Description
The construction activity involves assembling materials and components designed and produced by a multitude of suppliers, working in a diversity of disciplines and technologies, in order to create what is regarded as 'the built environment'.
Risk and Financial
Management in
Construction
SIMON A. BURTONSHAW-GUNN
Introduction
Book Format
Whilst there are natural overlaps between the two topic areas of Project
Management, for ease of use this book is divided into two parts: Part 1 dealing
with Construction Risk Management, and Part 2 with its corresponding
Financial Management. This introduction provides an overview of the
construction industry and also introduces the main themes of these two
interrelated construction management topics. It closes with an overview of the
forthcoming chapters.
An Overview of the Construction Industry – Setting
the Scene...
The construction activity involves assembling materials and components
designed and produced by a multitude of suppliers, working in a diversity of
disciplines and technologies, in order to create what is regarded as ‘the built
environment’. Such activities can include the planning, regulation, design,
manufacture, construction, maintenance and eventual decommissioning of
buildings and other structures. Their scale, complexity and intricacy varies
enormously, ranging from work undertaken by small ‘jobbing’ builders,
to international construction companies undertaking long-term, high-cost,
complex and sometimes high-risk projects such as single or multiple major
civil construction, with obvious examples being the Channel Tunnel, nuclear
power station construction and, of course for the UK, its showcase sporting
venues for the London 2012 Olympic Games.
From a ‘value chain’ viewpoint, new construction can be regarded as:
a means of production or provision of services (a factory or ofce
block);
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RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
2
an addition to, or improvement of, the infrastructure of the economy
(railway or roads);
a social investment (hospitals); or
provision to meet a direct need (housing).
Construction then is a major national investment, accounting for half of the UK's
annual fxed capital formation. As such, it plays a vital role in the competitive
delivery of goods and services by the rest of the economy. In addition the
house-building industry also stimulates other services (estate agents, solicitors)
and associated industries for example suppliers of carpets, curtains, furniture,
white goods and so on. The construction industry as a whole presents many
employment opportunities in the felds of building, civil engineering, ofshore
structures and the process-plant industry. It embraces the eforts of contracting
frms, specialist contractors, consulting architects and engineers, professionals
such as architects and quantity surveyors, suppliers of building materials and
manufacturers of equipment.
Construction, by its nature as a system integrator and a stimulus for other
parts of the economy, can therefore be regarded as a basic economic multiplier.
From a macroeconomic perspective the industry requires the three classic
‘factors of inputs’ of land, labour and capital, all of which can be afected by
government policy. The UK is neither a state-controlled economy, nor is it at the
other end of the continuum of being a free economy of no state intervention.
Indeed the UK operates by a compromise of mixed economy with a certain
amount of government intervention. At the national government level this
can be seen in the form of taxes, Health and Safety legislation, Construction
Management legislation and general employment law. At the local government
level this is exemplifed by control of planning approval and development
schemes, adherence to local requirements and bye-laws and cognisance of local
pressure groups.
Looking broader, the construction industry is not only of major national
importance but may also feature as an international industry as UK construction
companies may also be responsible for a signifcant amount of work undertaken
overseas, which typically represents between 10 to 15 per cent of the annual
turnover of the major British construction contractors. UK companies working
overseas require an understanding of, frstly, how to fnd and undertake
construction work in diferent countries; secondly, the level of competition,
tendering and procurement activities; and thirdly, how to comply with new
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•
INTRODUCTION 3
local and national government controls such as employment law, health and
safety requirements and so on.
An examination of the various sectors within the construction industry
reveals that this may be seen as a temporary activity as it is normally carried
out at the client’s premises and is viewed as an enabling activity to allow
the client organization to conduct its business; be this retail, manufacturing
or service related. However, because of these reasons, the industry has a
number of problems such as low and discontinuous demand, low productivity
compared to other industries and low proftability. There is no imposed or self-
regulation of the industry and there are so many companies that the industry
can be regarded as (and is ofen criticized for) being fragmented.
Historically the factors which infuence the location of a particular industry
have typically included the accessibility of raw materials, power supply (for
example, coal and water), transport, market access and so on. However,
examining the construction industry against such criteria reveals that the
industry is not itself infuenced by such location factors but by the locations
of its client’s base and, without a long-term commitment, construction work
becomes a mobile service industry. Indeed, in the vast majority of cases it is not
only undertaken at the client’s site but, importantly, only when other industrial
or commercial sectors are fourishing, allowing it to concentrate on the building
of factories, houses or service buildings.
The operation of the construction industry can be viewed against a
competitive strategy model (shown as Figure I.1) developed by Harvard
University Professor, Dr Michael Porter, which identifed fve key driving
forces on a business. These being:
Potential Entrants – the threat of new entrants;
Industry Competitors – rivalry among existing frms;
Substitutes – the threat of substitute products or services;
Buyers – the bargaining power of buyers;
Suppliers – the bargaining power of suppliers.
In looking at the frst two of these key business drivers – Potential Entrants
and Industry Competitors – it is recognized that the UK construction industry
is, in the main, confned to competition from established UK companies. This
is particularly so in the sectors of Non-residential Building and Infrastructure
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RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
4
because the construction industry operates diferently to other industrial
or economic sectors. Companies require manpower resources, plant and
equipment, health and safety procedures and various insurances to be in place
together with an established track record to be able to even bid for work in
this important sector. Consequently, these requirements imposes signifcant
barriers to entry to the construction market resulting in competition not from
international companies or new entrants but being confned largely to existing
UK companies or those international organizations with a UK subsidiary
operation. In looking at the third element – the threat of substitute products
or services – it is logical to assume that there is litle threat of substitution of
site-based infrastructure construction activities although the future may see
an increase in the prefabrication of buildings or other factory-based building
techniques.
The fnal two forces covering the bargaining power of buyers and those
of suppliers can also be grouped together. Both are infuenced by the same
factors of the concentration of construction companies, the number of capital
projects being undertaken within the UK market and the perceived importance
and willingness to undertake work for a particular client. These two forces and
that of competition have had an efect on client/contractor relationships over
a period of many years. Indeed, the traditional modus operandi of competition
with other construction companies has been driven, in the main, by the client’s
desire to achieve the lowest-cost bid, not only in the private sector but also
in the public sector, which has been supported by the government-inspired
Compulsory Competitive Tendering process. As a result, and with very
few exceptions, relationships have been adversarial with parties concerned
resorting to contractual claims, which lengthen timescales and drive up costs,
as a direct consequence of the behaviour of both parties. Where the client will
only award work to the lowest-priced contractor, the contractor responds to this
approach by submiting an uneconomic and unrealistic low price which results
in time and efort being spent by the contractor in fnding reasons for which
additional money will be sought. In essence, this became a common contractor’s
traditional strategy of submiting a low price in competition knowing that it
will be supplemented by post-contract extras, variations and fnancial claims
when delay and disruption opportunities presented themselves.
