The Importance of Risk Management

The Importance of Risk Management Risk management is an important part of decision making process in a construction company. Risk can affect productivity, performance, quality, and budget of a construction project. This chapter gives an overview of construction project risks. Meanwhile, risks in construction project will be recognized and classified into several groups. Furthermore, the current trend in risk management researches will also be discussed in this chapter. It is very important to elaborate risks in construction projects for the purpose of this project paper as to fulfil the first objective of this research, which is to identify and classify the risks in construction projects. Risk is defined as the chance of an adverse event depending on the circumstances (Butler, 1982). Risk is perceived as the potential for unwanted or negative consequences of an event or activity'(Rowe, 1977 ), a combination of hazard and exposure (Chicken and Posner, 1998). Recent research tends to emphasize the two-edged nature of risks, such as a threat and a challenge'(Flanagan and Norman, 1993), the chance of something happening that will have an impact on objectives; may have a positive or negative impact'(AS/NZS, 2004), combination of the probability or frequency of occurrence of a defined threat or opportunity and the magnitude of the consequences of the occurrence. This study examines mainly the negative impacts of risks inherent in construction projects through a combined consideration of the likelihood of occurrence and the magnitude of consequence. Risk management is a system which aims to identify and quantify all risks to which the business or project is exposed so that a conscious decision can be taken on how to manage the risks'(Flanagan and Norman, 1993). PMBOK included risk management as one of the nine focuses in project management and described it as the processes concerned with conducting risk management planning, identification, analysis, responses, and monitoring and control on a project. Recently, AS/NZS defined risk management as the culture, processes and structures that are directed towards realizing potential opportunities whilst managing adverse effects'(AS/NZS, 2004). In line with these definitions, risk management in the construction project management context is a systematic way of identifying, analysing and dealing with risks associated with a project in an aim to achieve the project objectives (Zou et al., 2007). Owing to its increasing importance, risk management has been recognized as a necessity in toda ys construction industry, and a set of techniques and strategies have been developed to control the influences brought by potential risks (Zou et al., 2007). A variety of risk and risk-related definitions are applied to construction projects, and no standard definitions or procedures exist for what constitutes a risk assessment. In the construction industry, risk is often referred to as the presence of potential or actual treats or opportunities that influence the objectives of a project during construction, commissioning, or at time of use (RAMP, 1998). Risk is also defined as the exposure to the chance of occurrences of events adversely or favourably affecting project objectives as a consequence of uncertainty (Al-Bahar and Crandall, 1990). According to (Walewski and Gibson, 2003) as mentioned by Dias and Ioannou (1995) , there are two types of risk: 1) pure risk when there is the possibility of financial loss but no possibility of financial gain, and 2) speculative risk that involves the possibility of both gains and losses. CIIs definitive work on construction risks (Diekmann et al., 1998) uses classic operations research literature t o distinguish the concepts of risk, certainty, and uncertainty, and is consistent with the literature (ASCE, 1979; CIRA, 1994; Kangari, 1995; Hastak and Shaked, 2000; PMI, 2001; Smith, 2001) on what is considered as the sequential procedures for construction risk management: 1) identification, 2) assessment, 3) analysis of impact, and 4) management response. Increased concerns about project risk have given rise to various attempts to develop risk management methodologies. An example of such is the Risk Analysis and Management of Projects (RAMP) method produced by the Institute of Civil Engineers and the Institute of Actuaries in the United Kingdom (RAMP, 1998) . This method uses a project framework to identify and mitigate risk by using the accepted framework of risk identification and project controls by focusing on risks as they occur during the project life cycle. It requires users to follow a rational series of procedures and to undertake this analysis at scheduled intervals during the life cycle of a project. Traditional risk assessment for construction has been synonymous with probabilistic analysis (Liftson and Shaifer, 1992, Al-Bahar and Crandall, 1990). Such approaches require events to be mutually exclusive, exhaustive, and conditionally independent. However, construction involves many variables, and it is often difficult to determine causality, dependence and correlations. As a result, subjective analytical methods that rely on historical information and the experiences of individuals and companies have been used to assess the impact of construction risk and uncertainty (Bajaj et al., 1997). Project risk is an uncertain event or condition that, if it occurs, has a positive or a negative effect on at least one project objective, such as time, cost, scope, or quality (i.e., where the project time objective is to deliver in accordance with the agreed-upon schedule; where the project cost objective is to deliver within the agreed-upon cost; etc.). A risk may have one or more causes and, if it occurs, one or more impacts. For example, a cause may be requiring an environmental permit to do work, or having limited personnel assigned to design the project. The risk event is that the permitting agency may take longer than planned to issue a permit, or the design personnel available and assigned may not be adequate for the activity. If either of these uncertain events occurs, there may be an impact on the project cost, schedule, or performance. Risk conditions could include aspects of the projects or organizations environment that may contribute to project risk, such as poor proje ct management practices, lack of integrated management systems, concurrent multiple projects, or dependency on external participants who cannot be controlled. Successful project management requires the identification of the factors impacting project scope definition, cost, schedule, contracting