RISK ASSESSMENT IN CONSTRUCTION INDUSTRY

Goran Cirovic
The College of Civil Engineering and Geodesy, Belgrade, Serbia
[email protected]

Simo Sudjic
The College of Civil Engineering and Geodesy, Belgrade, Serbia
[email protected]

Construction industry is a highly risky process mostly because of its long life duration and
unique product as a result of construction, and also many different professions are involved in
one project. Generally, risks in construction industry should be controlled and reduced during
design, procurement and construction phase, and the most important activities are define risk
management plan from the very beginning and to assign risks to different project members
and to manage their execution. In this paper risks on a project in initial phase will be
presented, cost and duration risks and complete contingency for the previously defined
budget will be described. Statistical data for one project in design phase will be analyzed and
general comments and recommendations will be proposed. Also, general method for
calculating risks will be presented.

KEYWORDS: construction, risk management, forecasting.

INTRODUCTION
Project management in the construction industry is mostly risk management oriented, and the
main goal is to achieve risk control in all project phases. Great and long-lasting construction
projects are exposed to many different risks, so the most important is to define risks at the
very beginning of the project and to control and reduce them during the project execution.
Risk management is a very important segment of project management, and generally the
main target on a construction projects is to manage cost and time since quality is very often
defined in an agreement. In order to systematize risk overview management it is necessary to
carry out risk analysis. Risk Analysis is a systematic approach to understanding these risks
and their impact so that the decision makers can account for them in contingency planning, as
well as plan for risk mitigation. The project risk can be in many areas, such as traffic
estimation, product pricing, host country's fiscal policy or political uncertainty, EHS risk, etc.

RISK ANALYSIS
Risk assessment should be the process which passes through few phases, and during risk
generation assessor should overview all risks on the project and their changes. Generally, the
risk management framework is [1]:

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 Risk identification

Risk classification

Risk analysis Risk attitude

Risk response

There are four objectives of doing risk analysis:

• to set the project’s funding requirement during Budget or Authorization for Expenditure
• to assess the highest risk items at different project stages so that mitigation can be
planned
• to return any excess contingency fund during project execution, so that the fund can be
used more profitably in other areas
• to set Stretch Target as a challenge to the Project Team

The most frequent risks on the construction projects are related to:

• land and property

During the initial phase risks are not completely defined, so it is very difficult to make
decision about future project strategy. As an example, one big marina and residential project
was in danger with many general risks, and the main risks were identified as in the following
table. Also, the in the table is presented description and management action for all identified
risks.

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 Reference No

Heading Description of Risk Management Action

1.0 General
1.1 Local market Projects in the Kotor area create high demand for Plan and secure commitment for human and
construction resources material resources

1.2 Montenegrin legislation Mis-understanding of Montenegrin legislation Translate legislation into English ; Local consultants
to provide interpretation to whole team

1.3 Montenegrin legislation Change in Montenegrin legislation Translate legislation into English ; Local consultants
to provide interpretation to whole team

1.4 Montenegrin legislation Montenegrin approvals take longer than planned Build in contingencies in master programme ; Keep
close to Montenegrin and municipal authorities ;
Monitor progress
1.5 Local infrastructure Local infrastructure cannot support the development Early contact with local authorities and utility
companies ; Allowance in cost plan
1.6 Utility companies Poor performance by utility companies for Agree scope, deliverables and programme with
infrastructure provision utilities companies
1.7 Utility companies Change in previously agreed plans by utility Agree scope, deliverables and programme with
companies/municipality utilities companies ; Regular liaison with utility
companies/municipal authorities ; Monitor progress

1.8 Local market Unfamiliarity with Montenegro Early meetings and regular contact with
Montenegrin authorities, utility companies, etc. ;
Identify good local partners and maintain regular
contact with them ; Identify other International
companies active in Montenegro and seek
1.12 Wastewater solution Currently assuming connection to new regional Monitor progress of regional strategy
strategy main sewers, which should be in place by implementation ; Identify contingency plans
summer 2009.
1.13 Storm water solution Existing combined discharges from Tivat cross site. Review results of Ehting survey ; Monitor
These must be intercepted and not allowed through programme for local infrastructure implementation ;
development to contaminate marina/ bay Identify contingency plans
1.14 Potable water supplies New regional supply to be available 2010. Also supply Identify contingency in liaison with local authorities.
from Herceg Novi is possible solution. ; Monitor Regional supply scheme implementation ;
Ensure design features incorporate measures to
reduce consumption
1.15 Power supplies Solution will require off-site works – new distribution Develop robust strategy for power supplies ;
lines and sub-stations. Possible 3rd party land Confirm off-site routes and requirements ; Add
issues. works to Tivat regional strategy ; Procure via local
distribution co as necessary
1.16 Land permit and Building permit Land Permit and Building Permit applications – Use local advisors/consultants to define exact
possible delay if documentation is not full and scope of information to be produced at each stage
complete. Time for approval by Ministry is not

At the planning phase of that project with very strict time frame and very big penalties
management decided to proceed risk analysis and to define time and cost contingencies. The
result was very interesting:

Cost risk 320,000 Euro / Time risk 120 days

As the penalties were 500 Euro per day third combination was optimal. That project was
managed with additional specialist, and more consultants during the design phase, so the risk
management plan defined at the initial stage helped the project finished successfully.

