Lec RMC - 4a

Risk Management in
Construction
Lec 4a
1
Risk Management in Projects
By
Martin Loosemore
Chapter 3
Risk and opportunity analysis
2
Introduction
• Having identified a potential risk and opportunity, the
next step is to analyze it
• Risk analysis is the process of evaluating identified risks
and opportunities to discover their magnitude, whether
they merit a response, and how responses should be
prioritized in the light of limited budget
• A misconception about risk analysis- it always involves
complex statistical procedures and computer programs
• Further due to increased obsession with numbers and
computer analysis, the quantitative techniques are
gaining inordinate amount of attention
3
Introduction
• It is possible to conduct a risk analysis competently,
consistently and comprehensively without the use of
mathematics
• Indeed, most risk analyses are carried out in two stages:
– Stage one- A qualitative analysis of risks and opportunities
using descriptive scales as high, medium and low
– Stage two-
• A quantitative analysis of risks and opportunities using
numerical estimates.
• This is normally conducted on risks and opportunities
which emerge as particularly important from stage one
and where reliable data for analysis is available
4
Quantitative Vs Qualitative
Risk Analysis
• Because of faith in numbers, managers remain under
pressure to look to statistical calculations which are
considered to be convincing and unchallengeable to justify
their decisions
• For these reasons, many managers believe that if one is not
doing quantitative risk analysis then one is not doing risk
analysis at all
• This perception is wrong and potentially dangerous.
• First, reliable quantitative risk analysis is not always possible
because of difficulties in attaching reliable statistics to many
types of risks (particularly those which arise from human
'sources).
• Indeed, it is rare to find a situation where the numerical data
available to decision-makers is any more than an, estimate.
5
Risk Analysis
• It may be a good estimate, but an estimate nonetheless.

• In this situation; playing mathematical games with intrinsically
inaccurate data will not only incur unnecessary costs and time
but may compound basic inaccuracies, encourage undue
confidence and increase the risk exposure of the organisation.
6
Risk Analysis
• Broadly speaking, you should conduct a quantitative risk
analysis only:
– When you have first conducted a qualitative analysis
– On the risks which emerge as particularly important from
qualitative Analysis
– When you have sufficient time or when time becomes
available
– When you have reliable data to assign numbers to
probabilities or when data becomes available
– When it makes sense to attribute numbers to the
consequences of a risk
– When you have the necessary expertise or support to
conduct and interpret the results of a quantitative analysis.
7
Risk Analysis
• The key point is that risk analysis needs good
information but this does not necessarily mean numerical
information.
• This has been supported by the many highly successful
organisations which go no further than qualitative risk
analysis.
• To them, the primary benefit of risk management is in
forcing people to set job priorities and to think through
projects in more detail.
8
Qualitative Risk Analysis
• The basic principle that underpins both qualitative and
quantitative risk analyses is exactly the same.
• It is that every event that represents a risk to an
organisation has probability of occurring and a
consequence if it occurs.
• The magnitude of the risk is its:
– Probability x Consequence·
(likelihood) x (impact)
– The terms likelihood/probability and
consequence/impact may be used interchangeably
9
• The only difference between quantitative and qualitative

analysis is the way that values are attributed to these
two components.
• In quantitative analysis, numeric values are used but in
qualitative analysis, words (or descriptors) are used. An
example of descriptors commonly used to qualitatively
label probabilities, consequences is shown in Tables 3.9
and 3.10.
10
11
• The labels used in Table 3.10 are used on many, if not
most, companies's risk management systems. However,
there is a major problem in that these labels do not
adequately recognise the upside (opportunistic) aspect of
risk.
• For example, the idea of a catastrophic opportunity makes
no sense. Therefore, despite the rhetoric of many
companies's systems documentation, which allude to
recognise the upside of risk, the vocabulary in most
systems does not facilitate this.
• This is not surprising since most texts on risk
management focus on the downside of risk and have
never recognised this other dimensions
12
• The author argues that risk management, if seen
positively, can make an enormous contribution to
optimising an organisation‘s triple bottom line - its social,
environmental and financial performance.
• To foster this opportunistic culture, the author
recommends using the consequence labels in Table 3.11
rather than those in Table 3.10.
• Table 3.11 distinguishes between risks and opportunities,
provides more detailed descriptions for different levels of
significance and replaces the word catastrophic with
extraordinary.
13
14
• Having developed qualitative matrices for
probabilities and consequences, it is now possible to
estimate the level of risk (probability x consequences)
by producing a combined matrix as illustrated in
Table 3.12.
15
• Using this is very easy. For example, if an event has a "moderate"

