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| Issue No: | 33 |
|---|---|
| Published: | Summer 2006 |
| Article No: | 4 |
| Author: | Mathew Joseph |
| Title: | Project Risk Management - Part 1 |
Change is a natural occurrence on construction projects, which makes it inherently risky. It is never possible to have conditions of total certainty. Projects are often affected by conditions of uncertainty producing opportunities or threats on project objectives (time, cost, quality etc.). A risk event implies that there is a range of possibilities for that event which could be more and less favorable than the most possible outcome, and that each outcome within a range has a probability of occurrence. In this two part article Mathew Joseph points out that the accumulation of risks and their potential outcomes can be termed ‘project risk’.
Traditionally, statistical theories have been used to model and quantify risk events. The following equation defines risk in statistical terms.
Risk Expected Value = (event likelihood) x (event consequence)
It is vital to recognise and identify the root causes of the risk and manage them before adverse consequences or the risk event occurs. Project managers and team members should undertake and propose actions which eliminate risks before they occur, or reduce the effects of risks or uncertainty and make provisions for them if they occur when this is possible and cost effective to do so. The team should be able to set realistic estimates for time and cost impacts for all risks and uncertainties which can be anticipated from experience, foresight and pro-activeness.
Risk management is not about predicting the future, but about understanding the project and making better decisions with regard to management of the project tomorrow. It is important that the project team endeavor to ask rational questions and look for answers to solve the unknowns, such as:
- What can go wrong ?
- How likely is it ?
- What are the potential consequences ?
The success of a project primarily depends on how sensibly the team can find answers to the above questions. The requisites being management support, motivation, insight, openness, involvement of key personnel and willingness for constant learning.
Project risk management involves the process of identifying, analysing and responding to risks primarily during the planning and execution phases of a project. As project risks are dynamic and constantly mutate, risk management should be a ontinuous process throughout the entire life cycle of the project. For a typical construction project, the life cycle consists of phases involving feasibility study, planning and design, construction, testingcommissioning- startup. The type, nature and intensity of the risks can vary according to the phase and state of the project. Hence, it is imperative appropriate stakeholders are involved in identifying, analysing and managing the risks. The team should also undertake quality management to ensure that the design is constructed correctly without the need for costly rework and value management to improve the definition of the design objectives.
Project risk management techniques methodically undertaken provides a means for the project team to:
- Realistically set reasonable schedule and cost contingencies;
- Estimate the probability of schedule delays and cost overruns;
- Estimate the probability of completing the project on-time and on-budget;
- Understand the accuracy of a schedule and / or cost estimate;
- Ensure the project team identifies the risks and implements a plan to mitigate them;
Risk Classification
Analysts generally classify risk events in to two categories based on cause, probability and impact:
Known Unknowns: The project team may be able to identify the risk, however unknown, when or if the event will occur. A contingency reserve is established at the activity level or each work package of the WBS (Work Breakdown Structure), inclement weather, price escalation, lower than anticipated productivity etc. The Project Manager is responsible for managing and allocating the contingency reserve.
Unknown Unknowns: These are events that cannot be predicted by the project team, yet must be planned for. A general management reserve is established to cover the mistakes made by the construction project management team in not identifying all the known project risks. A person above the level of the Project Manager is generally responsible for allocating the management reserve.
Risk Management Stages
According to PMI and PMBOK Guide, project risk management processes can be generally classified in to six stages;
- Risk management planning
- Risk identification
- Qualitative risk analysis
- Quantitative risk analysis
- Risk monitoring and control
Although each of these stages is distinct, involving unique processes and methods, they may also overlap and interact with each other. The remaining part of this article will focus on the analysis stage and simulation techniques used for schedule and cost risk analysis.
Risk Analysis
Project risk analysis is the identification and quantification of the probability and impact of events that may affect the objectives of the project. Risk analysis creates an opportunity to help identify and solve problems and enhance team effort and communication within the project and involves two subprocesses; qualitative and quantitative risk analysis. Usually quantitative analysis follows the qualitative analysis.
Qualitative Risk Analysis
Qualitative risk analysis is the process of assessing the impact and likelihood of identified risks. This process prioritises risks according to their potential impact on project objectives. Here risk probability and impact are described in qualitative terms like severe, very high, high, moderate low etc. and measured against a risk impact scale constructed using ordinal (very high, high, low… etc) or cardinal scales (0.1, 0.2, 0.3 … etc).
On completion of the qualitative risk analysis, the risk register formed during the risk identification stage will be fine tuned and the risk participants will have an ordered and ranked list of the various project risks. P-I Matrix/ Boston square are mechanisms generally used for ranking and classifying risks according to their probability and impact. The analysis helps to provide the project team good insight in to various risks that are likely to affect the project and the ones that requires further assessment and controlling.
Quantitative Risk Analysis
Quantitative risk analysis is the process of analysing numerically the probability of each risk event and its impact on the project objectives. The quantitative risk analysis can identify realistic and achievable schedule and cost targets and establish the contingency required for the total project as well as for each schedule and cost element and can form the basis of the risk mitigation plan. The analysis involves the use of simulation and statistical techniques and the commonly used ones are:
- Sensitivity analysis
- Decision tree analysis
- Scenario analysis
- Monte Carlo simulation/Latin hypercube simulation
Monte Carlo Simulation
Monte Carlo simulation is the most widely used technique for schedule and cost risk analysis. Software simulation systems based on the Monte Carlo algorithm are now commercially available. These systems are capable of reading an existing CPM schedule, allow the analyst to model schedule and/or cost uncertainty at an activity or resource level and then perform thousands of simulations to evaluate possible project occurrence scenarios.
Such simulation exercises using Monte Carlo techniques can point to the probability and confidence level of achieving a completion date or budget. The project team can gain considerable understanding of the risks and devise proper response mechanisms to eliminate or mitigate the risks before they impact the project objectives negatively.
(The Monte Carlo simulation technique will be covered in detail in the second part of this article)