Furthermore the traditional procurement systems and the contractual and
legal framework by which participants are bound together have been widely
and regularly criticized as being confrontational and adversarial. This should
not be too surprising as it is widely recognized that the construction industry
is historically famed for its adversarial approach and the amount of time and
INTRODUCTION 5
money spent on litigation which provides employment opportunities for a
signifcant number of professionals including claims consultants, quantity
surveyors and construction lawyers. Such recognition of the construction
industry’s adversarial atitudes is not new and a number of British Governments
have commissioned investigations into the industry, notably the reports
of Sir Ernest Simon in 1944, Sir Harold Emmerson in 1962 and Sir Harold
Banwell in 1964, all of which tell a similar tale. More recently this industry
‘norm’ so concerned the previous Government that it appointed Sir Michael
Latham to carry out yet another review of the procurement and contractual
arrangements in the industry. His report ‘Constructing the Team’, published in
Determinants of buyer power
• Bargaining leverage
• Buyer concentration v firm concentration
• Buyer volume
• Buyer switching costs relative to firm
switching costs
• Buyer information
• Ability to backward integrate
• Substitute products
• Pull-through
• Price sensitivity
• Price/total purchases
• Product differences
• Brand identity
• Impact on quality/performance
• Buyer profits
• Decision-makers incentives
COMPETITIVE
RIVALRY
Suppliers
Substitutes
New entrants
Buyers
Threat of
entrants
Threat of
substitutes
Bargaining
power
Bargaining
power
Entry barriers
• Economies of scale
• Proprietary product differences
• Brand identity
• Switching costs
• Capital requirements
• Access to distribution
• Absolute cost advantages-
• proprietary learning curve
• access to necessary inputs
• proprietary low-cost product design
• Expected retaliation
Rivalry determinants
• Industry growth
• Fixed (or storage) costs/value added
• Intermittent overcapacity
• Product differences
• Brand identity
• Switching costs
• Concentration and balance
• Informational complexity
• Diversity of competitors
• Corporate stakes
• Exit barriers
Determinants of
suppliers
• Differentiation of inputs
• Switching costs of suppliers and
firms in the industry
• Presence of substitute inputs
• Supplier concentration
• Importance of volume to supplier
• Cost relative to total purchases in
the industry
• Impact of inputs on cost or
differentiation
• Threat of forward integration
relative to threat of backward
integration by firms in the
industry
• Relative price performance
of substitutes
• Switching costs
• Buyer propensity to
substitute
Determinants of
substitute threat
Suppliers
Substitutes
New entrants
Buyers
Figure I.1 Competitive Rivalry
Source: Reprinted with the permission of The Free Press, a Division of Simon & Schuster
Adult Publishing Group, from ‘Competitive Advantage: Creating and Sustaining Superior
Performance’ by Professor Michael E Porter. © 1985, 1998 Michael E Porter. All rights
reserved.
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
6
1994, recommended change for the industry and gave a number of specifc
recommendations including a change in culture aiming to move away from
the traditional adversarial client/supplier relationship which it noted had
prevailed in the industry for many years. In particular the ‘Constructing the
Team’ report saw closer collaboration and ‘partnering’ as the development of a
strategic long-term commercial arrangement between a client, contractors and
suppliers and went further by proposing that this was one of the techniques
most likely to improve both cost efciency and customer relationships within
the construction industry. However, the traditional industry relationship
between client and contractor over a period of many years had led to a set
of assumptions that had become strong barriers to implementing partnering
relationships in this industry.
These adversarial atitudes resulting from traditional contractor/client
relationships ofen concern the priorities and goals of the client which in the
past have been substantially diferent from those of the contractor. This was also
due to the involvement of the client who appointed a number of consultants
on a construction project to design and supervise its construction. Ofen there
would be several such consultants on a single project, including architects, civil
and structural engineers, mechanical, electrical and services engineers and
quantity surveyors with one of these consultants appointed to undertake the
role of managing and coordinating the work of the others and the contract as
a whole. Because of the many specialist groups ofen involved in a project,
clients have expressed concern that they have limited communication of
progress and litle, or no, control over the costs of construction, nor of the time
taken to complete the project. Such comments arose from the past reluctance to
involve the client in the decision making process with a preference to keep any
technical problems concealed from the client until the fnal payment demand
was presented. In addition to poor communications clients had also felt that
they are the victims of poor design, inadequate supervision, insufcient choice
of materials and contract methods. To counter such problems major clients,
including the UK Government itself, demanded a change in the construction
industry’s behaviour with a change in emphasis from a ‘production-oriented’
to a ‘client-oriented’ outlook. This viewed was echoed in the major industry
reviews conducted by Sir Michael Latham and Sir John Egan in 1994 and 1998
respectively where such culture change was fundamental for work being
undertaken in a partnering arrangement promoted by the Latham and Egan
reviews. Over the last decade some government agencies, and other clients,
have had encouraging experiences in partnering, although the government still
does not defne the term ‘partnership’ in quite the same way as the construction
industry. For them partnership means, almost entirely, geting the private sector
INTRODUCTION 7
to employ its resources and assets to take on as much risk as possible including
the risk of cancellation or postponement, ofen for litle fnancial reward.
Against this industry backdrop, construction projects require the
deployment of project managers and their professional skills and experience
to bring the project to fruition. This role involves managing the interrelated
project performance parameters of cost, time and quality and managing the
risks which may adversely afect one, two or all three of them.
Introducing Construction Risk Management
In life there are risks: in driving a car, crossing the road or playing various
sports. Everything we do can be associated with risk in the form of events
that might prevent the achievement of stated objectives if they occur. So too
in business although in many cases such risk uncertainties are naturally
associated with a fnancial risk compared to the market volatility and hence the
ability to realistically provide expectations based upon a risk versus reward
trade of. Whilst the management of corporate fnancial risk is undertaken
through a very specialist risk discipline, this book examines the subject of risk
management from a project, business or operational viewpoint where such
risks can be internally or externally driven and may impact on the project’s
stated scope, schedule and cost objectives.
The objectives of risk management are to ensure the rapid identifcation of
risks within the business and to establish a clear process of assessment, action
planning and reporting of the risks identifed. In addition, it is important that
focus and atention is given to the identifcation of opportunities as this will
enable efective decision making to ensure that:
Business opportunities can be quickly assessed at an appropriate
level in order to decide whether and how it might proceed with
such opportunities.
Threats to the project or other parts of the company’s operations
can be eliminated or at least reduced to an acceptable level.
All decisions take account of contributing to sustainable shareholder
value.
The underlying principle is that key risks and the appropriate control measures
are kept under regular review and reported to project participants, project
sponsors and key client representatives.
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RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
8
In focusing on typical construction projects, the topic of risk management
can be seen in Figure I.2 to impact on many facets of the project. Whilst the
traditional view is that risk management is a part of the project management
function, carried out by the project manager or delegated project team member,
an alternative view is that if there were no risks in a project there would be no
need for project management and that the main purpose of project management
is to manage the risks and hence the term Risk-Driven Project Management has
started to come into being. From this understanding, risk management should
consider all aspects of the project and begin early in the life of a construction
project continuing through until project closure.