probability of occurring and a "major" consequence if it did occur, the
risk level according to Table 3.12 would be "high"
16
Important and potentially costly mistakes which
companies make when developing and using their
risk matrix
• First, many companies fail to define precisely what
they mean by a high, moderate or a low risk. For
example, a company may decide that a "high" risk
demands senior management attention and detailed
quantitative analysis but that a "moderate" risk does
not. If this is not made explicit then it is likely that a
decision-maker will fail to understand the significance
of the event they have identified and to respond
appropriately.
17
Important and potentially costly mistakes which
companies make when developing and using their
risk matrix
• A second common mistake is not to think carefully
about the location and relative numbers of high,
medium and low categories in the risk matrix. Many
companies fail to appreciate that the positioning of
the high, medium and low categories within their risk
matrix is an important consideration which is a
reflection of their risk attitude and appetite. For
example, a company that is risk averse should have
more "high“ categories within their matrix than one
which is risk seeking.
18
• Despite the above problems, the advantage of
qualitative risk assessment is that most competent
managers should find it quick and easy to master.
• It is also something that can be realistically
achieved in most organisations with minimal
training.
• Furthermore, it is appropriate where risks cannot
be meaningfully quantified and can provide
managers with a general understanding of
comparative risks associated with different events
which can be prioritised into distinct risk categories.
• This of course is assuming that the process is well
structured and managed.
19
• However, qualitative risk analysis also has a number of
disadvantages.
– It is quite imprecise because the categories of probability,
consequence and risk are generally quite crude.
– Different risk events placed within these broad categories
can have very different levels of risk.
– Categorising an event in terms of its likelihood and
consequences is a highly subjective process which is
difficult to justify.
– This means that there is no guarantee that the different
quadrants of "high" risk in Table 3.12 actually represent
the same level of risk.
– The consequence is that comparisons between different
risk classes can often lead to inconsistencies.
20
• However, qualitative risk analysis also has a number of
disadvantages.
– It is difficult to compare different risk events on a
similar basis such as a dollar value.
– It is difficult to associate a qualitative risk
assessment with an appropriate and economically
viable choice of risk treatment options. For example,
the output of qualitative risk assessments cannot be
incorporated into techniques such as cost-benefit
analysis, which can be very useful in identifying
economically viable risk response options.
21
Semi-Quantitative Risk Analysis
• To overcome some of the disadvantages of

qualitative risk analysis, it is possible to employ a
semi-quantitative analysis.
• This takes qualitative risk analysis a step further by
attributing predefined values to the probability and
consequences labels which can then result in more
refined and precise estimates of risk which can be
used to adjust programmes, estimates or bids.
• For example, in Table 3.13, a company has sat down
and discussed exactly what the different labels mean
to them and quantified them accordingly.
22
23
• This example relates to the risk of a cost overrun on

a $500,000 project and allows a company to
compare the risks within projects and across
different projects on a commonly agreed scale.
• Without such a scale, different people would attribute
different values to the various probability and impact
levels according to their own risk attitude - not
necessarily the company's.
• Furthermore, the figures in the table cells give some
rough indication of what single point contingency
allowances would need to be made for each level of
risk
24
• Every company will attribute different numbers to the
probability and consequence labels, resulting in different
values within the table.
• For example, a company which is highly risk averse
would be likely to attribute relatively higher numbers to
the probability labels and smaller numbers to the
consequence labels.
• A smaller company with fewer resources would tend to do
the same. For such a company, a $50,000 loss might be
extraordinary and bring it to the verge of bankruptcy while
for a large firm this may be a relatively insignificant loss.
• Clearly, companies need to adapt the‘ risk matrix to suit
their own financial horizons. Some companies might even
use different matrices for different projects, if they vary
enough in value.
25
• To overcome the inconvenience of producing

