Risk Management in Construction

Risk management is a systematic process of identifying, assessing and responding to project risk. The overall goal of the risk management process is to maximize the opportunities and minimize the consequences of a risk event. A variety of risk management models with different numbers of stages can be found in the literature.

The international standard “Project risk management – Application guidelines” (IEC 2001) offers a model with four steps: risk identification, risk assessment, risk treatment, and risk review and monitoring. PMBOK’s model (PMI 2000) is similar but divides risk assessment into two processes of qualitative risk analysis and quantitative risk analysis.Baloi and Price (2003) include an additional step of risk communication. Chapman and Ward (2003) present the SHAMPU (Shape, Harness, and Manage Project Uncertainty) framework which involves nine stages: define the project, focus the project, identify the issues, structure the issues, clarify ownership, estimate variability, evaluate implication, harness the plans, and manage implementation. Del Cano and de la Cruz (2002) propose an integrated methodology for project risk management in large and complex construction projects. The model is divided into four process phases: initiation, balancing, maintenance and learning. Each phase consists of several stages, which, in turn, are divided into different activities. Despite the variety of models, risk identification, assessment and response form the core of project risk management. Therefore, a model consisting of these three stages is mostly used in construction projects.

RISK IDENTIFICATION

Risk identification is the first step of the risk management process. It is aimed at determining potential risks, i.e. those that may affect the project. PMBOK (PMI 2000) suggests that as many project stakeholders as possible should participate in the risk identification process. There are a number of tools and techniques for identifying the project risks. These are brainstorming, expert opinion, structured interviews, questionnaires, checklists, historical data, previous experience, testing and modeling, evaluation of other projects. Empirical studies of risk management practice show that checklists and brainstorming are the most usable techniques in risk identification. They also highlight that risk identification often relies on individual judgments of the project participants. In this context, it is interesting to mention a recent study by Maytorena et al. (2007) that suggests that the role of experience in risk identification is less significant than is commonly assumed. During the risk identification process the potential risks fall in the different groups. There are several approaches to classifying project risks and risk sources. In general, the sources of risk in construction projects may be divided into three Groups:

• Internal or controllable risks design, construction, management and relationships.
• External or uncontrollable risks financial, economic, political, legal and environmental.
• Force majeure risks

Several studies contributed to knowledge by identifying unique, specific and country-related risks.

RISK ASSESSMENT

During risk assessment, identified risks are evaluated and ranked. The goal is to priorities risks for management. The research literature offers a large number of models that use both qualitative and quantitative methods for assessment of project risks. Tah and Carr (2000) develop a formal model for qualitative risk assessment based on fuzzy estimates of risk components. Baccarini and Archer (2001) describe a methodology for risk ranking of projects, which allows an effective and efficient allocation of the resources for the management of project risks. The JRAP (Judgemental risk analysis process) model proposed by Öztas and Ökmen (2005) is a pessimistic risk analysis methodology, which is effective in uncertain conditions within construction projects. Zeng et al. (2007) propose a risk assessment methodology based on fuzzy reasoning techniques and aimed at dealing with risks in complex projects. A fuzzy system is also used by Motawa et al. (2006) to evaluate the risk of change in construction projects. Poh and Tah (2006) have developed an integrated model that takes into account both duration and cost risks and can be used for modeling risk impacts that affect the project. Dikmen and Birgonul (2006) propose a methodology for both risk and opportunity assessment of international projects.

Empirical research on risk assessment practice investigates the use of the different risk assessment techniques in construction projects. A study by Baker et al. (1998) shows that the construction companies in UK use both qualitative and quantitative techniques for assessing the project risks. Personal and corporate experience and engineering judgment are the most successful qualitative techniques, while quantitative techniques include break-even analysis, expected monetary value and scenario analysis. Several authors report rather opposite results on the usage of quantitative techniques. The studies of risk management practice in the UK construction industry show that the practitioners rely mostly on professional judgment, intuition and experience (Akintoye and MacLeod 1997, Wood and Ellis 2003). A questionnaire survey conducted by Tang et al. (2003) shows that qualitative analysis is the most commonly used technique in the Chinese construction industry, while the use of quantitative methods is very low. The results of the study conducted by Simu (2006) show that the contractors mostly use professional experience and gut-feeling in risk assessment. Kähkönen (2007) argues that the quantitative methods used in risk management have advantages in comparison with the qualitative methods but their use is limited due to difficulties that practitioners face. He also discusses the elements that contribute to development of a workable solution for quantitative risk assessment.

