Risk Management

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What is Risk?
• A dictionary definition of risk is “the possibility of loss or injury” • Project risk involves understanding potential problems that might occur on the project and how they might impede project success • Risk management is like a form of insurance; it is an investment
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Speculative risk
A speculative risk is a risk that accompanies the possibility of earning a profit.  Most business decisions, such as the decision to market a new product, involve speculative risks.  If the new product succeeds in the marketplace, there are profits; if it fails, there are losses.
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Pure risk
A pure risk is a risk that involves only the possibility of loss, with no potential for gain.  The possibility of damage resulting from hurricane, fire, or auto accident is a pure risk.  In the above examples, there is no gain or profit if such damage does not occur.

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Why Take Risks? Because of Opportunities! Try to balance risks and opportunities Risks /drrazali Opportunities 5 .

productivity.g. bankruptcy: low/high probability but high impact Common risk in construction offer either loss or gain prospect. variation.Risks and Uncertainties – Basic concepts     Risks and uncertainties are associated with specific events/activities which can be individually identified. A risk event has a range of outcome and each outcome has a probability of occurrence Some risks only has adverse consequences (loss). e. inflation: typically high probability with low or high impact /drrazali 6 . structural collapse.

 The second consists of the costs of reducing or eliminating the risk of potential loss. /drrazali 7 .Costs of Risks Any risk entails two types of costs.  The first is the cost that will be incurred if a potential loss becomes an actual loss.  These two types of costs must be balanced against each other if risk management is to be effective.

Risk management    Risk management is the process of evaluating the risks faced by a firm or an individual and then minimizing the costs involved with those risks. /drrazali 8 .

assigning. and developing realistic estimates /drrazali 9 . and responding to risk throughout the life of a project and in the best interests of meeting project objectives • Risk management is often overlooked on projects.The Importance of Project Risk Management • Project risk management is the art and science of identifying. but it can help improve project success by helping select good projects. determining project scope.

solutions and contingencies  Is a thinking process requiring imagination and ingenuity  Generates a realistic (and sometimes different) attitude in project staff by preparing them for risk events rather than being taken by surprise when they arise /drrazali 10 .Risk Management  Requires that we accept that uncertainty exists  Generate a structured response of risk in term of alternative plans.

Risk Management • The goal of project risk management is to minimize potential risks while maximizing potential opportunities. Major processes include – Risk identification: determining which risks are likely to affect a project – Risk analysis: evaluating risks to assess the range of possible project outcomes – Risk response development: taking steps to enhance opportunities and developing responses to threats – Risk response control: responding to risks over the course of the project /drrazali 11 .

Risk Identification HIGH RARE CATASTROPHE PROBABLE DISASTER IMPACT LIKELY & MINOR LOW HIGH FREQUENT/ TRIVIAL LIKELIHOOD /drrazali LOW 12 .

• Time risk: Will the new project complete according to schedule? What is the effect of delay to this project? • Financial risk: Can the organization afford to undertake the project? Is this project the best way to use the company’s financial resources? • Design/Technology risk: Is the project technically feasible? Could the project design accommodate future changes? /drrazali 13 Time. Financial. and Technology Risk .

 early release of com petitive products Estim ating errors. inadequate productivity. purchasing. poor allocation  and m anagem ent of float. lack of consultation  m w ith key stakeholders   Ignoring risk. abse nce of leadership       Carelessness in planning or com unicating. poor project organization and  definition of responsibilities. poor insurance  m anagem ent   U nenforceable conditions or contract clauses. lack of post -project review   Poor definition of scope or w ork packages. poor integration  m anagem ent. or  contingency control. poor resource allocation. inadequate quality assurance  program   Poor conflict m anagem ent. cost.Potential Risk Conditions Construction Project R C isk onditions Integration Scope   Tim   e Cost   Q uality     H an Resources um Com unications m Risk   Procurem ent           Inadequate planning. inadequate  scope control   Errors in estim ating tim e or resource availability. incom plete definition  of quality requirem ents. poor m aintenance.  security. change. substandard  design/m aterials/w orkm anship. etc. unclear assignm ent of risk. ad /drrazali versarial relations 14   . Poor attitude tow ard quality.

flood. reliability.Primary sources of risk Physical Environmental Design Loss or damage by fire. pollution.safety Detail. earthquake. accident. investigations Likelihood of change Interaction of design with method of construction Loss or damage in the transportation of materials and equipment Availability of specialized resources Access and communications Organizational interfaces /drrazali 15 Logistic . waste treatment Public enquiry New technology. innovative applications. landslide Ecological damage. precision and appropriateness of specifications Design arising from surveys.