numerous risk matrices for different projects or types
of risk, some orgnisations use weigtings rather than
precise numbers.
• In this approach to semi-quantitive analysis, the
values attributed to different categories of likelihood
and consequences reflect the relative magnitude of
consequences and likelihood rather than absolute
values,
• This is illustrated in Table 3.14 where company
discussions have resolved that the consequences of
a "major" event (say, an injury) are twice those
derived , from a "moderate" injury.
26
– The resultant risk factors within the table itself then provide
a much more accurate scale of risks and can become
weightings that are applied to estimates or forecasts to
reflect relative levels of risk.
27
• Semi-quantitative analysis overcomes some of the
disadvantages of qualitative analysis.
• For example, it is more useful in a practical sense and
provides a useful basis for understanding comparative
risk levels between different events.
• It also results in a less crude categorisation of risks (not
just high, moderate and low).
• In Tables 3.13 and 3.14 we have a whole range of
numbers reflecting a far wider range of risk levels.
• Nevertheless, the numbers attributed to the various
categories of risk and consequences are often
meaningless (particularly in consequences). Numbers are
useless unless people think about what they mean and
about their relativity
28
• At best they are still subjectively derived estimates
(whether they are relative or absolute values), which
means that it is not possible to say that two events that
are assigned the same risk values do in fact represent the
same level of risk.
• Furthermore; without producing different matrices for
different types of decisions, the analysis becomes even
cruder.
• Finally, it is always important to remember that if numbers
cannot be sensibly attributed to probabilities and
consequences, and if the resulting risk indices cannot be
used to adjust estimates or programmes, then there is no
point in undertaking a semi-quantitative analysis.
29
Quantitative Risk Analysis
• While many managers and organizations like to use
numbers to justify their decisions, the rigorous use of
quantitative techniques to assess project and business
risks is very limited outside major hazard industries such
as oil, chemical, nuclear power etc
• The reluctance may be due to widespread belief that the
complexity and cost of risk analysis increases as it
becomes quantitative.
• Also it may be due to a lack of quantitative data available
to input into such analyses
30
• Though construction industry is notorious of record
keeping, the business corporate reporting requirements
become more stringent and demanding, companies can
no longer afford to ignore the need of quantitative
analysis
• Quantitative risk assessment can now be carried out
very simply, quickly and economically and where
appropriately used can have significant advantage over
qualitative methods, which can be very restricted in
scope
31
• Quantitative risk analysis can be undertaken

