The case for risk management in the Middle East construction market has been saved
The case for risk management in the Middle East construction market
ME PoV Summer 2017 issue
The Middle East construction industry has not fully embraced the concept of risk management as regards construction projects—or the value it can provide—despite the countless risks that may affect projects and their typical consequences.
- Increased unrecoverable project costs and reduction in profit;
- Delays to key milestones and project completion;
- Reputational damage; and at worst,
- Financial distress, or insolvency.
The risks associated with capital projects are often manifested in two ways: the first is at the start of projects, where budgets used to control costs, either do not include a monetary allowance for possible risk events or, more typically, use an arbitrary percentage allowance for non-specific risks (“contingency”.)
The second is during project execution. Risk events that could affect the likelihood of project success are not proactively identified, quantified or managed and are inaccurately reported, due in large part to the absence of a dedicated risk management team within an organization and an understanding of the difference between risks and issues.
The results are cost and time overruns that often come as a shock to project sponsors and senior management within organizations. In the absence of any risk allowance and proactive risk management, the project manager ultimately takes the blame—and often unfairly so.
The challenge—changing mindsets
When questioned on the absence of risk management processes, procedures and specialists in organizations, responses from project teams are usually met with indifference.
It is perhaps difficult to see how this view will continue to prevail with a decreasing pipeline of new opportunities and tighter financial policies across the Middle East region. Tight management of project costs and clear visibility of project risks will become critical in ensuring overruns are avoided and stakeholders retain confidence in an organization’s ability to deliver projects successfully.
The other challenge often encountered is of the “if we price risk, we won’t win the job” type which, in a competitive market fighting for limited opportunities, may hold some weight. However when costs begin to escalate and margin forecasts erode because of risk events, it is inevitable that strained relationships and difficult conversations will arise. Open and honest disclosure of project risk (and quantification thereof) at the outset is essential.
The solution—tools and techniques
An increased focus on risk management, as a key part of robust and mature project controls, is required to provide certainty of a project’s outturn cost and completion date. Companies are typically at stage one or two of the risk management maturity scale shown in Figure 2 on the right.
Stage three represents the creation of a risk management plan and risk register at the start of the project, which forms a key component of project performance monitoring and reporting. Through various identification techniques, risk events are identified and probabilities and cost impacts assigned in order to define the risk exposure for the project, which is then maintained, developed (and re-assessed) throughout the project.
Stage four (a more advanced good practice approach) is to use the risk register, project budget and schedule to undertake a quantitative schedule and cost risk analysis using modeling tools, such as Monte Carlo analysis. This provides a range of benefits including a determination of the probability that the project will be delivered according to a given budget and timescale.
Establishing appropriate risk processes, utilizing some of the tools described above, and establishing a proactive risk management culture will generate the following benefits:
- Open and honest disclosure – all project stakeholders obtain a clear perspective on project risks and achieve a greater certainty in a project’s outcome—avoiding sudden shocks;
- Resilient project budgeting – appropriate cost and time risk budgets, based on robust analysis, can be established through their inclusion in a project’s baseline budget; and,
- Avoidance of blame culture – project teams are encouraged to identify and preempt risk and, importantly, share responsibility for their mitigation (or exploitation.)
Finally, clients who award work to contractors who fully consider project risk benefit from greater certainty in outturn costs, since such contractors are less inclined to continually submit change notices in order to recover unpriced losses due to risk events.
Risk Management is an essential part of project controls and in a “survival of the fittest” construction market those who proactively manage risk to increase certainty of the final cost of projects are most likely to prevail.
by Matt Hanson, Assistant Director, Capital Projects, Financial Advisory, Deloitte, Middle East