Risk Management in Construction
Risk is very common not only for organizations but to individuals as well, there a lot of risks that we are encountering in our everyday lives. However, proper management could eventually, if it could not be effectively prevented, it could be minimized or be avoided. This paper will discuss about Risk Management in the Construction Industry. Furthermore, the paper will also identify the process of Qualitative Risk Analysis and Quantitative Risk Analysis. In addition, the paper would focus on Quantitative Risk Management and what innovative implications it can give if it would be applied by an organization and its efficiency towards the betterment of the company.
Risk Management
Risk Management is a Management process in which it deals with planning, leading, and controlling the use of the organization’s budget or resource in order to diminish its risk of loss effectively. It is the process of balancing the risk of loss from unexpected causes against the economic cost of protection. (Wikipedia) Furthermore, it is imperative to have a good project management practice where you learn how to manage risk to improve outcomes by identifying and analyzing a wider range of issues and proving a systematic way to make informed decisions. (ETWB, 2005) As these definitions suggests, it is a very important process in every organization and as the paper suggests it is integral in the Construction Industry.
Risk Management in the Construction Industry
In the construction industry perspective, risk management is viewed as function, which is mostly related to insurance. Mostly, the contractor’s wrong assumption about it is that they think of Risk Management as an equivalent to Insurance Management in which its goal is to seek out the most favorable economic insurance coverage for the insurable risks. (Ahmed & Azhar & Ahmad, 2003) Furthermore, Risk Management in this kind of industry is more likely to face almost same kinds of problems, however these problems seems to occur consecutively or simultaneously. As a result, most Risk Management in the Construction Industry could not fully fulfill its obligations to its stakeholders.
Kinds of Risk in the Construction Industry
There are 2 types of risks; they are the controllable and uncontrollable risks. Controllable Risks are those losses that originate from a source that can be controlled. These are risks that a decision-maker embarks on his own will and the outcome can be controlled by his or her decisions. (Öztaş, n.d) Uncontrollable Risks are those in contrary with the latter. These are risks than cannot be prevented by man or the organization; it is an unexpected event in a man, or an organization cannot stop. These risks usually emanate from the external environment, the political, social or economic spheres. (Öztaş, n.d)
Below is a table of the kinds of Risks that are commonly managed in the construction industry. However, these two kinds of risks are somewhat interchangeable to the fact that a strategy could be implemented to manage the risk even if it would be an uncontrollable. Forecasting would be an effective way of doing it. However, the division within controllable and uncontrollable risk has shades of grey. In which:
The importance of knowing the types and its categories is to fully understand the kinds of risks that the construction industry faces. In order to determine an effective quantitative and qualitative risk analysis, it is significant to determine what the factors that affect such losses are.
Qualitative Risk Analysis (QRA)
From the word itself, Quantitative Risk Analysis is a non-quantitative method of assessing risks. The analysis is based on a descriptive and a subjective approach of assessment. Like in most case studies and researches, Qualitative Risk Analysis is based on surveys and interviews made by the organization to the employees and their laborers.
Qualitative Risk Analysis is done in accordance to a scheme in coordination to the project. Furthermore, Risk Tolerance should have been clearly proliferated among the members of the organization, the project managers and the main stakeholders in order to have a meaningful Qualitative Risk Analysis. The ability to represent a seemingly complex idea into simple and meaningful terms is the key benefit of Qualitative Risk Analysis. It is also used to change the level of urgency of a management response and so it does have business value. (Kwak, 2003)
Below is a table of an example of a qualitative risk analysis matrix. In which it depicts how a risk should be attended.
Table 2. Qualitative Risk Analysis Matrix (Joy, 2005)
The above-mentioned table shows the consequences and the probability of risks within the organization. It is the basic kind of qualitative risk assessment in which it determines if a risk would be categorized as high, medium or low. Furthermore, the table identifies the severity of a certain risk to the stakeholders and the organization. Qualitative Risk Analysis should be effectively implemented in order to plan a good Quantitative Risk Analysis Technique. This method is appropriate to the construction industry because it determines, if not all, most of the risks that are being maintained as mentioned in Table 1. In addition, this method of assessment is integral on every Risk Management of every organizations.
Quantitative Risk Analysis
Contrary to Qualitative Risk Analysis, the Quantitative Approach focuses more on the numerical figures rather than on the description of the problem. Estimation and Probability are the keywords for the Quantitative Approach. Furthermore, the Quantitative Approach involves the calculation of probability and sometimes consequences. In the calculation of numeric figures, numbers represent the probability of a selected outcome, in which it is a percentage of how seldom or how frequent a risk is occurring. (Joy, 2005)
Techniques to Quantitative Risk Analysis
There are various approaches to Quantitative Risk Analysis here some descriptions to some of them. Although all of them seems to be effective to any organization or industry, some of which are just an upgraded version of the basic techniques to Quantitative Risk Analysis.
Decision Tree Analysis – it is a kind of Quantitative Approach in which, it calculates the results of a certain interdependency of risk in a project. A technique determines the overall risk associated with a series of risks. This would be best if:
- Risks are sequential or risks having caused by another risk.
