Best Practice Risk Management Approach for Asset

Replacement Programs
Nations have trillions worth of assets, ranging from houses and industrial buildings
to infrastructure and utility networks. A large share of these assets age however, and
studies show that today billions in assets are either up for maintenance or
replacement, or are nearing that point. As a result, large scale replacement
programs have over the years become more common in the industry.

Organizations that undertake large scale infrastructure replacement programs, face a range of
strategic challenges. The chief factor considered a burden is the sheer cost of execution – such
programs can sometimes gulp up to 60% of the available CAPEX budget. As a result, the room
left behind for alternative decision-making in the investment portfolio is significantly reduced –
an issue for many organizations, in light of the magnitude of change being faced, including the
likes of the Internet of Things, big data and “smart” technology solutions. Moreover, managing
such large programs is challenging, with tasks commonly highly specialized and resources scarce.

The risks associated with such programs are immense, ranging from business and financial risks
to safety and liabilities in the value chain. For asset managers, the key question that arises is: how
long can you continue with a re-active replace after failure strategy? The other end of the spectrum
– moving to a pro-active replacement approach – can be more fruitful, yet, if the timing is off track,
then companies (and even society) could be exposed to risks deemed unacceptable.

It is this combination of high risks with high investments that makes large scale replacement
programs one of the most complex projects of their kind to execute.
Risk Management Approach for Asset Replacement Programs

In a bid to optimize the way how asset management owners run their programs, UMS Group
recently developed a best practice approach to applying, measuring and using risk for such
investment decisions. The consulting firm, specialized in the field, was asked for advice by a gas
infrastructure company that faced a large-scale replacement issue. On one hand the company had
no immediate indication of significant threats, however, known was that the infrastructure
structure was ageing, leaving the infrastructure provider wondering how other asset owners deal
with similar situations and what best practices there are in the market.

UMS Group performed a study at seven major asset owners to assess their practices. To pinpoint
how these organizations perform, the consultancy develop a process framework of four steps and
each of these steps were evaluated using a six scale maturity model. The maturity model – spanning
from innocent (least mature) to excellent (most mature) is compliant to the scales used in the
international standard of ISO55000. “For every phase in the approach, characteristics of each
maturity level have been developed. By aggregating scores and benchmarking those against a best
practice in the industry, organizations can find how they perform vis a vis their peers and unravel
improvement potential”, says Jan Schipper, Managing Director at UMS Group and author of the
best practice model.

The first step looks at the existing risk position of the organization. “At the beginning of the
reinvestment process, it is key to introduce a step to define the company’s current risk position, as
well as understand the board’s level of risk tolerance. The level of accepted risk tolerance is then
used as one of the constraints for the overall reinvestment program”, explains Schipper. Best
practices in this phase include a clear governance on the relationship between risk and time (“this
determines the ‘ramp up’ time of a program and the pace at which investments are done”) and a
robust quarterly reporting process (“risk reporting is a must for executive buy-in”).
On the back of insight in the risks, the next phase focuses on identifying mitigation strategies.
Key here is to distinguish between risks that are deemed acceptable, in line with planning, and
those that exceed the level of risk tolerance. “A prioritization methodology based on integrity
assessments should be applied. This involves both desk analysis and technical studies, and once
scores are assigned to assets, an overall guideline rolls out.” Mitigations are then developed, he
adds. The dataset reveals that best practice companies focus on initiatives with the highest impact
in risk reduction to determine the scope of work in terms of the level on reinvestment per year per
region. “They priority those investments which will reduce risk the most. The scope of work is
identified via a long-term perspective based on a total cost of ownership approach”, comments
Schipper.

Then an important next stage in the process starts, highlights Schipper, since it is now known per
region which assets should be started with first. However, many scenarios are still on the table: is
replacement the best strategy, should the technology be upgraded or could a small modification
instead of a replacement sufficiently mitigate the risk exposure? The different strategies are
subsequently assessed, weighted for impact and evaluated for practical feasibility, and out of this
comes an overarching assessment of the amount of risk reduction that can be sought after. “The
mitigation strategy results in a portfolio of projects for each service region. For each project, the
impact on risk reduction can be calculated by determining the risk mitigation per invested euro.
These can be summed up to provide a measure of the total Risk Reduction per region, which is
then included in the quarterly risk reporting”, explains Schipper.
The fourth step turns decision making into action – the actual optimization of the portfolio. In
this step of the process, the overall portfolio of investment projects, maintenance projects and other
projects for all asset classes in a service area are combined in one proposed portfolio for the region.
Sophisticated skills, methods and tools are applied to the portfolio to perform short-term scenario
testing and risk optimization. Each program or project within a service area is evaluated on the
value it adds to meeting strategic objectives and reducing risk (risk mitigation per euro spend). To
ensure consistency of scoring across projects a standard set of scoring tools and templates are used.

Then constraints like budget and/or resource are set and an optimization of the project portfolio is
performed. “For the scenario testing, tools are used that have intelligent logic to run mathematical
equations and solve the multi-constraint optimization problem. The final result is an optimal
scenario to meet the short term objectives!” explains Schipper.

Two-Step Decision-Making Process

Besides growing the level of maturity per phase, Schipper says that, according to the study, there
is one main feature found that underpins a best practice method for reinvestment strategies: an
approach built around a two-step decision-making process. The first step relies on taking a long-
term perspective, and is typically developed between the first and second phase. “The majority of
leading companies in this respect apply evaluation methods based on ‘total cost of ownership’ to
defend the investment decisions made”, reflects Schipper. The second step that is regarded as a
differentiator is the ability to focuses on dealing with short-term constraints (e.g. budget limitation
or resource constraint). “This step commonly comes into play in the fourth phase, portfolio
optimization.” In doing so, leader companies use a range of sophisticated modelling techniques
leveraging optimization algorithms to solve multi-constraint bounds.
“Not all companies applied this two-step decision making process balancing between long term
and short term strategic objectives. Only those companies that have to deal with very tight
constraints in terms of compliancy, shareholder requirements, limited budget and limited resources
apply the two stage decision making model”, says Schipper. Case studies show that an effective
application of best practices can lead up to 20% more flexibility in the portfolio, which down the
line frees up valuable, previously strapped, resources for other uses. “This bolsters the return on
investment on projects, paves the way for more focus on innovation, and to an extent relieves an
organization from a tough working capital challenge.”