competently and comprehensively with the use of very
little mathematics, statistics and computer programming
• However fundamentals of probability adds considerably
to the focus of the professional who needs to make
decisions under conditions of uncertainty
• Next few slides introduce basics of probability in simple
and easy way to help managers understand the
practicality of probability to make risky decisions
32
• Probability
– Probability is any number between zero and one, both
inclusive, which represents a judgment about the
relative likelihood of some event
– Zero implies that event is impossible and one implies
that it is certain
– Probabilities can be derived from one or a
combination of three sources
• Objective calculation
• A priori basis
• Subjective probability
33
• Probability
– Objective calculation
• Objective calculation is based on observed relative
frequencies of past incidences of the same events
• E.g the number of times there has been more than two
centimeters of rain in November in Sydney
• This type of judgment is only reliable if it applies to
identical and repeatable events in a strictly controlled
situation where all variables are perfectly controlled
• Frequencies are commonly used to calculate
probabilities in project environment, the differences
between project environments ensure that resulting
objective calculations of risk and opportunity have to be
treated with extreme caution
34
• Probability
– A priori basis
• A priori basis, derived from some visible symmetry,
for a particular event
• This renders unnecessary the collection of
frequency observations
• E.g if one tosses a coin, the probability if flipping a
head is 0.5. similarly for a perfectly balanced die
the probability of throwing any number between
one and six is 1/6 (0.17)
35
• Probability
– Subjective probability (personality view)
• Reflection of consistent perceptions, opinions and
judgments about an event
• E.g people frequently make verbal statements
about probabilities and choices about gambles,
reflecting their own belief in the likelihood of an
event
• In the absence of an a priori basis for judgement
and reliable frequency data based on previous
identical and repeatable and repeated event,
personal subjective probabilities allow just as
meaningful a discussion of unique events as
objective calculations do of repeatable events
36
• Probability
– Personal subjective probabilities
• It has been argued in real world situation like a
construction project, that there is no possibility of
repeatable events under substantially identical and
controllable conditions
• Similarly there is little possibility of gathering large sets
of relative frequency data
• Thus for most practical purposes subjective
probabilities allow just as meaningful way of dealing
with these risks and opportunities encountered in
project decisions
• Two approaches to eliciting subjective probabilities are:
– Direct method
– Indirect method
37
• Probability
• Direct method assumes the existence of a rational
decision- maker well aware of the fundamentals of
probability
• It involves asking the subject (person being asked)
to assign a number to his or her opinion about the
likelihood of the outcome in question
38
• Probability
• In contrast, the indirect method involves asking a
series of questions, from answers of which it is
possible to impute a personal probability
• E.g for a supervisor dealing with operatives having
no concept of probability, indirect method will be
used but for a manager dealing with professionals
who likely to understand probability direct method
will be used
39
• Probability
• Whatever method is used, someone has to
ultimately make a judgement about probability
levels and in doing so it is worthwhile to employ a
range of practical strategies to maximize reliability
and validity
• E.g managers have a tendency to overestimate
low probabilities; most would prefer to warn of a
suspected event and be proved wrong later on
than not to have warned it
40
• Probability
• Hence it is a good practice to ask for causal events
while asking probability of a specific event, plotting
these onto ‘event tree’
• By doing so one will invariably find that joint
probability of causal events will not add upto the
judged probability of the end event
41
• Probability
• It is also a good practice to ask the same question
a number of ways in a search for inconsistencies in
answers
• Group based questioning can often be useful in
eliciting such inconsistencies
• Normally experts are considered to give out better
probability however, research suggests that
inconsistencies may be greater with the experts
being very confident in their judgements and their
self-knowledge (meta cognition) is often poor
compared to lay people
42
• Probability
• Further there is evidence to suggest that personal
interaction between experts should be avoided; for
this reason the use of methods like Delphi
technique is suggested
43
• Calculating Probabilities
– Calculating the probability of an event occurring
involves understanding two principles
• Joint probabilities
• Compound probabilities
44
– Joint probabilities
• The probability of a number of mutually exclusive
events (independent events that cannot occur together)
occurring is calculated by adding together the
probabilities of the individual events
• This is known as joint probability of the set of outcomes
• E.g betting on two horses in same six-horse race is
calculated by adding together the probabilities of the
winning of the winning of both the individual horses
• 1/6+1/6=0.34
• If every horse is betted to win in the same race then
one is guaranteed to win
• 1/6+1/6+1/6+1/6+1/6+1/6=1.00
45
– Compound Probability
• Compound probability is relevant when betting across
different races is done, where one outcome is
dependent on the other
• Putting money on horses in two separate races such
that if the first horse wins then the winnings are placed
on the horse in the second race, then the probability of
winning would be the product of the probabilities of
each horse i.e. 1/6*1/6=0.028
• 0.028 is quite a lower probability because winning of
second horse is dependent on first horse
• This is a compound probability where we are interested
in calculating the overall likelihood of both
(interdependent) events occurring
46
• Compound probability has a well known application in the
construction field
• E.g consider budget forecast for a new library to service a
rapidly expanding neighborhood
• Decision rule for deriving the worst case estimate is that it

should represent an event that should not occur more than
once in ten times. A probability of 0.1 can therefore be
assigned to each worst case 47
• Assuming correct estimation and components of budget are
independent of each other, probability of costing $ 2,139,000
is
• 0.1x0.1x0.1x0.1=0.0001
• This simple example tells probability of worst cases
happening together, rapidly diminish to a very small
numbers- 10000 to 1 in this case
48
Risk Analysis:
Objectively determined probabilities
Case Study
• Assume you are responsible for a train scheduling