Risk Response Process

The risk response process is directed at identifying a way of dealing with the identified and assessed project risks. There are four main risk response strategies: risk avoidance, risk reduction, risk transfer and risk retention (IEC 2001, PMI 2000, Smith et al. 2006). Risk avoidance deals with the risks by changing the project plan or finding methods to eliminate the risks. Risk reduction aims at reducing the probability and/or consequences of a risk event. Those risks that remain in the project after risk avoidance and reduction may be transferred to another party either inside or outside the project. Risk retention or acceptance indicates that the risk remains present in the project. Two options are available when retaining the risk: either to develop a contingency plan in case a risk occurs, or to make no actions until the risk is triggered. Several studies (Baker et al. 1999, Lyons and Skitmore 2004, Tang et al. 2007) have identified risk reduction as the most frequently used technique within the construction industry. The results of a questionnaire survey (Akintoye and MacLeod 1997) report that risk transfer is the most preferable strategy among the UK practitioners.

TYPICAL CONSTRUCTION PROJECT RISKS AND UNCERTAINTIES

Construction projects are characterized as very complex, always unique projects, where risks raise from a number of different sources. These projects are characterized by a continuous decision making due to numerous sources of risk and uncertainty, many of which are not under the direct control of project participants. Construction projects have a bad reputation of failing to meet the deadlines and cost targets. That’s why identifying risk sources is extremely important, since it is not necessarily possible to identify single risks. Odeh and Battaineh studied the most typical reasons for construction delays in Far-East construction projects. They found seven significant causes of delays: owner interference, inadequate contractor experience, financing and payments, labor productivity, slow decision making, improper planning and subcontractors. Authors emphasize the meaning of experience and capability of project participants to have the most effect on these causes of delays. These kinds of risks can be seen as network-related. Thus in order to have a successful project, it should be guaranteed by some means that all participants are experienced and trained to do the project: it matters what kind of network is conducting the work. To improve the present situation, authors suggest different kinds of improvements to the contracts, incentives for good quality and awarding capabilities more than just the price. Construction project risks are categorization in two different perspectives; a broad risk list and an impact type list.

Broad Risk List

Impact Risk List

Three of the most important risks in construction projects include weather, productivity of labor and plant and quality of material. For example these areas are not easily controllable by a contractor before the project execution. Cohen and Palmer identified risk trends in construction projects. They found that typically, risks are determined at the very early phases of the project (feasibility and planning) while the impacts are not experienced until the construction and production start-up phases. Their list of typical sources for risks in construction projects is presented in table

Dubois and Gadded found that complexity in construction projects comes from two basic sources; interdependence of tasks and uncertainty.

Uncertainty has four sources: management is unfamiliar with local resources and local environment, lack of complete specifications for activities at the construction site, lack of uniformity of materials, work, and teams with regard to time and place and unpredictability of environment. Again, the bolded phrases indicate the sources with the highest relevance to this study. Dubois and Gadde’s study’s main conclusion was that the unstable and changing network is a major cause of the short-term sub optimization hampering a longer-term productivity, innovation and learning. To reduce this uncertainty, a firm should consider at least four different types of coordination inside the network and think relationships longer than just one project’s perspective. As can be seen from the risk lists and categorizations presented here, networks are the cause of risks to projects, both directly and indirectly. Indirect means that networks cause significant uncertainties that pose risks to projects. All the bolded items in the section above relate to networks as sources of risk. Risks that are caused by people in networks are social risks, they might also relate to personal chemistry. Other network actors are not totally in one actor’s control: their behavior is uncertain, local conditions and politics slowed decision making and uncertainty about other actors’ capabilities cause risks to projects. It is also very clear that these lists or categorizations are based on the assumption that risk is something negative and threatens the project. This sense is more prevalent in construction risk categorizations than in general project risk categorizations in the frequent use of terms such as “lack of ” ,”inefficiency”, and “errors”, among others. Opportunities in their part are rarely mentioned, thought it is obvious that without, for example business opportunities, business risks would not be worthwhile.