Project
Risk
Project
Management
integration
Cost
Quality
Human
Resources
Scope
Information /
communication
Time
Contract
Management
Requirements and
standards
Expectations and
feasibility
Ideas, directions
data exchange
accuracy
Life cycle and
environment
variables
Availability
productivity
Time objectives
restraints
Services, plant
materials
performance
Cost objectives
restraints
Project
Risk
Project
Management
integration
Cost
Quality
Human
Resources
Scope
Information /
communication
Time
Contract
Management
Project
Risk
Project
Management
integration
Cost
Quality
Human
Resources
Scope
Information /
communication
Time
Contract
Management
Project
management
integration
Cost
Quality
Human
resources
Scope
Information /
communication
Time
Contract
management
Figure I.2 Integrating risk management with other project management
functions
Source: Project Management Institute, Project & Program Risk Management: A Guide
to Managing Project Risks and Opportunities, Project Management Institute, Inc., 1992.
Copyright and all rights reserved. Material from this publication has been reproduced with the
permission of PMI.
INTRODUCTION 9
A project by defnition is trying to introduce some form of change – a new
production system or way of working, a new building, and so on. Change
involves uncertainty, which in turn means that projects are more likely to
be ‘blown of course’ by a potential future event. In other words, projects in
themselves are inherently risky undertakings. Dennis Lock, in introducing the
topic of risk management in his book, Project Management, proposes that:
’It is not surprising that projects, which metaphorically (and sometimes
literally) break new ground, atract project risk. Project risks can be
predictable or completely unforeseeable. They might be caused by the
physical elements or they could be political, economic, commercial,
technical or operational in origin. Freak events have been known
to disrupt projects, such as the unexpected discovery of important
archaeological remains or the decision by a few members of a rare
protected species to establish their family home on what should have
been the site of the project.’
There is widespread agreement within the project management community
that a project risk is any event or series of events, whether internally or
externally driven, that on occurring will have negative consequences on the
project or business opportunity in terms of performance, functionality, time
of delivery, acceptance or cost. There are, however, strong views that project
risks are always those risks that impact on one or more of the project baseline
elements – time, cost or quality (note that quality is sometimes referred to as
technical).
The British Standard on Project Management (EN BS 6079-3:2000) defnes
risk as:
’An uncertainty inherent in plans and the possibility of something
happening (i.e. a contingency) that can afect the prospect of achieving
business or project goals.‘
In the Vocabulary of this Standard a further defnition is also provided as a:
’combination of the probability or frequency of occurrence of a defned
threat or opportunity and the magnitude of the consequences of the
occurrence.’
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
10
Another common defnition of risk and one frequently used is:
’the threat or possibility that an action or event will adversely or
benefcially afect an organization’s ability to achieve its objectives.’
There are many potential benefts to the efective use of risk management
techniques, the most signifcant are shown in Figure I.3 below.
Introduction to Finance and Investment of
Construction Projects
Whilst the frst part of the book deals with project delivery risks there are also
many risks associated with fnancing of large-scale investments, both by private
and public organizations. Every project requires fnancial means, regardless of
whether it is a public, public-private or a privately-funded venture and investors
are ofen afraid of making decisions due to lack of full knowledge in the feld
of fnancing methods and their associated risks. As such, the second part of
this book will deal with the methods of fnancing, assessment of efectiveness
and identifcation and management of risks while undertaking construction
investment projects.
Ability to
grasp new
opportunities
Reassures
stakeholders that
project is being
professionally
managed
Provides ability to
allocate risk to the
most appropriate
party
Encourages positive
attitude to
management of
project risks
Reduces shocks
and unwelcome
surprises
Provides a focus to
internal audit
programmes
Promotes continual
improvement for current
and future projects
Supports decision
making on effective
use of resources
Enhances
communication between
main contractor,
sub-contractors, suppliers
and client
Systematic approach
to strategic and
business planning
Provides a vehicle for
communication with
stakeholders, investors
and other interested
parties
Captures project
teams concerns on
risk identification
Provides mechanism to
review risks and
changes in status or
impact or potential risks
Encourages risk
reduction rather
than risk recovery
Potential
benefits of
Risk
Management
Potential
benefits of
Risk
Management
Figure I.3 Benefts of risk management
INTRODUCTION 11
All organizations will expect the potential investor to consider risks inherent
in large-scale ventures, both those risks associated with the construction and
operation and those pertaining to the mode of fnancing of the project. Many
projects undertaken in developing countries are fnanced by multilateral,
bilateral or special purpose fnancial organizations. In most cases, however, a
lack of developed fnancial markets ofen limits fnancing to only a few limited
sources. In countries characterized by a highly developed market economy, both
the state and private companies can be seen to fnance numerous undertakings.
Here the sources of private fnance have traditionally come from pension
funds, insurance companies, commercial banks, niche investment banks, large
corporations, stock exchanges, assistance agencies, investors and property (real
estate) developers.
The sources of fnance from the public sectors almost wholly arise from
taxation or subventions to provide the required level of fnancing of the project.
In regression periods only urgent projects may be fnanced this way since
income from taxation is likely to be limited and subventions, ofen in form of
interest-free loans, are then the only option.
Modern economic analysis and fnance management methods provide
numerous solutions that allow investors to make the right decisions throughout
all phases and stages of the investment process. Specifc groups of methods
also allow for management of uncertainty and risk while making investment
decisions. In the case of construction projects, the main problems are in the
estimates of their proftability and ensuring the proper modes of fnancing. Afer
securing the project from a client where funded by internal, external or the client,
project cost control and fnancial performance will be key areas to be managed.
Book Overview: Part 1
This book consists of two parts; in the frst part are fve chapters on risk
management which are presented in a natural sequence of the components of
the topic of risk management. These chapters are introduced below:
CHAPTER 1: RISK MANAGEMENT IN CONSTRUCTION PROJECTS
In introducing the topic of risk management it should be noted that whilst there
will be a cost to the project in adopting a risk management process and indeed
culture, this cost can also be considered with respect to the consequences of not
undertaking risk management in a systematic and professional way. Clearly
all risks cannot be controlled but to ignore risks and risk mitigation tools,
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
12
covered in this and the subsequent chapters, will undoubtedly lead to adverse
consequences on projects. Such consequences of failing to deal efectively with
risk can include signifcant cost overruns, schedule delays and inability to
achieve desired project technical objective(s). Other important consequences
may include:
project de-scoping;
loss of credibility;
ultimately, project cancellation and unhappy clients; and
personal or organizational liability and fnes.
The balance between the organization’s ability to take risks for business
purposes and that of risk management in the form of corporate governance and
a management process is shown in Figure I.4 which illustrates the difculty
of balancing risk taking with risk management; in reality these two forces
inevitably cause the project to osculate around the organization’s optimum
approach.
Chapter 1 looks at the subject of risk management from a project, business
or operational viewpoint. Its aim is to provide an introduction to the topic
where such risks can be internally or externally driven and have the ability
to impact on a project’s stated scope, schedule and cost objectives. The role of
risk management and that of the project manager are discussed in this chapter,
•
•
•
•
Risk
Taking
Risk Management
Out of Control
- ‘fire fighting’
- crisis management
Over Control
- ‘red tape’
- loss of quality
Theory
Practice
Figure I.4 Balancing risk control
Source: From ‘The Essential Management Toolbox’, S.A. Burtonshaw-Gunn (2008). © John
Wiley and Sons. Reproduced with permission.