project.
• You need to plan the peak hour frequency for a
suburban train line.
• Historical records are available to provide data on
peak hour passenger loads for the line.
• You have data on the aapproximate number of
passengers arriving at the terminal on each of 21
occasions…
Risk Analysis:
• On one occasion there were between 851-900

passengers.
• Twice there were between 801 and 850 passengers.
• Three times there were 751-800 passengers.
• Seven times there were 701-750 passengers.
• Four times there were 651-700 passengers.
• Three times there were 601-650 passengers.
• On one occasion there were fewer than 600
passengers.
• Plot the data…
Risk Analysis:
6
Frequency
5
Distribution
Number
of 4
occasions
train 3
observed
2
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900
Average number of passengers per train

Risk Analysis:
The data plot shows that the

frequency distribution curve is
close to a normal distribution...
Risk Analysis:
6 Frequency
5 Distribution
Number
of 4
occasions
train 3
observed
2
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
Now convert the frequency

distribution curve into a cumulative
frequency distribution plot, by
adding the stacks successively...
Risk Analysis:
25
Cumulative
20 Frequency
Number
Distribution
of 15
occasions
train 10
observed
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
And then convert that into a

percentage cumulative
frequency distribution plot…
RISK Analysis:
100
90 Probability
80 Density
% of total
70 Function
number 60
of 50
occasions
train 40
observed 30
20
10
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
A curve can be fitted to the

resulting plot, to create a
probability density function
curve...
Risk Analysis:
100
90 Probability
80 Density
% of total
70 Function
number 60
of 50
occasions
train 40
observed 30
20
10
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
• This curve allows you to measure the

probability associated with any of the
passenger load rates chosen for the
scheduling exercise.
• Supposing you decide that an
appropriate rate would be 850
passengers per train...
Risk Analysis:
100
90
80
70
% of total
number 60
of 50
occasions
train 40
observed 30
20
10
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
• Then there is a 5% chance that the

train loads will be more than 850
passengers.
• There is a 95% chance that the train
loads will be less than 850
passengers.
Risk Analysis:
• While we have actually said is that

there is a 95% chance that the
passenger loads will be 850 or less per
train, we have not examined the
relative risks at more specific loads.
• Thus there is a 10% chance of the
actual load being between 800 and 850
passengers per train (95% - 85%)...
Risk Analysis:
100
90
80
70
% of total
number 60
of 50
occasions
train 40
observed 30
20
10
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
Or a 15% chance of the load being

between 800 and 750 passengers
(85% - 70%)...
Risk Analysis:
100
90
80
70
% of total
number 60
of 50
occasions
train 40
observed 30
20
10
0
<=600 <=650 <=700 <=750 <=800 <=850 <=900

Risk Analysis:
• This information allows us to make

decisions about scheduling the trains,
with information about the risks of
making wrong decisions.
• The probabilities are statistically

deduced from the (objective)
observations.
THANK YOU!

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Risk Management in

• It may be a good estimate, but an estimate nonetheless.

• The only difference between quantitative and qualitative

• Using this is very easy. For example, if an event has a "moderate"

• To overcome some of the disadvantages of

• This example relates to the risk of a cost overrun on

• To overcome the inconvenience of producing

• Quantitative risk analysis can be undertaken

• Decision rule for deriving the worst case estimate is that it

• Assume you are responsible for a train scheduling

• On one occasion there were between 851-900

Average number of passengers per train

The data plot shows that the

Average number of passengers per train

Now convert the frequency

Average number of passengers per train

And then convert that into a

Average number of passengers per train

A curve can be fitted to the

Average number of passengers per train

• This curve allows you to measure the

Average number of passengers per train

• Then there is a 5% chance that the

• While we have actually said is that

Average number of passengers per train

Or a 15% chance of the load being

Average number of passengers per train

• This information allows us to make

• The probabilities are statistically

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