Chapter 4: Reducing Risk‎ 

Contents:

Having identified and assessed the risk you are in a position to consider ways of reducing it. There are three basic approaches:

-         Avoidance: having identified the risk, you replan to eliminate it

-         Deflection: you try to pass the risk on to someone else

-         Contingency: you take no action in advance of the deviations occurring other than to draw up contingency plans should they occur.

Pym and Wideman use an analogy of a man being shot at. He can take cover to avoid the bullets: he can deflect them using a shield or divert the bullets by placing someone else in the firing line: or he can allow them to hit him and plan to repair the damage.

4.1

Avoidance

4.1 Avoidancet

The warehouse project above showed how to avoid the risk of snow holding up the preparation of the foundations, by starting the work early enough so that it is finished before the snow comes. Under avoidance you change the plan for anyone of the five system objectives or any combination of them to reduce the risk or eliminate it entirely.

4.2

 Deflection

4.2 Deflection

There are three ways of deflecting risk:

-         Through insurance: by which it is passed on to a third party.

-         Through bonding: by which a security is held against the risk.

-         Through the contract: by which it is passed between owner, contractor and subcontractors.

1.      Insurance: A third party accepts an insurable risk for the payment of a, premium, which reflects the impact of the risk and the likelihood combined with the consequence.

2.      Bonding: One or both parties to a contract deposit money into a secure account so that if they or either party defaults, the aggrieved party can take the bond in compensation. This is a way of transferring the risk of one party defaulting to that organization.

3.      Contract: Through contracts the risk is shared between owner contractor and subcontractors. There are two common principles of contracts:

a)     Risk is assigned to that pony most able and best motivated to control it.  There is no point passing risk onto a contractor or subcontractor if neither has the power or the motivation to control it. The Institution of Civil Engineers is currently revising its standard forms of contract around this principle. There are four styles of contract for different approaches to sharing risk:

-         Fixed price

-         Cost-plus

-         cost reimbursable

-         Target cost.

b)     Under fixed price contracts. In Figure 4.1-a, the contractor accepts all the risk by taking a fixed fee for the work regardless of how much it costs. It is assumed that the owner has completely specified the requirements and as long as they do not change the contractor can meet a given price. This approach is adopted for turnkey contracts, where the contractor takes full responsibility and delivers to the owner an operating facility. The owner has no role in its construction. Often in fixed price contracts the owner and contractor haggle over every change arguing over which one of them caused it and whether it is within the original specification.

When the owner cannot specify the requirements, the contractor should not accept the risk, but it should be borne by the owner. The simplest way is through cost-plus contracts, Figure 4.1-b. The owner refunds all the contractor’s costs and pays a percentage as profit. The disadvantage is that the contractor is still responsible for controlling costs, and yet the higher the costs the higher the profit. This is a recipe for disaster as the party responsible for control is not motivated to do it; in fact the exact opposite. It is possible to adopt strict change control and that passes responsibility for controlling costs back to the owner, but can lead to strife. Typically, cost-plus contracts are used on research contracts.

Another way of overcoming the problem is to pay the contractor a fixed fee as a percentage of the estimate, instead of a percentage of the out-turn. This is a cost reimbursable contract. Figure 4.1-c. The contractor can be motivated to control costs if paid a bonus for finishing under budget, or charged a penalty if over budget. However, the parameters for the bonus or penalty must be carefully set to ensure that the accepted risk is not beyond the contractor’s control. Even without a bonus the contractor may be motivated to control costs, as that increases the percentage return.