INTRODUCTION 13
followed by an overview of the risk management process and where it is used
in the project process.
This chapter also provides a risk identifcation checklist as an appendix.
CHAPTER 2: RISK IDENTIFICATION AND PLANNING
This chapter covers the important task of risk identifcation which is
traditionally considered to be the frst step in the risk management process
and includes tools and techniques to aid this process. Once the risks have been
identifed then a Risk Plan can be developed and Chapter 2 discusses both the
rationale and suggested contents of a typical risk plan. The chapter concludes
with a look at the defnitions of risk probabilities and their consequences
which are key features in efciently using resources to implement the risk
plan.
CHAPTER 3: QUALITATIVE RISK ANALYSIS AND QUANTITATIVE
RISK EVALUATION
Chapter 3 covers two main topics. Qualitative risk analysis covers a range of
techniques for assessing the impact and likelihood of identifed risks. These
approaches can be used to prioritize the risks according to their potential efect
on project objectives and is one way to determine the importance of addressing
specifc risks and guiding risk responses. The time-criticality of risk-related
actions may magnify the importance of a risk and together with an evaluation
of the available information also helps modify the assessment of the risk.
Quantitative risk evaluation generally follows the qualitative risk analysis
activity. The second part of the chapter shows that quantitative risk evaluation
requires risk identifcation and that both qualitative and quantitative risk
analysis processes may be used separately or together. There are many tools
available for the identifcation and evaluation of risks and risk controls, ranging
from experience-based judgement, checklists and risk matrices, to specialist
review and analysis techniques. The most appropriate tool depends on the
operation complexity and level of risk; and the ease of use and form of output.
This chapter also covers the more specialist risk tool ‘Bowtie’ methodology
which is used in a number of the high-risk industries and is a very popular tool
in the oil and gas sector.
CHAPTER 4: RISK RESPONSE PLANNING, MONITORING AND
CONTROL
Risk response planning is the process of developing options and determining
actions to enhance opportunities and reduce threats to the project’s objectives.
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
14
This includes the identifcation and assignment of individuals and parties to
take responsibility for each agreed risk response. This process ensures that
identifed risks are correctly addressed and that the efectiveness of response
planning will directly determine whether the risk increases or decreases for the
project. There are a number of factors that risk response planning must satisfy,
namely:
its appropriateness to the severity of the risk;
that it needs to be cost efective in meeting the challenge;
that it needs to be timely to be successful;
that it needs to be realistic within the project context;
that it needs to be agreed upon by all parties involved in the project;
and,
that it needs to be owned by a responsible person.
Selecting the best risk response from several options is ofen required and these
are discussed in Chapter 4 together with risk monitoring and control in order
to keep track of the identifed risks, monitoring residual risks and identifying
any new risks as they emerge during the life of the project. The chapter covers
a typical project control system to ensure the execution of the risk plan and
evaluating the plan’s efectiveness in reducing risk. Risk response planning
also needs to be monitored against the risk plan and may involve choosing
alternative strategies, implementing a contingency plan, taking corrective
action(s), or, at worst, replanning the project.
CHAPTER 5: CONSTRUCTION PRIME CONTRACTING AND THE
IMPORTANCE OF RISK MANAGEMENT IN INTERNATIONAL PROJECTS
Having examined risk management for all construction projects, this fnal
chapter on risk management commences by considering risk management
applied to large-scale projects. It also introduces the topic of Prime Contracting
and goes on to conclude with an examination of the risks likely to be prevalent
in international construction projects.
Book Overview: Part 2
The second part of the book covers four chapters on fnancial management
commencing at the strategic fnancial level of raising project funding, through
to project performance contract strategy and on to project fnancial aspects of
•
•
•
•
•
•
INTRODUCTION 15
estimating, budgeting and cost control. These fnancial chapters are introduced
below:
CHAPTER 6: FINANCING OF CONSTRUCTION PROJECTS
The frst chapter of the second part of the book now represents a move to fnancial
management with a good starting point being to look at how investment in
construction projects is undertaken at various stages of the project. The chapter
then goes on to discuss the infuences on, and the criteria for, making such
investments together with some reference to risk and uncertainty of project
investment.
Whilst some construction clients may look to external investors to provide
funds for the construction of their business facilities, they are also likely to
use their own funds in addition to such externally raised capital. Where the
client company does not have enough immediate funds from either its normal
business income activities, or even by raiding its ‘piggy-bank’ of retained profts
it is unable to provide sufcient funding for large-scale investment, the options
to raise and/or increase initial project funding for construction projects in both
the long and short term are explored in this chapter.
CHAPTER 7: FINANCIAL ASSESSMENT AND PERFORMANCE OF
PROJECTS
Following on from Chapter 6 and the project performance criteria of cost, time
and quality is the fnancial assessment of the project investment and a number
of techniques for examining the fnancial performance of projects including
Value Management.
CHAPTER 8: ADVANCES IN CONTRACT STRATEGY
This chapter examines construction contract strategy with a focus on risk and
insurance providing a link back to the earlier chapters of the book. This chapter
ends with a look at the fnancial aspects of Public-Private Partnerships – a
contract strategy growing in popularity especially for large-scale infrastructure
projects.
CHAPTER 9: ESTIMATING, BUDGETING AND COST CONTROL
The fnal chapter covers the main fnancial functions of project delivery. Project
management requires accurate cost estimates; if the project information used is
detailed and precise, the resulting cost estimate will be also. Indeed during the
duration of the project, as the project technical scope of work becomes defned
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
16
so the precision of the estimate will improve. Although individual companies
will use their own estimating processes usually these will follow a typical
approach, such as:
Obtaining specifc technical and operational concept defnition to
understand what the project’s objectives are and how will they be
accomplished.
Developing the Work Breakdown Structure (WBS) and input on
how the project be organized.
Building a structured cost chart of accounts to allow the costs to be
categorized.
Building a data collation plan and identifying what data is needed,
and how it will be collected.
Data collection: obtaining and recording the required information.
Structuring the cost database with consideration on how the data is
to be organized for best developing cost estimates.
Data analysis to understand what the data indicates about the
project costs.
Developing a cost estimating relationship to determine if certain
costs can be forecast as a function of the project’s parameters.
Building an interactive cost model to represent the project costs
which will demonstrate how overall project costs change as various
conditions change.
Making an estimate of the costs based on expectations and project
conditions.
Analyzing the results to ensure that the cost estimate refects any
changes in the project conditions.
The chapter details these necessary cost control functions and provides
guidance on the three main areas of the chapter title.
REFERENCES
Where material has been taken from other publications this is detailed in the
references section to assist readers if further detail is required.
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INTRODUCTION 17
GLOSSARY
It is considered useful to include a glossary covering terms used in the topics
from both parts of this book.
doc_649439006.pdf
The construction activity involves assembling materials and components designed and produced by a multitude of suppliers, working in a diversity of disciplines and technologies, in order to create what is regarded as 'the built environment'.