RISK ALLOCATION THROUGH CONSTRUCTION CONTRACTS

It is impossible to eliminate all potential risks in a construction project. Therefore, an appropriate allocation of risks among project actors is very important. Risk allocation influences the behavior of project actors and, therefore, has a significant impact on the project performance in terms of the total cost. Unclear allocation of the project risks leads to disputes between the client and the contractor. One of the problems identified in the

literature is the actors’ different perceptions of to whom a specific risk or group of risks should be allocated. Usually, contractors indicate that they have to bear the majority of project risks and price these risks through adding a contingency to the bid price (Andi 2006). Using contingency funds has been identified by the researchers and practitioners as a significant source of the project’s cost increase (Zaghloul and Hartman 2003). Evaluation and conscious allocation of risks to the appropriate actor under the contract allows reducing the bid price by decreasing contingency funds and, therefore, leads to lower total cost (Zack 1996). A number of models providing a framework for risk allocation decisions can be found in the literature (Lam et al. 2007, Li et al. 2005, Olsen and Osmundsen 2005). Smith et al. (2006) highlight the importance of considering the following issues when making risk allocation decision:

• who has the best ability to control risk events;
• who has the best conditions to manage risks;
• who should carry the risks that cannot be controlled;
• How much does it cost to transfer the risks?

Risk allocation strategy in construction projects is defined through the contractual arrangements. The contract is a written agreement between a client and a contractor where the liabilities and responsibilities of each party are assigned. The contract can also be defined as a trade-off between the contractor’s price for executing the project and his willingness to take the risks (Flanagan and Norman 1993). There are different contract strategies available. The objective of clients is to choose the strategy that ensures achievement of the project objectives in the most efficient way.

Two contract strategies that are mostly used in Sweden are separated (design-bid-build) contracts and integrated design-build contracts. The collaborative form of partnering has become popular in Construction industry during the last decade. In contrast with the UK, partnering does not have the status of a contractual form in Sweden. As a form of project implementation, partnering is intended to create effective collaboration between the project’s actors.

Many countries have developed standardized conditions of contract that are intended to be used in construction projects. In Sweden, the majority of contracts are based on the general conditions of contract. These documents are developed and issued by the Building Contracts Committee (BKK), a non-profit association consisting of authorities and organizations in the sector. “General Conditions of Contract for Building, Civil Engineering and Installation Work” (AB) are used in design-bid-build projects. The design-build projects are regulated by “General Conditions of Contract for Building, Civil Engineering and Installation Work performed on a package deal basis” (ABT). AB and ABT assign responsibilities and liabilities of each contracting party regarding job performance, organization, timeframes, guarantees, insurances, errors and payment.

Design-Bid-Build

Separated contracts are characterized by a traditional separate appointment of a design team and a construction firm. First, the client appoints an architect or engineer to produce design documents (Design) and then procures (Bid) the contractor to execute (Build) the project. Thus the client is responsible for the planning, design and function of a construction and the contractor is responsible for the job execution. The DBB procurement is the most widely used strategy in many countries, e.g. the UK, USA and Singapore (Ling et al. 2004). Within this contract strategy, two main organization alternatives are possible: divided contracts and general contracts. Schematically their organization structures are shown in Figure

A divided contract implies that the client appoints several contractors and signs a separate contract with each contractor. It allows the client to choose the best possible tender for every part of the work. On the other hand, the coordination costs are very high and it might be difficult to identify exactly which contractor is responsible for a particular error. A general contract implies that a client signs only one contract with a general contractor, who in turn appoints subcontractors to carry out the work. The general contractor is solely responsible for the coordination of subcontractors.