Figure 4.1: Four types of contract

A related approach is target cost, Figure 4.1-d. The contractor is paid a fixed price, if the out-turn is within a certain range typically ± 10 per cent of the budget. If the cost goes outside this range, then the owner and contractor share the risk at say 50p in the pound. If the costs exceed the upper limit, the owner pays the contractor an extra 50p per pound of overspend and if the price is below the range the contractor reduces the price. This is often used on development projects where there is some-idea of the likely out-turn but it is not completely determined. The contractor may also share in the benefits from the product produced.

c)      Risk is shared with subcontractors if it is within their sphere of control. To achieve this, back-to-back contracts are used: the clauses in the contract between owner and contractor are included in that between contractor and subcontractors. In some instances, where the contractor feels squashed between two giants and accepts quite severe clauses from the owner to win the work but believes that the subcontractors will not accept them because they do not need the work. This often happens to contractors on defense or public sector projects. The way to avoid this is to try to get the subcontractors to make their contracts directly with the owner and use the owner's power to pull the supplier into line. The supplier may not need the business from the contractor but may have a better respect for the owner.

4.3

 Contingency

4.3 Contingency

The third response to risk is to make an allowance for it by adding a contingency. You can add an allowance to anyone of the five system objectives, but typically there are two main approaches:

-         Make an allowance by increasing the time and/or cost budgets.

-         Plan to change the scope by drawing up contingency plans should the identified risks occur.

4.4

Time and/or Cost

4.4 Time and/or Cost

You can either add the allowance as a blanket figure calculated through a bottom-up approach as above or you can add it work element by work element. Either way, the project manager should maintain at least two estimates, a raw estimate without contingency and an estimate with contingency. The former called the baseline is communicated to the project team as their working “budget” and the latter to the owner for the provision of money and resources. The project manager may also maintain two further estimates the most likely out-turn the figure to which they are working and the current estimate, which is the baseline with some contingency already consumed. The reason for giving the project team the baseline or current estimate as their working figure is that their costs will seldom be less than the estimate and will consume contingency if it is given to them. The reason for communicating the estimate with contingency to the owner is allow him to budget for the maximum likely time and cost.

4.5

 Contingency Plans

4.5 Contingency Plans

These are alternative methods of achieving the milestones to be used in different circumstances. The alternative plans mayor may not cost more money to implement though, presumably, if they cost less, it would be better to follow them in the first place. On the extension to the steam system on the ammonia plant above, it was shown how alternative plans were available should the valve shut tight shut partially and not shut at all. The latter plans each would have cost more than the first which is the one we followed although the second would have only been marginally more expensive.

However, it is better to plan to eliminate the risk than to plan how to over-come it and it is better to plan how to overcome it than to increase the cost and extend the duration to pay for it.

4.6

Controlling Risk

4.6 Controlling Risk

Having identified ways of reducing risk, you can implement a plan to control the reduction. There are four basic steps in control:

-         Draw up a plan

-         Monitor progress against the plan

-         Calculate variances

-         Take action to overcome variances.

4.7

The Risk Management Plan

4.7 The Risk Management Plan

The risk management plan identifies the risk associated with a project the means by which they have been assessed and the strategy for their reduction. A risk item tracking form provides a framework for recording the relevant information for each risk. The form which may be held in a spreadsheet or computer database describes:

-         Why the risk is significant?

-         What is to be done to reduce it?

-         When the risk will have its impact on the project?

-         Who is responsible for resolving the risk?

-         How the reduction will be achieved?

-         How much it will cost to resolve the risk?

4.8

Monitoring Risk

4.8 Monitoring Risk

The risks are then monitored on a regular basis (weekly fortnightly monthly or at other predetermined intervals) to determine how far each risk has actually been reduced. At each review the risk tracking forms arc sorted into their order of current importance. A list of the most significant risks usually the "top-ten" is produced giving rank this period rank last period and periods on the list.

4.9

Risk Reassessment

Reassessment should be carried out whenever new risks are identified in the course of risk monitoring. In addition, there should be explicit reassessment at key milestones in the project and at transition between stages. The launch meetings for subsequent stages are ideal media for this reassessment. All the above techniques are used for reassessment. It is always easier to improve on an existing plan but there is the disadvantage that new risks may be ignored. Figure 4.2 shows a risk item tracking form for TRIMGI communication BV company.

Figure 4.2: Risk item tracking form

Example "How to reduce risks in projects?"