Risk and Financial
Management in
Construction
SIMON A. BURTONSHAW-GUNN
Introduction
Book Format
Whilst there are natural overlaps between the two topic areas of Project
Management, for ease of use this book is divided into two parts: Part 1 dealing
with Construction Risk Management, and Part 2 with its corresponding
Financial Management. This introduction provides an overview of the
construction industry and also introduces the main themes of these two
interrelated construction management topics. It closes with an overview of the
forthcoming chapters.
An Overview of the Construction Industry – Setting
the Scene...
The construction activity involves assembling materials and components
designed and produced by a multitude of suppliers, working in a diversity of
disciplines and technologies, in order to create what is regarded as ‘the built
environment’. Such activities can include the planning, regulation, design,
manufacture, construction, maintenance and eventual decommissioning of
buildings and other structures. Their scale, complexity and intricacy varies
enormously, ranging from work undertaken by small ‘jobbing’ builders,
to international construction companies undertaking long-term, high-cost,
complex and sometimes high-risk projects such as single or multiple major
civil construction, with obvious examples being the Channel Tunnel, nuclear
power station construction and, of course for the UK, its showcase sporting
venues for the London 2012 Olympic Games.
From a ‘value chain’ viewpoint, new construction can be regarded as:
a means of production or provision of services (a factory or ofce
block);
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RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
2
an addition to, or improvement of, the infrastructure of the economy
(railway or roads);
a social investment (hospitals); or
provision to meet a direct need (housing).
Construction then is a major national investment, accounting for half of the UK's
annual fxed capital formation. As such, it plays a vital role in the competitive
delivery of goods and services by the rest of the economy. In addition the
house-building industry also stimulates other services (estate agents, solicitors)
and associated industries for example suppliers of carpets, curtains, furniture,
white goods and so on. The construction industry as a whole presents many
employment opportunities in the felds of building, civil engineering, ofshore
structures and the process-plant industry. It embraces the eforts of contracting
frms, specialist contractors, consulting architects and engineers, professionals
such as architects and quantity surveyors, suppliers of building materials and
manufacturers of equipment.
Construction, by its nature as a system integrator and a stimulus for other
parts of the economy, can therefore be regarded as a basic economic multiplier.
From a macroeconomic perspective the industry requires the three classic
‘factors of inputs’ of land, labour and capital, all of which can be afected by
government policy. The UK is neither a state-controlled economy, nor is it at the
other end of the continuum of being a free economy of no state intervention.
Indeed the UK operates by a compromise of mixed economy with a certain
amount of government intervention. At the national government level this
can be seen in the form of taxes, Health and Safety legislation, Construction
Management legislation and general employment law. At the local government
level this is exemplifed by control of planning approval and development
schemes, adherence to local requirements and bye-laws and cognisance of local
pressure groups.
Looking broader, the construction industry is not only of major national
importance but may also feature as an international industry as UK construction
companies may also be responsible for a signifcant amount of work undertaken
overseas, which typically represents between 10 to 15 per cent of the annual
turnover of the major British construction contractors. UK companies working
overseas require an understanding of, frstly, how to fnd and undertake
construction work in diferent countries; secondly, the level of competition,
tendering and procurement activities; and thirdly, how to comply with new
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INTRODUCTION 3
local and national government controls such as employment law, health and
safety requirements and so on.
An examination of the various sectors within the construction industry
reveals that this may be seen as a temporary activity as it is normally carried
out at the client’s premises and is viewed as an enabling activity to allow
the client organization to conduct its business; be this retail, manufacturing
or service related. However, because of these reasons, the industry has a
number of problems such as low and discontinuous demand, low productivity
compared to other industries and low proftability. There is no imposed or self-
regulation of the industry and there are so many companies that the industry
can be regarded as (and is ofen criticized for) being fragmented.
Historically the factors which infuence the location of a particular industry
have typically included the accessibility of raw materials, power supply (for
example, coal and water), transport, market access and so on. However,
examining the construction industry against such criteria reveals that the
industry is not itself infuenced by such location factors but by the locations
of its client’s base and, without a long-term commitment, construction work
becomes a mobile service industry. Indeed, in the vast majority of cases it is not
only undertaken at the client’s site but, importantly, only when other industrial
or commercial sectors are fourishing, allowing it to concentrate on the building
of factories, houses or service buildings.
The operation of the construction industry can be viewed against a
competitive strategy model (shown as Figure I.1) developed by Harvard
University Professor, Dr Michael Porter, which identifed fve key driving
forces on a business. These being:
Potential Entrants – the threat of new entrants;
Industry Competitors – rivalry among existing frms;
Substitutes – the threat of substitute products or services;
Buyers – the bargaining power of buyers;
Suppliers – the bargaining power of suppliers.
In looking at the frst two of these key business drivers – Potential Entrants
and Industry Competitors – it is recognized that the UK construction industry
is, in the main, confned to competition from established UK companies. This
is particularly so in the sectors of Non-residential Building and Infrastructure
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RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
4
because the construction industry operates diferently to other industrial
or economic sectors. Companies require manpower resources, plant and
equipment, health and safety procedures and various insurances to be in place
together with an established track record to be able to even bid for work in
this important sector. Consequently, these requirements imposes signifcant
barriers to entry to the construction market resulting in competition not from
international companies or new entrants but being confned largely to existing
UK companies or those international organizations with a UK subsidiary
operation. In looking at the third element – the threat of substitute products
or services – it is logical to assume that there is litle threat of substitution of
site-based infrastructure construction activities although the future may see
an increase in the prefabrication of buildings or other factory-based building
techniques.
The fnal two forces covering the bargaining power of buyers and those
of suppliers can also be grouped together. Both are infuenced by the same
factors of the concentration of construction companies, the number of capital
projects being undertaken within the UK market and the perceived importance
and willingness to undertake work for a particular client. These two forces and
that of competition have had an efect on client/contractor relationships over
a period of many years. Indeed, the traditional modus operandi of competition
with other construction companies has been driven, in the main, by the client’s
desire to achieve the lowest-cost bid, not only in the private sector but also
in the public sector, which has been supported by the government-inspired
Compulsory Competitive Tendering process. As a result, and with very
few exceptions, relationships have been adversarial with parties concerned
resorting to contractual claims, which lengthen timescales and drive up costs,
as a direct consequence of the behaviour of both parties. Where the client will
only award work to the lowest-priced contractor, the contractor responds to this
approach by submiting an uneconomic and unrealistic low price which results
in time and efort being spent by the contractor in fnding reasons for which
additional money will be sought. In essence, this became a common contractor’s
traditional strategy of submiting a low price in competition knowing that it
will be supplemented by post-contract extras, variations and fnancial claims
when delay and disruption opportunities presented themselves.
