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 today’s 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. CII’s definitive work on construction risks
(Diekmann et al., 1998) uses classic operations research literature to 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 project’s or organization’s
environment that may contribute to project risk, such as poor project 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 author’s 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.