- The decisions can have probable results, not an infinite one.
- There are some financial or monetary losses to the risks being calculated. (PMI, 2004)
Furthermore it assesses the level of risk associated with different courses of action in accordance to the decision and is appropriately used for risk-based decision-making. In this process, it starts from a single node in which it represents the decision to be done. After which, branches originate from the main node that represents options for action. These options are then evaluated and investigated and the most appropriate options will be discernable. (ETWB, 2005)
Sensitivity Analysis
In sensitivity analysis, the approach is to determine which risks have the most potential impact on the proposed project of the organization. It checks the incompetence and uncertainty of the project elements to the other uncertain elements that are held on their baseline values. In which it is similar to the “tornado diagram” – a figure, in which it compares the significance of variables that have high degree of uncertainty that are more stable. (PMI, 2004)
In addition, sensitivity analysis can be considered and included in the expected monetary value and simulation analysis technique. It involves the altering of the parameters of a certain set of probability or impact variables for a particular activity. After the altering, a simulation would be re-runned to create the sensitivity of the partial assumptions to the risks. Moreover, simulation software can instantly produce sensitivity diagrams to analyze the risks. Such information prioritizes risks, which will have most impact on output parameters like total cost and time. (ETWB, 2005)
Expected (Monetary) Value Analysis and Simulation and Modeling Analysis
According to the ETWB, (2005) in the construction project context, the most common methods are Simulation and Expected Value. Hence, these two techniques would be the appropriate Quantitative Analysis Technique for the Company.
Expected (Monetary) Value
Expected Monetary Value (EMV) Analysis, as a technique in Quantitative Risk Analysis, calculates the average outcome when the risks could potentially happen or not. The EMV of opportunities would be expressed as positive values, in contrary to it; risks would be marked as negative values. EMV is computed by multiplying the value of the possible outcomes by its probability of occurrence, and it is done separately before adding them all together. EMV is commonly applied to the Decision Tree Approach. (PMI, 2004)
This Approach is used commonly for contingencies, (monetary sum to the cost estimate or days to the program), “To explain the logic behind this method of assigning contingency, consider the following example. A particular risk is assessed as having a probability of 20% and an impact of ,000. Therefore, a contingency amount of ,000 is assigned to the budget.” (ETWB, 2005) However, Expected Value is also used “to prioritize risks for treatment (since the expected value of each risk can be calculated and so risks can be put in order – risk with the highest expected value being treated first)” (ETWB, 2005)
Simulation and Modeling
In this kind of Technique, it uses a model that translates the uncertainties specified at detailed level of the project into their potential impact on project objectives. In a simulation, the proposed project is computed redundantly, with the values inputted randomly from a probability distribution function chosen for each iteration from the probability distributions of each variable. A probability distribution is calculated. (PMI, 2004)
ETWB (2005) states that “Simulation is industry standard and considers the effect that the variability of project risks is likely to have on the project outcome, both in terms of cost and time. The main difference between expected value calculation and simulation is that simulation is able to model an array of different probability distributions that reflect the identified risks associated with the activity. For example, a uniform distribution considers that the value of the activity has an equal probability of falling at any point between two values. Other distributions such as discrete or normal are also commonly used to model the uncertainty and inherent variability of the cost and time impacts of activities. Simulation gives a much more realistic view of the characteristics of project delivery.” (ETWB, 2005)
Implementation of Quantitative Risk Analysis
In order to have a Quantitative Risk Analysis, an organization must have an effective Qualitative Risk Analysis, in order for it to estimate and forecast the probability of the risks that have been identified. The Quantitative Approach relies on the Qualitative Approach, so to speak.
In addition, Quantitative Risk Analysis generally follows the Qualitative Risk Analysis process, although experienced risk managers sometimes perform it directly after Risk Identification. In some cases, Quantitative Risk Analysis may not be required to develop effective risk responses. Availability of time and budget, and the need for qualitative or quantitative statements about risk and impacts, will determine which method(s) to use on any particular project. Quantitative Risk Analysis should be repeated after Risk Response Planning, as well as part of Risk Monitoring and Control, to determine if the overall project risk has been satisfactorily decreased. Trends can indicate the need for more or less risk management action. (PMI, 2004)
In the general view, the output that we can get from Quantitative Risk Analysis is that it can potentially determine the cost that will have to incur in cases of these risks, given that it can be handled by the Construction Organization. Furthermore, having a Quantitative Risk Analysis also include having a Cost/Benefit Analysis in which it handles quantifiable risks that qualitative analysis cannot handle. Furthermore, having introduced Quantitative Risk Analysis, it would not only offer value for money but it would efficiently budget the cost that would be incurred by the risks. Determining the probability of the risk would mean the definite cost of each risk, given that it is a controllable risk. Using the analysis in the Construction Industry would be perfect because the Construction Industry handles mostly risks pertaining to costs within the laborers and costs from defective equipments or procedures.
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