Furthermore the traditional procurement systems and the contractual and
legal framework by which participants are bound together have been widely
and regularly criticized as being confrontational and adversarial. This should
not be too surprising as it is widely recognized that the construction industry
is historically famed for its adversarial approach and the amount of time and
INTRODUCTION 5
money spent on litigation which provides employment opportunities for a
signifcant number of professionals including claims consultants, quantity
surveyors and construction lawyers. Such recognition of the construction
industry’s adversarial atitudes is not new and a number of British Governments
have commissioned investigations into the industry, notably the reports
of Sir Ernest Simon in 1944, Sir Harold Emmerson in 1962 and Sir Harold
Banwell in 1964, all of which tell a similar tale. More recently this industry
‘norm’ so concerned the previous Government that it appointed Sir Michael
Latham to carry out yet another review of the procurement and contractual
arrangements in the industry. His report ‘Constructing the Team’, published in
Determinants of buyer power
• Bargaining leverage
• Buyer concentration v firm concentration
• Buyer volume
• Buyer switching costs relative to firm
switching costs
• Buyer information
• Ability to backward integrate
• Substitute products
• Pull-through
• Price sensitivity
• Price/total purchases
• Product differences
• Brand identity
• Impact on quality/performance
• Buyer profits
• Decision-makers incentives
COMPETITIVE
RIVALRY
Suppliers
Substitutes
New entrants
Buyers
Threat of
entrants
Threat of
substitutes
Bargaining
power
Bargaining
power
Entry barriers
• Economies of scale
• Proprietary product differences
• Brand identity
• Switching costs
• Capital requirements
• Access to distribution
• Absolute cost advantages-
• proprietary learning curve
• access to necessary inputs
• proprietary low-cost product design
• Expected retaliation
Rivalry determinants
• Industry growth
• Fixed (or storage) costs/value added
• Intermittent overcapacity
• Product differences
• Brand identity
• Switching costs
• Concentration and balance
• Informational complexity
• Diversity of competitors
• Corporate stakes
• Exit barriers
Determinants of
suppliers
• Differentiation of inputs
• Switching costs of suppliers and
firms in the industry
• Presence of substitute inputs
• Supplier concentration
• Importance of volume to supplier
• Cost relative to total purchases in
the industry
• Impact of inputs on cost or
differentiation
• Threat of forward integration
relative to threat of backward
integration by firms in the
industry
• Relative price performance
of substitutes
• Switching costs
• Buyer propensity to
substitute
Determinants of
substitute threat
Suppliers
Substitutes
New entrants
Buyers
Figure I.1 Competitive Rivalry
Source: Reprinted with the permission of The Free Press, a Division of Simon & Schuster
Adult Publishing Group, from ‘Competitive Advantage: Creating and Sustaining Superior
Performance’ by Professor Michael E Porter. © 1985, 1998 Michael E Porter. All rights
reserved.
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
6
1994, recommended change for the industry and gave a number of specifc
recommendations including a change in culture aiming to move away from
the traditional adversarial client/supplier relationship which it noted had
prevailed in the industry for many years. In particular the ‘Constructing the
Team’ report saw closer collaboration and ‘partnering’ as the development of a
strategic long-term commercial arrangement between a client, contractors and
suppliers and went further by proposing that this was one of the techniques
most likely to improve both cost efciency and customer relationships within
the construction industry. However, the traditional industry relationship
between client and contractor over a period of many years had led to a set
of assumptions that had become strong barriers to implementing partnering
relationships in this industry.
These adversarial atitudes resulting from traditional contractor/client
relationships ofen concern the priorities and goals of the client which in the
past have been substantially diferent from those of the contractor. This was also
due to the involvement of the client who appointed a number of consultants
on a construction project to design and supervise its construction. Ofen there
would be several such consultants on a single project, including architects, civil
and structural engineers, mechanical, electrical and services engineers and
quantity surveyors with one of these consultants appointed to undertake the
role of managing and coordinating the work of the others and the contract as
a whole. Because of the many specialist groups ofen involved in a project,
clients have expressed concern that they have limited communication of
progress and litle, or no, control over the costs of construction, nor of the time
taken to complete the project. Such comments arose from the past reluctance to
involve the client in the decision making process with a preference to keep any
technical problems concealed from the client until the fnal payment demand
was presented. In addition to poor communications clients had also felt that
they are the victims of poor design, inadequate supervision, insufcient choice
of materials and contract methods. To counter such problems major clients,
including the UK Government itself, demanded a change in the construction
industry’s behaviour with a change in emphasis from a ‘production-oriented’
to a ‘client-oriented’ outlook. This viewed was echoed in the major industry
reviews conducted by Sir Michael Latham and Sir John Egan in 1994 and 1998
respectively where such culture change was fundamental for work being
undertaken in a partnering arrangement promoted by the Latham and Egan
reviews. Over the last decade some government agencies, and other clients,
have had encouraging experiences in partnering, although the government still
does not defne the term ‘partnership’ in quite the same way as the construction
industry. For them partnership means, almost entirely, geting the private sector
INTRODUCTION 7
to employ its resources and assets to take on as much risk as possible including
the risk of cancellation or postponement, ofen for litle fnancial reward.
Against this industry backdrop, construction projects require the
deployment of project managers and their professional skills and experience
to bring the project to fruition. This role involves managing the interrelated
project performance parameters of cost, time and quality and managing the
risks which may adversely afect one, two or all three of them.
Introducing Construction Risk Management
In life there are risks: in driving a car, crossing the road or playing various
sports. Everything we do can be associated with risk in the form of events
that might prevent the achievement of stated objectives if they occur. So too
in business although in many cases such risk uncertainties are naturally
associated with a fnancial risk compared to the market volatility and hence the
ability to realistically provide expectations based upon a risk versus reward
trade of. Whilst the management of corporate fnancial risk is undertaken
through a very specialist risk discipline, this book examines the subject of risk
management from a project, business or operational viewpoint where such
risks can be internally or externally driven and may impact on the project’s
stated scope, schedule and cost objectives.
The objectives of risk management are to ensure the rapid identifcation of
risks within the business and to establish a clear process of assessment, action
planning and reporting of the risks identifed. In addition, it is important that
focus and atention is given to the identifcation of opportunities as this will
enable efective decision making to ensure that:
Business opportunities can be quickly assessed at an appropriate
level in order to decide whether and how it might proceed with
such opportunities.
Threats to the project or other parts of the company’s operations
can be eliminated or at least reduced to an acceptable level.
All decisions take account of contributing to sustainable shareholder
value.
The underlying principle is that key risks and the appropriate control measures
are kept under regular review and reported to project participants, project
sponsors and key client representatives.
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RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
8
In focusing on typical construction projects, the topic of risk management
can be seen in Figure I.2 to impact on many facets of the project. Whilst the
traditional view is that risk management is a part of the project management
function, carried out by the project manager or delegated project team member,
an alternative view is that if there were no risks in a project there would be no
need for project management and that the main purpose of project management
is to manage the risks and hence the term Risk-Driven Project Management has
started to come into being. From this understanding, risk management should
consider all aspects of the project and begin early in the life of a construction
project continuing through until project closure.