strategy and work execution plan. However much of the research related to risk identification, assessment and management for constructed facilities is focused on specifics such as location, categories of risks aspects, or types of projects. For example lists of relevant construction project risks have been developed (Kangari, 1995, RAMP, 1998, Smith, 1999, Hastak and Shaked, 2000, Diekmann et al., 1998) as well as political risk are available (Ashley and Bonner, 1987, Howell, 2001) . The value of systematic risk management of project activity is not fully recognized by the construction industry (Walewski et al., 2002) . Since no common view of risk exists, owners, investors, designers, and constructors have differing objectives and adverse relationships between the parties are common. Attempts at coordinating risk analysis management between all of the project participants have not been formalized and this is especially true between contractors and owners. (Hayes et al., 1987) defined three phases for risk management process (RMP), namely: risk identification; risk analysis and risk response. (Uher and Toakley, 1999) indicated that out of three phases involved in risk management, the concept of risk identification appears to be the most known and practiced. (Lam, 1999), in his paper which discussed risks associated with major infrastructure projects, and defined risk identification as listing of most, if not all, the potential areas where an undesired outcome may result. Such listing should be done at the earliest possible stage of the project. Furthermore, the author listed some techniques that could be used in risk identification such as brain storming, prompt lists, structured interviews and hindsight reviewers. Another useful method is to simulate events and relationships using a hypothetical project life cycle so that the relevant risk factors are made apparent. Risk identification is normally done in a group.(Chapman, 1997) introduced three methods for risk identification, namely: brain storming; Nominal Group Technique (NGT) and Delphi. These are ways to collect judgments from the project team. However, brainstorming was the most commonly cited technique. (Tummala and Burchett, 1999) defined Risk Management Process (RMP) as a logically, consistent and structured approach to enumerate and understand possible risk factors and to assess their consequences and uncertainties.(Chapman, 1997) stated that a formal (RMP) should be applied at all stages in the project lifecycle by project owners and contractors. Alternatively, the process is referred to by many authors as (PRAM) Project Risk Analysis and Management. However, it is the authors opinion that (PRAM) and (RMP) are similar terms for the same concept and can be used interchangeably. (Uher and Toakley, 1999) resented a paper discussing the use of risk management in the conceptual phase of the construction project development cycle where uncertainty is at its peak. Furthermore, (Cano and Cruz, 2002) explained a generic risk management process to be undertaken by organizations with the highest level of risk management maturity in the largest and most complex construction projects. As a final validation, Delphi analysis was applied to assess the risk management methodology. (Fang et al., 2004) presented a risk assessment model for tendering of Chinese building projects on the basis of identification and evaluation of the major risk events in the Chinese construction market. The findings showed that the risk of a project can be assessed through analysis of factors such as: owner type; source of project financing; existence or lack of cooperation between contractors and the owner; the intensity of competition for tendering and the reasonableness of the bid price. (Charoenngam and Yeh, 1999) stipulated the importance of a proper contractual foundation to ensure successful project execution, especially in case of projects involving multidisciplinary teams.(Thompson and Perry, 1992) addressed the necessity of model or standard sets of conditions of contracts where risk is allocated to different contract parties, but the principals behind this allocation have not been stated . Construction contracts are one of the primary vehicles of risk allocation and management, Ibbs et al. (1986). Furthermore, (Bubshait and Almohawis, 1994) stated that when a contractor is working in an unfamiliar construction environment, one source of risk is the contract conditions. There is significant evidence in the literature that checklists are the most commonly used methods of risks identification.(Uher and Toakley, 1999, Akintoye and MacLeod, 1997, Simister, 1998), all stated that checklists recorded the highest use among practitioners of risk management as compared to other techniques. (Uher and Toakley, 1999) stated that the most commonly applied risk identification techniques were checklists, brainstorming and flowcharts. Other techniques such as questionnaires, scenarios building and case based approaches were less popular, while techniques such as influence diagrams and Hazop were largely unknown. (Akintoye and MacLeod, 1997) on the basis of the results of a survey of risk management techniques conducted on general contractors and project management firms, stated that checklists based on intuition, judgment and experience recorded the highest formality with the respondents. The authors also stated that checklists could not be considered as a formal technique. (Simister, 1998) indicated that traditional methods are still favored in the UK, even though the level of awareness of other formal and more complex techniques is high. The study listed 12 techniques and indicated a percentage of the current/past use as well as the level of awareness for each technique. Checklists were the most popular technique, followed by Monte Carlo Simulation, Project Evaluation and Review Techniques (PERT), Sensitivity Analysis and Decision Trees. (Hassanein and Afify, 2007) in their study about Risk management practices of contractors: a case study of power station projects in Egypt identified a marked lack of consistency in the contractors risk identification effort. Contractors possessing past experience in Egypt were far better able to identify the relevant risks. On the other hand, local Egyptian contractors with vast experience in Egypt but limited project management experience were shown to lack the necessary expertise to properly identify risks and to take the appropriate exceptions. Furthermore, the results revealed that bidders do not include in their proposals their true lists of exceptions which represent genuine risks to them.