All projects are unique and carry their own risks. Defining, understanding and managing the risks involved in project delivery is fundamental to the success of any project.
Once the project delivery risks have been identified and assessed, the next key issue to manage is who should take ownership of the risk - owners, consultants, engineers, contractors, suppliers or labour force.
The Definition of Project Delivery Risk
One formal definition of a project delivery risk is an event or occurrence that may negatively impact the project.
Alternatively, the exposure to a company that arises from taking on a particular task. A project risk can be internal to the business, it can involve external events or it can stem from any other circumstances that can hamper the project's overall success and result in loss or embarrassment to the firm undertaking it.
There are two key features that characterise risk:
- The probability (likelihood) that they may occur.
- The consequence (impact) on the project if they do occur.
Risk Identification and Categorisation in Project Delivery
The actual identification of project delivery risks can be challenging depending on the complexity of the project. Identification methods will vary with the experience of the participants and their understanding of the project delivery process.
The intent is to generate a comprehensive list of sources of risk and events that might influence the delivery of the project and which may degrade, delay, or enhance the project outcomes.
Risk identification methods may include reference to preceding projects, facilitated workshops and brainstorming, site inspections, expert advisors, use of checklists and risk categorisation frameworks (see below) as prompts for more directed assessment.
In an effort to analyse risk, researchers have applied themselves to developing risk categorisation frameworks. An example of such a framework developed by Zhang et al for construction contracts, is presented in Figure 1 below.
This framework could be extended to include technical and commercial risk categories in order to cover project delivery issues, for example those applicable before and after the construction stage, as listed below.
The number and type of project risks considered under a selected framework will depend on a range of contributing factors including:
- Project size
- Technical complexity
- Level of understanding of the project
- Number of parties involved
- Behaviours of project participants
- Project schedule
- Delaying events
- Contracting strategy
- Contract – form
- Contract – performance and cost
- Contract – sufficiency and adequacy of documentation
- Scope of work –clarity of intent and language
- The owner’s ability to pay for the project
- Balance sheet and financial stability of contracting parties
- Payment terms
- Liquidated damages
- Source of finance
- Payback period and required rate of return.
- Site conditions
- Supply chain logistics
- Process guarantees;
- Equipment warranties
- Labour supply and management
- Regulatory and compliance environment
- Safety and environmental
- Political and legal
- Social licence to operate
- Market conditions
- Ownership of the asset.
The design and construction of a simple steel structure using approved engineering standards and standard construction contract terms and conditions within a known legal jurisdiction, will have fewer risks than the design, construction and commissioning of a complex metallurgical processing plant utilising new technology with process guarantee obligations, volatile product stream market conditions in a remote, developing country location.
Developing a Risk Register
Risk can be managed, reduced, transferred or accepted, but it cannot be ignored. (1)
A common practice for owner, consultant and engineer organisations at project commencement is the development of a risk register to methodically identify and assess known or perceived project delivery risks, consider the consequences of those risks, and develop targeted mitigation plans and actions to manage those risks through the project life cycle.
The risk register remains a live document with scheduled reviews throughout the course of the project to close-out, add, update or modify risk mitigation activities - subject to progress achieved and issues or events that have already occurred. It also provides a record at project completion of the risks managed and those that may carry over into the project’s operating life.
Project Delivery Risk Allocation
While equitable allocation of risk between the parties involved in the project is important, the task of proper allocation of project delivery risk often rests with one dominant party - the owner. Project financiers or insurers, through their imposition of commercial terms on the owner, may ultimately drive where the owner allocates risk.
Allocation of project delivery risk to the party best placed to manage that risk can have a significant impact on the final cost of the project. In a perfect world, project performance would be improved and overall project delivery risk reduced when this philosophy is applied, however not all projects allocate risk equitably, or allocate the power and authority to manage the risk along with the risk itself.
Key areas of project delivery risk for the owner will be different to the project delivery risks applying to a financier, a consultant, an engineer, or a contractor. Accordingly, it is important to differentiate between risks that are, and those that are not, within the respective party’s ability to control.
Where a party is required to assume responsibility for a project delivery risk over which it has limited or no control, a natural consequence is for that party to attempt to offset its risk via the application of a risk premium, i.e., increasing the cost of its goods or services. Accumulation of these ‘cost loading’ events may then impact on:
- The bankability of the project
- The level of project insurances required, or even those available for consideration
- The owner paying an inflated price for the project.
Allocation of risk to a party not skilled or competent in managing that risk may ultimately generate a number of more significant, and potentially damaging, project delivery risks for the owner to manage, including:
- Technical failures
- Late completion
- Withdrawal of warranties and performance guarantees
- Commercial and legal disputes
- Absence of regulatory approvals
- Inability to commence operation and generation of cashflow
- Collapse of third party offtake agreements
- Insolvency of one or a number of parties in the project delivery chain that may result in failure of the project or even the owner.
There are also cases where risk sharing may provide a better project outcome. For example, a project owner may grant an extension of time for a defined cyclone event, while the contractor absorbs the cost of the standby and downtime for his labour and plant up to a pre-determined value.
An Appetite for Risk
The owner’s power in allocation of project delivery risk does not necessarily follow an equitable path.
Consultants, contractors and suppliers are participants in a competitive market, and will have varying degrees of risk appetite subject to their capabilities, competence, and level of financial security. Their ability to assess and apply a competitive risk premium in pricing their goods and services may be driven by a range of factors such as market conditions (demand for their goods and services), access to finance, free cashflow, process warranties, ability to lay off risk to subcontractors, and accumulated risk carried from other contracts.
With the recent collapses of contractor builders and engineering and construction contractors, the flow-on effect on subcontractors and suppliers has prompted both State Government and industry groups to focus attention on providing greater protection to subcontractors and suppliers through secure ‘project bank accounts’ for State-funded contracts to ensure payments flow down the subcontracting chain.
Its is unlikely to protect subcontractors if the head contractor went into administration or collapsed, as that would trigger the application of Commonwealth insolvency laws outside the control of the State.
It could be argued that this process has limited benefit other than adding an additional layer of administration, with associated costs, in the contracting payment chain.
The real issue to be addressed is the avoidance of these circumstances by the appropriate allocation, and acceptance, of risk at commencement of the project.
- Lam, K.C., Wang, D., Lee, P.T.K., Tsang, Y.T.; (2007). Modelling risk allocation decision in construction contracts; International Journal of Project Management 25(5), pp 485-493
Project Manager - Engenium Pty Ltd