Project
Risk
Project
Management
integration
Cost
Quality
Human
Resources
Scope
Information /
communication
Time
Contract
Management
Requirements and
standards
Expectations and
feasibility
Ideas, directions
data exchange
accuracy
Life cycle and
environment
variables
Availability
productivity
Time objectives
restraints
Services, plant
materials
performance
Cost objectives
restraints
Project
Risk
Project
Management
integration
Cost
Quality
Human
Resources
Scope
Information /
communication
Time
Contract
Management
Project
Risk
Project
Management
integration
Cost
Quality
Human
Resources
Scope
Information /
communication
Time
Contract
Management
Project
management
integration
Cost
Quality
Human
resources
Scope
Information /
communication
Time
Contract
management
Figure I.2 Integrating risk management with other project management
functions
Source: Project Management Institute, Project & Program Risk Management: A Guide
to Managing Project Risks and Opportunities, Project Management Institute, Inc., 1992.
Copyright and all rights reserved. Material from this publication has been reproduced with the
permission of PMI.
INTRODUCTION 9
A project by defnition is trying to introduce some form of change – a new
production system or way of working, a new building, and so on. Change
involves uncertainty, which in turn means that projects are more likely to
be ‘blown of course’ by a potential future event. In other words, projects in
themselves are inherently risky undertakings. Dennis Lock, in introducing the
topic of risk management in his book, Project Management, proposes that:
’It is not surprising that projects, which metaphorically (and sometimes
literally) break new ground, atract project risk. Project risks can be
predictable or completely unforeseeable. They might be caused by the
physical elements or they could be political, economic, commercial,
technical or operational in origin. Freak events have been known
to disrupt projects, such as the unexpected discovery of important
archaeological remains or the decision by a few members of a rare
protected species to establish their family home on what should have
been the site of the project.’
There is widespread agreement within the project management community
that a project risk is any event or series of events, whether internally or
externally driven, that on occurring will have negative consequences on the
project or business opportunity in terms of performance, functionality, time
of delivery, acceptance or cost. There are, however, strong views that project
risks are always those risks that impact on one or more of the project baseline
elements – time, cost or quality (note that quality is sometimes referred to as
technical).
The British Standard on Project Management (EN BS 6079-3:2000) defnes
risk as:
’An uncertainty inherent in plans and the possibility of something
happening (i.e. a contingency) that can afect the prospect of achieving
business or project goals.‘
In the Vocabulary of this Standard a further defnition is also provided as a:
’combination of the probability or frequency of occurrence of a defned
threat or opportunity and the magnitude of the consequences of the
occurrence.’
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
10
Another common defnition of risk and one frequently used is:
’the threat or possibility that an action or event will adversely or
benefcially afect an organization’s ability to achieve its objectives.’
There are many potential benefts to the efective use of risk management
techniques, the most signifcant are shown in Figure I.3 below.
Introduction to Finance and Investment of
Construction Projects
Whilst the frst part of the book deals with project delivery risks there are also
many risks associated with fnancing of large-scale investments, both by private
and public organizations. Every project requires fnancial means, regardless of
whether it is a public, public-private or a privately-funded venture and investors
are ofen afraid of making decisions due to lack of full knowledge in the feld
of fnancing methods and their associated risks. As such, the second part of
this book will deal with the methods of fnancing, assessment of efectiveness
and identifcation and management of risks while undertaking construction
investment projects.
Ability to
grasp new
opportunities
Reassures
stakeholders that
project is being
professionally
managed
Provides ability to
allocate risk to the
most appropriate
party
Encourages positive
attitude to
management of
project risks
Reduces shocks
and unwelcome
surprises
Provides a focus to
internal audit
programmes
Promotes continual
improvement for current
and future projects
Supports decision
making on effective
use of resources
Enhances
communication between
main contractor,
sub-contractors, suppliers
and client
Systematic approach
to strategic and
business planning
Provides a vehicle for
communication with
stakeholders, investors
and other interested
parties
Captures project
teams concerns on
risk identification
Provides mechanism to
review risks and
changes in status or
impact or potential risks
Encourages risk
reduction rather
than risk recovery
Potential
benefits of
Risk
Management
Potential
benefits of
Risk
Management
Figure I.3 Benefts of risk management
INTRODUCTION 11
All organizations will expect the potential investor to consider risks inherent
in large-scale ventures, both those risks associated with the construction and
operation and those pertaining to the mode of fnancing of the project. Many
projects undertaken in developing countries are fnanced by multilateral,
bilateral or special purpose fnancial organizations. In most cases, however, a
lack of developed fnancial markets ofen limits fnancing to only a few limited
sources. In countries characterized by a highly developed market economy, both
the state and private companies can be seen to fnance numerous undertakings.
Here the sources of private fnance have traditionally come from pension
funds, insurance companies, commercial banks, niche investment banks, large
corporations, stock exchanges, assistance agencies, investors and property (real
estate) developers.
The sources of fnance from the public sectors almost wholly arise from
taxation or subventions to provide the required level of fnancing of the project.
In regression periods only urgent projects may be fnanced this way since
income from taxation is likely to be limited and subventions, ofen in form of
interest-free loans, are then the only option.
Modern economic analysis and fnance management methods provide
numerous solutions that allow investors to make the right decisions throughout
all phases and stages of the investment process. Specifc groups of methods
also allow for management of uncertainty and risk while making investment
decisions. In the case of construction projects, the main problems are in the
estimates of their proftability and ensuring the proper modes of fnancing. Afer
securing the project from a client where funded by internal, external or the client,
project cost control and fnancial performance will be key areas to be managed.
Book Overview: Part 1
This book consists of two parts; in the frst part are fve chapters on risk
management which are presented in a natural sequence of the components of
the topic of risk management. These chapters are introduced below:
CHAPTER 1: RISK MANAGEMENT IN CONSTRUCTION PROJECTS
In introducing the topic of risk management it should be noted that whilst there
will be a cost to the project in adopting a risk management process and indeed
culture, this cost can also be considered with respect to the consequences of not
undertaking risk management in a systematic and professional way. Clearly
all risks cannot be controlled but to ignore risks and risk mitigation tools,
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
12
covered in this and the subsequent chapters, will undoubtedly lead to adverse
consequences on projects. Such consequences of failing to deal efectively with
risk can include signifcant cost overruns, schedule delays and inability to
achieve desired project technical objective(s). Other important consequences
may include:
project de-scoping;
loss of credibility;
ultimately, project cancellation and unhappy clients; and
personal or organizational liability and fnes.
The balance between the organization’s ability to take risks for business
purposes and that of risk management in the form of corporate governance and
a management process is shown in Figure I.4 which illustrates the difculty
of balancing risk taking with risk management; in reality these two forces
inevitably cause the project to osculate around the organization’s optimum
approach.
Chapter 1 looks at the subject of risk management from a project, business
or operational viewpoint. Its aim is to provide an introduction to the topic
where such risks can be internally or externally driven and have the ability
to impact on a project’s stated scope, schedule and cost objectives. The role of
risk management and that of the project manager are discussed in this chapter,
•
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•
Risk
Taking
Risk Management
Out of Control
- ‘fire fighting’
- crisis management
Over Control
- ‘red tape’
- loss of quality
Theory
Practice
Figure I.4 Balancing risk control
Source: From ‘The Essential Management Toolbox’, S.A. Burtonshaw-Gunn (2008). © John
Wiley and Sons. Reproduced with permission.