Design-Build

In design-build contracts the contractor is responsible for both design and construction. The client signs only one contract, thus this form is the most straightforward from the perspective of responsibility. In the procurement documentation, the clients set their demands in terms of functionality. The popularity of DB contracts has increased in recent years, because a single point of responsibility is attractive to clients. A study by Ernzen and Schexnayder (2000) shows that the average profit margin for a DB project was higher than that for DBB. Konchar and Sanvido (1998) confirm that DB projects on average show a better performance than DBB in terms of unit cost, construction speed, delivery speed, cost growth and schedule growth. From the risk allocation perspective, DB contracts are more attractive for the client as the responsibility for design implies that more risk is allocated to the contractor. On the other hand, the DB alternative may be more expensive compared with DBB contracts. Furthermore, the quality of the final product may be lower if the contractor uses cheaper solutions, trying to decrease his own costs (Gransberg and Molenaar 2004). This problem is especially relevant in contracts with a lump sum payment mechanism. In terms of time, the DB system arguably provides an earlier start for project execution than is the case for other forms. Toolanen (2004) found that clients choose DB contracts more often when the project’s timeframe and availability of resources are critical factors. From the contractor’s point of view, DB construction projects can be very risky when the contractor lacks knowledge and experience of the design-build system. Håkansson et al. (2007) highlight that the competence requirements are higher in DB contracts, and hence structured risk analysis should be made very early in the project. Simu (2006) shows that smaller contractors in Sweden prefer DBB to DB contracts. In the case where a DB contract is used, contractors increase their price by including insurance for the extra risks involved.

COLLABORATIVE RELATIONSHIPS IN CONSTRUCTION PROJECTS

Adversarial and opportunistic behavior is common in the construction industry (Cox and Thompson 1997, Zaghloul and Hartman 2003). It means that the actors are focused on the short-term relationship and economic results rather than on long-term cooperation. In response to this behavior, many researchers try to find the concepts for more collaborative relationship between the project actors. Two concepts are of special interest in this research: relational contracting and joint risk management. Both focus on improvement of contractual relationships, better risk allocation, and, therefore, on more effective risk management.

RELATIONAL CONTRACTING AND PARTNERING

Over the last decade, the researchers and practitioners have recognized that the relationships between the client and the contractor play a significant role for successful project implementation. Relational contracting (RC) is a concept that concentrates on the relationship between the contract parties. RC recognizes mutual benefits and win-win scenarios through cooperative relationship (Rahman and Kumaraswamy 2002). A study by Akintoye and Main (2007) shows that UK contractors are positive about collaborative relationships and believe they lead to cost and risk reduction. The results of the other study (Drexler and Larson 2000) show that relationships in partnership projects are much more stable than in other types of projects.

The collaborative form of partnering is based on the RC principles. The concept of partnering is variously defined in the research literature (Drexler and Larson 2000, Kadefors 2002, Rahman and Kumaraswamy 2004a, Rhodin 2002). To summarize, partnering is a way to create effective collaboration between the project’s actors. Components such as common goals, continuous improvement and structures for problem solving form the concept of partnering. Effective collaboration is claimed to lead to fewer disputes, lower construction costs and a better quality product. Positive experiences of partnering in the USA, UK, Norway and Denmark have led to the partnering concept being adopted in Sweden.

Examples of partnering projects are presented in Rhodin (2002) and Kadefors (2002). The three largest construction companies in Sweden, Skanska, NCC and Peab, actively work with partnering projects and report positive results. One of the goals of partnering is better utilization of the overall qualifications of the project actors. The concept of trust is tightly connected to partnering. Trustful relationships between project actors result in a more effective risk allocation process, decrease of contingency funds and, finally, to project cost reduction (Zaghloul and Hartman 2003). Furthermore, partnering helps in transfer knowledge and experience between the project actors. It is important to note that the partnering concept demands high professionalism and very good knowledge of the project on the part of the client and the contractor.

JOINT RISK MANAGEMENT

Even efficient allocation of the identified risks through the contract in the procurement phase does not guarantee that no conflicts occur in the project. During the project life cycle the nature and extent of identified risks may change and new risks may appear. Sometimes new risks may require joint efforts to manage them effectively. Joint risk management (JRM) is about working together at mitigating unforeseen project risks at the post contract stage (Rahman and Kumaraswamy 2004b). Participants in a questionnaire survey of the Hong Kong construction industry (Rahman and Kumaraswamy 2004a) recommend JRM as the best option for managing unforeseen risks and indicate a high motivation towards the JRM approach.