Quality and availability of management and supervision Fluctuation in market demand for product or service Maintenance needs. contractors – war.Primary sources of risk Financial Availability of funds. safety Industrial relations Extent of change.suppliers Exchange rate fluctuations. designers Political risks in countries of owner and suppliers. Climate. Fitness for purpose Safety operation /drrazali Legal Political Construction Operational 16 . inflation. taxation Liability for acts of others. contractors. adequacy of insurance Adequate provision of of cash flow Losses due to default of contractors. revolution. direct liabilities Local law. changes in law Feasibility of construction methods. legal differences between home country and countries of suppliers.

Risk Analysis  Many risks are quantifiable in term of terms of their effect on cost or time or revenue  Can be analysed by measuring their effects on the parameters used to assess project or contract viability  Application of statistical probability /drrazali 17 .

Monte Carlo)  Decision tree  Utility theory /drrazali 18 .g.Risk analysis techniques  Sensitivity analysis  Probability analysis (e.

 Defining a likely range of of variation for those variables which have a high impact on cost. /drrazali 19 . time or economic return and to which the project will be most sensitive.Sensitivity analysis  SA seeks to place a value on the effect of change of a single variable within a project.

Sensitivity Analysis – Spider Diagram /drrazali 20 .

Sensitivity Analysis – Spider Diagram /drrazali 21 .

Sensitivity diagram with Probability contours Aaaa /drrazali 22 .

Probability Analysis  Specifying a probability distribution for each variable and then considering situations where any or all of these variables can change their initial values at the same time. it has proved possible to make a tentative estimate  Example using Monte Carlo technique /drrazali 23 .  Though defining probability of occurrence may be difficult.

Decision tree  Graphical means of bringing together the information about investment possibilities and a sequence of decision choices.  It shows the present possible courses of action and future possibilities  It requires the decision maker to place some degree a probability on an outcome occurring. /drrazali 24 .

Utility theory  Utility theory attempts to take into account of the attitude of the decision maker to risk or to the magnitude of risk  It endeavours to assess the decision profile of the decision maker and formalize management’s attitude toward risk /drrazali 25 .

Risk Utility • Risk utility or risk tolerance is the amount of satisfaction or pleasure received from a potential payoff – Utility rises at a decreasing rate for a person who is risk-averse – Those who are risk-seeking have a higher tolerance for risk and their satisfaction increases when more payoff is at stake – The risk neutral approach achieves a balance between risk and payoff /drrazali 26 .

Risk Utility Function and Risk Preference /drrazali 27 .

usually by eliminating its causes • Risk acceptance: accepting the consequences should a risk occur • Risk mitigation: reducing the impact of a risk event by reducing the probability of its occurrence /drrazali 28 .Risk Responses • Risk avoidance: eliminating a specific threat or risk.

different packaging of the work content or different method of construction /drrazali 29 .  Such an action should be determined at the project appraisal stage  Risks can be avoided by redesign. risks may have serious consequences as to warrant a reappraisal or even the replacement of the project by an alternative one.Risk Avoidance  In extreme cases.

it makes sense to assume a risk when one or more of the following conditions exist: . .Insurance coverage.The potential loss is too small to worry about. is too expensive.There is no other way of protecting against a loss. . Risk assumption is the act of taking responsibility for the loss or injury that may result from a risk. /drrazali 30 . .Risk Acceptance    An individual or firm will-and probably must-take on certain risks as part of living or doing business. if available. Generally.Effective risk management has reduced the risk.

Risk Reduction If a risk cannot be avoided. perhaps it can be reduced. /drrazali 31 . In general risk may be reduced by:  Obtaining additional information  Performing additional tests/simulations  Allocating additional resources  Improving communication and managing organizational interfaces  The risks involved in management decisions can be reduced only through effective decision making.

contractor or sub-contractor to surety /drrazali 32 . contractor.Risk Transfer  Common route of risk transfer in construction projects are: .sub-contractor or designer to insurer .contractor to sub-contractor .client to contractor or designer .client.

