision of the necessary training and brain storming the project

practitioners and decision makers increases their perception about risk.

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The Current Practice…Industry Study

Capacity Reluctant
Mistrust
Limitation to change Low bid of risk
….knowledge, …reactive
Tend for climate
analysis
system, facility approach

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Risk Allocation through contracts
Riskcan be transferred through terms and conditions of
the contract which helps to allocate risks between
contracting parties
Standardconditions of contracts (FIDIC, JCT, ICE and etc)
are designed to allocate risks to the contracting parties
thegeneral condition of contracts sometimes amended
through particular condition of contract to suit to the
project’s conditions.
theeffectiveness of risk management increases as risks
are allocated with the party involved in the management
and who is in the better position to deal with it.

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Risk Allocation through contracts...
The improper risk allocation could be the reason
for the highly inflated contractors cost as more
premium budgeted to counter the effect of risk.
◦High inflated cost,
◦claim and disputes,
◦abandon/terminate the contract
Usually contractors notified through tender
documents that to which risks they are responsible
for, and the successful tender will usually called
for pre-contract award negotiations to conclude
the owner ship of risks and etc.

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Risk Allocation through contracts...
The Principles behind contractual risk allocation
1.Thefault standard: cost & time impacts of risks caused (or not
avoided) through the fault of a party should be borne by that
party.

2.The Foreseeable standard: who is best able to foresee the risk

3.The Management standard: who is the best able to control and
manage the risk
 - unforeseen circumstance – to the employer
 - stick of labour – contractor
4.The Incentive standard: risks should be placed on the party most
in need of incentive to prevent and control them
As per the Dispute Review expert view:
◦ Who could foresee the risk?
◦ Who could best bare the impact?
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Risk Management through contracts...

 There are three principal categories of

allocation of risk in FIDIC contracts:-
(a) Entirely on the Employer: Contractor receives
extension of time and costs; Employers risk

(b) Loss lies where it falls: Contractor receives extension

of time but no costs; (adverse climatic condition) and

(c) Entirely on the Contractor: no provision for

extension of time or costs; liquidated damages
deducted.

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Risk allocation in Standard (FIDIC)
1. Risks related to death, bodily injury and physical loss or
damage
Eg. Defective design, defective material, defective workmanship, act
of God, fire, failure to take adequate precaution

 Employer’s Risks – normal and special risks

◦ Normal risks – Sub Clause 20.4 (a-h) –war, hostilities, invasion,
military usurped, civil war, radiation, nuclear and etc
◦ Special risks - Sub Clause 65.2 cum sub clause 20.4

 Contractor’s risks related to;

◦ Works - sub clause 20.1 cum 21.1 –care of works
◦ Equipment - sub clause 21.1- insurance of works and contractor’s
equipment
◦ Property of employer and property of third party - sub clause
23.1- Third party insurance (including employer's property)

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Risk allocation in Standard (FIDIC)
2. Economic or time loss risks
Eg. Late position of site, Delay in provision information, Change
design and variation

Employer
◦ Delay in performance and cost overrun
◦ Defective design by the engineer
◦ Non performance like delay in payment

Contractor
◦ Delay in performance- resulting LD – Sub Clause 47.1
◦ Additional costs due to inefficiency or otherwise
◦ Patent defects, latent defects (DLP – as per civil code)
◦ Non performance – cause 63

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Risk Management through contracts...
 The contracts serve as instruments for transferring risk from the
employer to the suppliers or contractors for delivery of projects.
 The choice of contracts may take different forms designed for
specific purposes such as economy of prices, fast track
programme, budgetary uncertainties, mitigation of claims for
disturbance and delay, multiple of small projects.

 Some examples of contracts are: -

◦ Traditional contracts (DBB)
◦ Design and build contracts
◦ Build-operate-transfer contracts
◦ Build-operate-transfer contracts
◦ Domestic sub-contracts
◦ Nominated sub-contracts
◦ Term contracts for multiple minor works
◦ Joint venture contracts

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Risk Management through contracts...
◦ Contractor’s all risks insurance,
◦ employee’s compensation insurance,
◦ third party insurance,
◦ liquidated damages,
◦ performance bonds,
◦ warranties and guarantees are typical examples where risk has been
transferred to the party (contractor and insurer) best able to manage
it.

 the employer is in the end the party suffering from the risk,
a victim of his own decision as drafter of the contracts.

 Risk sharing allocates proportions of risk to different

parties. Sharing risk has been seen as a motivation for
reducing risk and cutting project cost.

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Way to forward

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Way to forward...
 Though the construction industry realized the benefits of
risk management, it is moving so slowly to accept risk
management as project management tool.

 Thus,it is necessary to implement well established risk

management system in which project risk identified,
analyzed and appropriate response applied in order to
minimize the negative effect of risks on the project
objectives.
 It
is essential to take actions to improve risk management
system in the construction industry at all stages of the
project (from feasibility to construction stages).

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Way to forward ...
◦ This includes adoption of risk register to record and update
the risk management activities at all project stages of the
project.

◦ Proper guideline would be helpful to enhance the movement

to risk management practice in the industry.

◦ Provision of the necessary training and workshop to the

construction professionals to change their perspective about
risk management, to improve their knowledge about risk
management and to foster the risk culture in the industry.

◦ There is lot of work is expected from the Consultant and

Contractor’s Associations as well as from Ethiopia Roads
Authority – risk management department, as a major road
client in the country.

◦ It is also useful if the subject is included in the curriculum of

the formal learning institutes and universities. 75
 Create the culture, process and Structure
within the organization …… ownership

◦ It is important to communicate/ create

awareness to all levels of staff

◦ Delegation of responsibility to those responsible

for managing different organizational activities.

◦ The top management regular review reports …

internal / external

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Improvement Initiatives
 The personnel managing the risk should
have necessary :
◦ Knowledge,
◦ Skills,
◦ Information
◦ Authority

 Bench marking is advisable

 Make sure ‘Cost for risk’ is well considered and

distributed
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Thank you

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