INTRODUCTION 13
followed by an overview of the risk management process and where it is used
in the project process.
This chapter also provides a risk identifcation checklist as an appendix.
CHAPTER 2: RISK IDENTIFICATION AND PLANNING
This chapter covers the important task of risk identifcation which is
traditionally considered to be the frst step in the risk management process
and includes tools and techniques to aid this process. Once the risks have been
identifed then a Risk Plan can be developed and Chapter 2 discusses both the
rationale and suggested contents of a typical risk plan. The chapter concludes
with a look at the defnitions of risk probabilities and their consequences
which are key features in efciently using resources to implement the risk
plan.
CHAPTER 3: QUALITATIVE RISK ANALYSIS AND QUANTITATIVE
RISK EVALUATION
Chapter 3 covers two main topics. Qualitative risk analysis covers a range of
techniques for assessing the impact and likelihood of identifed risks. These
approaches can be used to prioritize the risks according to their potential efect
on project objectives and is one way to determine the importance of addressing
specifc risks and guiding risk responses. The time-criticality of risk-related
actions may magnify the importance of a risk and together with an evaluation
of the available information also helps modify the assessment of the risk.
Quantitative risk evaluation generally follows the qualitative risk analysis
activity. The second part of the chapter shows that quantitative risk evaluation
requires risk identifcation and that both qualitative and quantitative risk
analysis processes may be used separately or together. There are many tools
available for the identifcation and evaluation of risks and risk controls, ranging
from experience-based judgement, checklists and risk matrices, to specialist
review and analysis techniques. The most appropriate tool depends on the
operation complexity and level of risk; and the ease of use and form of output.
This chapter also covers the more specialist risk tool ‘Bowtie’ methodology
which is used in a number of the high-risk industries and is a very popular tool
in the oil and gas sector.
CHAPTER 4: RISK RESPONSE PLANNING, MONITORING AND
CONTROL
Risk response planning is the process of developing options and determining
actions to enhance opportunities and reduce threats to the project’s objectives.
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
14
This includes the identifcation and assignment of individuals and parties to
take responsibility for each agreed risk response. This process ensures that
identifed risks are correctly addressed and that the efectiveness of response
planning will directly determine whether the risk increases or decreases for the
project. There are a number of factors that risk response planning must satisfy,
namely:
its appropriateness to the severity of the risk;
that it needs to be cost efective in meeting the challenge;
that it needs to be timely to be successful;
that it needs to be realistic within the project context;
that it needs to be agreed upon by all parties involved in the project;
and,
that it needs to be owned by a responsible person.
Selecting the best risk response from several options is ofen required and these
are discussed in Chapter 4 together with risk monitoring and control in order
to keep track of the identifed risks, monitoring residual risks and identifying
any new risks as they emerge during the life of the project. The chapter covers
a typical project control system to ensure the execution of the risk plan and
evaluating the plan’s efectiveness in reducing risk. Risk response planning
also needs to be monitored against the risk plan and may involve choosing
alternative strategies, implementing a contingency plan, taking corrective
action(s), or, at worst, replanning the project.
CHAPTER 5: CONSTRUCTION PRIME CONTRACTING AND THE
IMPORTANCE OF RISK MANAGEMENT IN INTERNATIONAL PROJECTS
Having examined risk management for all construction projects, this fnal
chapter on risk management commences by considering risk management
applied to large-scale projects. It also introduces the topic of Prime Contracting
and goes on to conclude with an examination of the risks likely to be prevalent
in international construction projects.
Book Overview: Part 2
The second part of the book covers four chapters on fnancial management
commencing at the strategic fnancial level of raising project funding, through
to project performance contract strategy and on to project fnancial aspects of
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•
•
•
INTRODUCTION 15
estimating, budgeting and cost control. These fnancial chapters are introduced
below:
CHAPTER 6: FINANCING OF CONSTRUCTION PROJECTS
The frst chapter of the second part of the book now represents a move to fnancial
management with a good starting point being to look at how investment in
construction projects is undertaken at various stages of the project. The chapter
then goes on to discuss the infuences on, and the criteria for, making such
investments together with some reference to risk and uncertainty of project
investment.
Whilst some construction clients may look to external investors to provide
funds for the construction of their business facilities, they are also likely to
use their own funds in addition to such externally raised capital. Where the
client company does not have enough immediate funds from either its normal
business income activities, or even by raiding its ‘piggy-bank’ of retained profts
it is unable to provide sufcient funding for large-scale investment, the options
to raise and/or increase initial project funding for construction projects in both
the long and short term are explored in this chapter.
CHAPTER 7: FINANCIAL ASSESSMENT AND PERFORMANCE OF
PROJECTS
Following on from Chapter 6 and the project performance criteria of cost, time
and quality is the fnancial assessment of the project investment and a number
of techniques for examining the fnancial performance of projects including
Value Management.
CHAPTER 8: ADVANCES IN CONTRACT STRATEGY
This chapter examines construction contract strategy with a focus on risk and
insurance providing a link back to the earlier chapters of the book. This chapter
ends with a look at the fnancial aspects of Public-Private Partnerships – a
contract strategy growing in popularity especially for large-scale infrastructure
projects.
CHAPTER 9: ESTIMATING, BUDGETING AND COST CONTROL
The fnal chapter covers the main fnancial functions of project delivery. Project
management requires accurate cost estimates; if the project information used is
detailed and precise, the resulting cost estimate will be also. Indeed during the
duration of the project, as the project technical scope of work becomes defned
RISK AND FINANCIAL MANAGEMENT IN CONSTRUCTION
16
so the precision of the estimate will improve. Although individual companies
will use their own estimating processes usually these will follow a typical
approach, such as:
Obtaining specifc technical and operational concept defnition to
understand what the project’s objectives are and how will they be
accomplished.
Developing the Work Breakdown Structure (WBS) and input on
how the project be organized.
Building a structured cost chart of accounts to allow the costs to be
categorized.
Building a data collation plan and identifying what data is needed,
and how it will be collected.
Data collection: obtaining and recording the required information.
Structuring the cost database with consideration on how the data is
to be organized for best developing cost estimates.
Data analysis to understand what the data indicates about the
project costs.
Developing a cost estimating relationship to determine if certain
costs can be forecast as a function of the project’s parameters.
Building an interactive cost model to represent the project costs
which will demonstrate how overall project costs change as various
conditions change.
Making an estimate of the costs based on expectations and project
conditions.
Analyzing the results to ensure that the cost estimate refects any
changes in the project conditions.
The chapter details these necessary cost control functions and provides
guidance on the three main areas of the chapter title.
REFERENCES
Where material has been taken from other publications this is detailed in the
references section to assist readers if further detail is required.
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INTRODUCTION 17
GLOSSARY
It is considered useful to include a glossary covering terms used in the topics
from both parts of this book.
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