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General risks during design and procurement (tender) stages are how to coordinate design
and to estimate cost, as well as to prepare cost plan in a realistic boundaries. Cost and
programme is very difficult to estimate. Thus, during the pre-construction phase it is very
important to manage all design risks and to organize design according to design brief as well
as to minimize budget increase.

After risk elements identification, possible scenarios for all risk elements should be
evaluated. The worst case or the most pessimistic scenario and the best case or the most
optimistic scenario should be considered as the maximum and minimum impacts of risk
elements.

Not all risk elements will impact all cost items. For example, labor productivity will impact
only labor cost items and not the material cost items. Also a risk item, if it impacts on several
areas, may not impact on them equally. For example, if major equipment scope changes, it
will affect the equipment cost significantly, but it will also affect the corresponding bulk
material and labor cost by a lesser amount.

For the risk calculation the key factors are the variation from initially defined value (cost or
programme) and the probability that the variation can occur. For example, the estimated
foundation cost is 1,000,000 £ and the maximum expected variation is 200,000 £, with the
probability of 30 %. The expected cost is:

1,000,000 £ + 0,30 x 200,000 £ = 1,060,000 £

The following matrix is an example how to categorize risks according to cost and time
variation and probability percentage.
%Probability
100% 80% 60% 40% 20%
(€) Cost / Time
Greater than 3,000,001
max 5,000,000 / Greater
than 90 days max 180 25 20 15 10 5
days

Up to 3,000,000 / Up to 90
days 20 16 12 8 4

Up to 1,000,000 / Up to 30
days 15 12 9 6 3

Up to 500,000 / Up to 14
days 10 8 6 4 2

Up to 100,000 / Up to 7
days 5 4 3 2 1

This matrix presents the guideline for assigning the risk categories of importance 1,2,3,4 or 5
and is based on a combination of (€) Cost / Time and Probability Percentage. The color
indication presents proposal how to categorize risks as a low (green), middle (orange) and red
(high) risk.

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RISK CALCULATION AND OVERVIEW
Risk register is a document which should be updated regularly and it is one of the key
documents on the project. All risks and all risks management actions for risk reducement or
control should be described in the document. For all the risks a response could be to accept,
reduce, transfer or avoid them. It is very important to propose management action based on
current situation on the project. Every risk should be assigned to the specific owner and close
out date for every risk should be defined.

Since the cost and duration and cost of the project are in an interrelation and the changes of
cost very often cause changes in duration or vice versa, the risk calculation is mostly related
to the cost and duration.
Cost of Risk Occurrence (€K) Duration of Risk Occurrence (Weeks) Cost of Risk Occurrence (€K)
Raw Information Raw Information With Probability Factor
Min Most Max Min Most Max Probability Min Most Max Expected Category Risk
Likely Likely Likely Likely Likely Likely of Likely Likely Likely Exposure to of Response
Occurrence Risk Risk
(%) A, B or C

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The tables above show a real example of risk calculating at a great construction project. It is
very important to describe the risk and management action in order to keep it on an
acceptable level or possibly to eliminate it. This method is applied to determine the impact of
risk on costs and project duration in the range 1 - 5, where each value presents our assessment
how much a certain risk can affect cost increase and project delay. Besides these values, the
assessor should also determine the probability of risk occurrence during the project
completion. Through a calculation determined in advance factual costs and time risks are
obtained.

This calculation functions based on the principle of fuzzy logic as it should be taken into
account that it is difficult to determine how much a certain risk can affect the project, so the
values are kept within specific limits. It is very important to determine how much all the risks
can increase the project value and duration, however, it should be taken into consideration
that many risks are overlapped, so that through this calculation a great reserve or contingency
is very frequently obtained.

The following diagram presents the curve that actually shows the probability in which range
the project costs can vary. Considering that costs are generally estimated as a fixed value, by
this approach the probability of completing the project for this value would be added to the
value. For example, it can be seen from this graph that the project can be completed for $ 550
million with the probability of 68%.

These values have been gained in such a way that some items from the bill of quantities were
given the value with definite probability, and thus these cost values of a complete project
have been gained from the analyzed project.

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CONCLUSION
The principal objective of risk analysis and calculation is to offer the decision maker more
variants of cost and project duration, perceiving the probability to complete the project within
this range. It is also essential to forecast reserves, with which the risk from budget exceeding
is reduced. The decision maker makes the decision with what risk level the project will be
completed based on the data at his disposal. During the project completion all these values
must be controlled and corrective actions must be proposed.

REFERENCES:
Flanagan R., Norman G., "Risk Management and Construction", Blackwell Science, 2003.

Ivković B., Popović Ž., (2005). "Construction Project management", Građevinska knjiga,
Beograd (in Serbian)

Brook M., (2008) "Estimating and tendering for construction work", Oxford : Butterworth-
Heinemann

Hinze J.W., (2004) "Construction Planning and Scheduling", Pearson Prentice Hall

Jamadi O.A., Almishari S., "Risk assessment in construction", Journal Construction

Edwards L., (2008) "Practical risk management in the construction industry"

Koller G.R., (2007) "Risk assessment and decision making in business and industry"

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