Risk Transfer The transfer of risk should ensure the client best interests in the project. Factors to consider:  The party which can best control the events which may lead to the risk occurring  The party which can best control the risk if it occurs  Whether or not it is preferable for the client to retain an involvement in the control of the risk  The party to carry the risk if it cannot be control /drrazali 33 .

Risk Transfer    Whether the premium to be charged by the party to which the risk is allocated is reasonable and acceptable Whether this party is likely to be able to sustain the consequences if the risk occurs Whether. if the risk is transferred. it leads to the possibility of risks of a different nature being transferred back to the client /drrazali 34 .

The fee charged by an insurance company is called the premium.Risk Transfer The most commonly used method of dealing with risk is to shift.  An insurer (or insurance company) is a firm that agrees. the risk to an insurance company. or transfer.A contract between an insurer and the person or firm whose risk is assumed is known as an insurance policy. /drrazali 35 .  Insurance is thus the protection against loss that is afforded by the purchase of an insurance policy. . . for a fee. to assume financial responsibility for losses that may result from a specific risk.

Contingencies • A risk management plan documents the procedures for managing risk throughout the project • Contingency plans are predefined actions that the project team will take if an identified risk event occurs • Contingency reserves are provisions held by the project sponsor for possible changes in project scope or quality that can be used to mitigate cost and/or schedule risk /drrazali 36 .Risk Management Plans.

Contingencies The setting of contingencies is an essential part of project management Three types of contingencies:  Time (float)  Cost (allowance in budget)  Performance/quality (tolerance) This requires a named person in-charged and consistent monitoring /drrazali 37 .

Application of risk management  The greatest degree of uncertainty about the future is encountered in the appraisal stage of a new project  Decisions taken in this stage tend to have the largest impact on final cost  Change is an unavoidable characteristic of major capital projects and its extent and effects are frequently under-estimate during this phase /drrazali 38 .

Application of risk management /drrazali 39 .

Risk decision during appraisal  The related decisions or action during appraisal stage: .quantification of each risk in term of time and cost where possible .assessment of relative impact/probability of each risk . establishment of contingency funds to protect the client against those risk which are unavoidable and retained by him /drrazali 40 .identification of all project risks .allocation of these risks to various parties.identification of the most serious risks for consideration project management .

number of times the risk appears on the list over a period of time.Top 10 Risk Item Tracking • Top 10 risk item tracking is a tool for maintaining an awareness of risk throughout the life of a project • Establish a periodic review of the top 10 project risk items • List the current ranking. and a summary of progress made in resolving the risk item /drrazali 41 . previous ranking.

Example of Top 10 Risk Item Tracking Monthly Ranking Risk Item Inadequate planning Poor definition of scope Absence of leadership This Month 1 2 Last Month 2 3 Number of Months 4 3 Risk Resolution Progress Working on revising the entire project plan Holding meetings with project customer and sponsor to clarify scope Just assigned a new project manager to lead the project after old one quit Revising cost estimates Revising schedule estimates /drrazali 42 3 1 2 Poor cost estimates Poor time estimates 4 5 4 5 3 3 .

Project Manager’s roles  An in-depth study of risk and uncertainty for all projects  Estimates cost and time that include specific contingency allowance and also provide ranges commensurate with the identified major risks and uncertainties built in  Proposal of ways of at least reducing effects of risks and uncertainty  The adoption of methods for allocating the remaining risks to the various parties in a way which will optimise project performance /drrazali 43 .

Project Manager’s roles  The recognition that risk and reward go handin-hand and that the allocation of risk to a party should be accompanied by a motivation for good management  An open minded approach to innovative solutions to problems  A regular and preferably independent review of project proposals and conceptual design to reduce misunderstandings and ensure that the full spectrum of uncertainties is exposed /drrazali 44 .

Using Software to Assist in Project Risk Management • Databases can keep track of risks • Spreadsheets can aid in tracking and quantifying risks • More sophisticated risk management software helps develop models and uses simulation to analyze and respond to various project risks e. @RISK /drrazali 45 .g.

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