Are the risks real or imagined?
Of course sometimes there are real dangers of walking through a dark empty house – you could trip and fall down the stairs, so using a torch or turning the lights on would be a good precaution. Also, you wouldn’t wander alone through a derelict house in a bad neighbourhood because you may just bump into someone high on drugs who could resent being disturbed. We need to understand what the real risks are and not let out imagination create problems where there aren’t.
So it is when we price projects. Sometimes we can imagine all kinds of perils and dangers. In fact construction projects seem fraught with danger. Tap, creak, scratch! What if it rains, the client doesn’t pay, there are labour problems, we can’t get materials, the information is late, equipment breaks down or things don’t go as planned? Well I have news for you, if you don’t already know it - in construction things seldom go exactly as planned. You can expect the unexpected.
It’s good to be cautious. It’s good to feel that fear go through your body when you price a project. Feel the adrenalin flow and your senses become more aware. Fight or flight?
To be honest, there are some projects where flight is the best course of action. No matter how hard you’ve worked on your price, no matter how much you want the project, if the risks of doing the project are too big for your company, walk away. You wouldn’t walk into that derelict building alone in a bad neighbourhood, so why do contractors take stupid risks and take on risky projects.
But as in that empty dark house our imaginations can run wild imagining all kinds of risks and dramas that don’t exist. Tap, creak, scratch – who is there? If we take all these imaginary risks, real and otherwise, into account we wouldn’t submit a price for any project. In fact just give up construction.
So how do we treat risk on our projects?
- We need to understand the project. This includes reading through the contract documents, looking at the drawings, visiting the project site and doing additional research ensuring you understand the local conditions, the client, the availability of resources, etc.
- List all the possible risks.
- Rate the likelihood of the risk eventuating. Is it very likely, likely, slightly likely or just a slim chance? I normally put a percentage chance with 100% representing something that will definitely happen and 0% representing something that probably isn’t going to happen. Try and be realistic. The more knowledge you have the more realistic this will be. Some of us are more pessimistic than others while others are very optimistic, so it may pay to look back at your past project experiences to see how often some of these risks actually eventuated.
- Then I allocate a cost impact to the risk. This doesn’t have to be an actual cost, although later we can calculate potential costs. Of course we aren’t just dealing directly with money here and we also need to consider safety (a death or serious injury would be considered a very high impact) and company reputation. I would rank cost impacts from very high (serious implications for the company with the possibility of bankrupting it), high (will cause financial distress to your company), medium (will cause serious distress to the project, but will have only minor implications for the company), low cost (medium financial loss for the project but no impact to the company), and very low cost. For those who like numbers you could allocate a number from 0 to 100, with 100 being a very high cost and 0 being no cost.
We now have a list of all our perceived risks and have allocated a possibility of the risk eventuating and the possible cost impact of the risk event if it should eventuate. What now?
Dealing with risks
- Ignore the risk. There will be some risks on your risk schedule that have a very low probability of happening, and if they do their costs could be minimal. Cross these risks off since they are not worth worrying about. Contractors are expected to deal with and accept some risk. Life is full of risk and we cannot totally avoid risk. Flying can be risky, yet we all fly as the odds of something happening are relatively small.
- Check that the risk is actually your problem. If your client or owner is late with information or changes their design midway through construction is that your problem? Chances are the contract protects you and you will have cause to ask for a variation to compensate you. If it’s not your problem then it’s not your risk.
- Transfer the risk. There are some risks contractors can’t control – especially extraordinary weather events such as tornedos and cyclones. When we worked in cyclone prone areas we couldn’t predict how many cyclones would form in a season. We therefore specifically excluded cyclones from our price. This was the fairest way for both us and our customer.
- Mitigate the risk. This is where we put in place steps to reduce either the chance of the event happening or where we could reduce the impact of the event. Mitigating the risk could mean re-engineering the project to reduce the impact of poor weather and could take the form of prefabrication or fabricating the structure in modules on or off-site. It could also entail changing the schedule so that tasks most at risk from weather events occur in the times of least risk such as the dry season.
- Research the risk events further. Even discuss your concerns with the customer. You may be seeing a ghost that doesn’t exist or you may have misinterpreted the possible events. Upgrade or downgrade the risks as you obtain more information.
- Accept the risk and allow for it in your price and schedule. But how much? This is a topic for my next post.
- Take insurance for the risk. In some cases it is possible to insure for a risk. Again more on this in my next post.
- Add additional profit to compensate for taking on excessive risks. The additional profit may compensate the company should things go wrong – hopefully meaning that you only make a lesser profit and not a loss. However, contractors should also expect a greater reward for accepting projects with a higher risk.
- Walk away from the project. If the risks on a project are too high and could jeopardise your company’s survival then walk away. Don’t be too proud, or too stubborn to walk away. Tell your customer or potential client why the risks aren’t acceptable, maybe they’ll be prepared to change the conditions of contract to accept more of the risk. If not, let another contractor take the risks. Maybe they are better able to accept the risks, or maybe they are just stupid.
What happens now?
Many estimators do the right thing and create a risk schedule while pricing the project, but then it’s forgotten in the file somewhere. The estimator has implemented risk strategies, transferring risks to the customer, adding costs to cover risks or adding mitigating measures, but during bid negotiations the risk schedule is forgotten. Over eager managers in the excitement of negotiating the project award forget about the risk schedule (maybe they don’t know it exists or don’t understand it) and they concede to the customer’s requests to remove some of the risk mitigating strategies by withdrawing clauses to transfer risks or reducing the cost allowances for risks. Of course, if during the course of the bid negotiations it becomes apparent that the impact or likelihood of the risk happening has been over exaggerated then it may be necessary to review the risk schedule. (More on this topic in my next article.)
It’s also important the potential risks are communicated to the project team so they understand the mitigation strategies and ensure they are implemented when your company is awarded the project.
Like a dark empty house a construction project is filled with unknowns and risk, don’t let your imagination run wild, but also don’t enter it without being well prepared and ready to confront the real risks. Contractors need to take a considered approach to risk. Don’t rush in blindly where others fear to tread, but also don’t imagine risks where there aren’t risks, or blow risks up into insurmountable mountains when they can be easily dealt with. Also you do need to understand that contractors have to accept some risks.
By researching and understanding your projects you will be better able to tackle the risks. Creating a risk schedule will enable you to better understand and deal with risk.
Don’t fall down the stairs in the darkness but don’t let every strange noise frighten you into building an impenetrable fortress.
How do you view risks on your projects? What is your approach?
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