Concept of Risk in Construction Industry
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Published: Fri, 09 Feb 2018
3.1 General risks
The meaning of risk changes when time goes on and the meanings differ when they are at the specific socio-cultural and historical contexts which we are located in. (Deborah Lupton, 1999) Risk is exposure to the possibility of economic or financial loss or gain, physical damage or injury, or delay, as a consequence of the uncertainty associated with pursuing a particular course of action (Cooper, Chapman, 1987). According to Cornelius Keating, risk is not the present problem which should be immediately addressed, but it is considered as future issues that can be avoided or mitigated. Risk is considered as a situation which may lead to negative consequences. Generally, six major categories of risk can be identified as the most important concerns for the majority. They are:
- Environmental risks, including pollution, radiation, chemicals, floods, fires, dangerous road conditions and so on;
- Lifestyle risks, which related to the consumption of such commodities as food and drugs, engagement in sexual activities, driving practices, stress, leisure and so on;
- Medical risks, which related to experiencing medical care or treatment. Such as drug therapy, surgery, childbirth, reproductive technologies and diagnostic tests;
- Interpersonal risks, related to intimate relationships, social interactions, love sexuality, gender roles, friendship, marriage and parenting;
- Economic risks implicated in unemployment or under-employment, borrowing money, investment bankruptcy, destruction of property, failure of a business and so on; and
- Criminal risks are those risks emerging from being a participant in or potential victim of illegal activities.(Deborah Lupton, 1999)
3.2 Risks in Construction Industry
3.2.1 The Concept of Risk in Construction Industry
The construction industry experienced a wide variety of risks which may occur in financing, designing, constructing and managing facilities of a project. There are different definitions of risk in construction industry. In order to understand the process of risk management, it is important to understand the basic concept of risk in all aspects. The international standard â€œProject risk management â€“ Application guidelinesâ€? holds the theory of probability and consequence and defines risk as a combination of probability of an event which is occurring and its consequences to project objectives (IEC 2001). Ward and Chapman (2003) have made a broader definition of risk and suggest using a more general concept of uncertainty. They argue that risk is considered as threats but not opportunities and when it occurs it affects the project performance. Edwards (1995) points out that risks have a negative impact on the projectâ€™s cost, quality or time in most situations. These definitions have a common feature: they define risk in terms of uncertain events and may have positive or negative impact on a projectâ€™s objectives.
According to An (2010), risk interpretations can be considered as the following:
- The same as the word ‘hazard’
- The consequence of an unwelcome outcome or failure
- Chances of achieving a given outcome
- Signifies danger
- Taking a chance in an activity
An (2010) argues the term risk can be defined in the two components: the probability of occurrence of the risk and the magnitude of the consequences if the risk happened. And the relationship is written in the formula: Risk = consequences x probability. The general trend of risks is shown in the figure 3.1 below. When the probability of occurrence is high, the consequences of risks seem to be low and vice versa. Risks with major or severity consequences rarely happen, but risks which are or have low consequences tend to happen frequently.
Figure 3.1: Consequences versus probability trend (An, 2010)
As mentioned above, the equation seems to be simple, however, the most important thing is to understand and calculate the probability of occurrence and the severity of consequences and express those using numbers.
3.2.2 Risk Classification
Project risks can be categorized in a number of ways by considering the level of detail or a selected viewpoint. (Anna Klemetti, 2006) Categorizing risks will do help in identifying risks.
According to the study of National Economic Development Office, construction risks can be broadly grouped in the following categories:
Technical Risks include poor design, inadequate site investigation, and uncertainty over the source and availability of materials and appropriateness of specifications.
Logistical Risks include availability of resources such as construction equipments, spare parts, fuel and labour and availability of sufficient transportation facilities.
Construction Risks include uncertain productivity of resources, weather or seasonal implications and industrial relations problems.
Financial Risks include inflation, availability and fluctuation of foreign exchange, delay in payment, repatriation of funds and local taxes.
Political Risks include constraints on the availability and employment of expatriate staff, customs and import restrictions and procedures, difficulties in disposing of plant and equipment and insistence on using of local firms and agents.
Both Smith (2006) and An (2010) argue that all project risks can be divided into three main categories: known risks, known unknowns and unknown unknowns. The difference between the categories is the decreasing ability to predict or foresee the risks. Table 3.1 presents a brief explanation about these three categories of risks.
Table 3.1 Categories of risks (An, 2010)
Including minor variations in productivity and swings in material costs. These occur frequently and are an inevitable feature of all construction projects.
Including the risk events whose occurrence is predictable. Either their probability of occurrence or their likely effect is known.
Those events whose probability of occurrence or their likely effect is unknown.
Risk resources can also be divided into four elements: trivial, expected, hazard and risk management. Events with a low impact are not serious and can be divided into the elements of trivial and expected. For the high impact and low probability, these events are hazards which might occur but are too remote to be considered. (An, 2010)Taking into consideration of the probability of the occurrence and the consequence for project objectives, those events that have high probability and high impact are subjected to risk management. Figure 3.2 shows the classification of risk resources.
Figure 3.2 Classification of risk sources (Smith, 2006)
The causes of risk are various and depending on the size, complexity, novelty, location of the project as well as on the speed of construction and political or commercial plan. Long-term projects are thought to be more risky because the possibility of something going wrong is bigger to appear and the need for immediate plans of action that allow change is fundamental. The sources of risk are presented in Table 3.2.
Table 3.2: Sources of risk (Thompson, Perry, 1992)
Client, Government, regulatory agencies
Bureaucratic delays, changes in local regulations
Changes in government funding policy, liaison between several funders
Definition of project
Change in project scope
Authority of project manager, involvement of outside bodies
Adequacy to meet need, realism of design programme
Local customs, weather windows
Permanent plant supply
Degree of novelty, damage or loss during transportation
Experience, financial stability
Excessive wastage, quality, delivery
Industrial relations, multi-racial labour force
Resale value, spares availability
Remoteness, access to site
Relevance to specific project availability
It is important to use the table as the first step in risk assessment process in order to identify all the relevant risks of the construction project. By identifying all the construction risks in the early stage of risk assessment process, successful risk management can be achieved. Failing to identify risks in the risk identification stage is a hazard to the risk management process. (Perry and Thompson, 1992)
Moreover, risks can be classified based on the ability of the project to control them. A separation of risk as a local, global and extreme is based on the controlling ability of project parties on risks. As a result, this method helps to identify 80% of the risk, the last may not be worthwhile looking for, and a few of these risks could not be reasonably foreseen. (Smith, 2006) Figure 3.3 shows the hierarchy of identified risks.
Figure3.3: Hierarchy of identified risks (Smith, 2006)
Project parties have to manage the manageable risks by the settled frame and prepare to accept the challenges of the unmanageable risks. The preparation can reduce the losses caused by the unmanageable risks. Besides, some global risks can be reduced for sure.
Categorization of risks would definitely help to identify risks. No matter what method is used to identify the risks, it is important that risks should be identified and assessed carefully, which is even more important in the early stages of the project since it will affect the decision making of the project participants.
3.2.3 Importance of Risk Management in the Construction Industry
Change is inherent in construction work. When an uncertain event occurs, it will impact some of objectives such as the cost, schedule, and quality of the project. Construction projects often have a poor performance due to a lack of reasonable risk management process. (Liu Renhu, 2005) Many projects fail to meet deadline or cost and quality targets. As a result, risk management becomes an important part of construction management. Risk management intends to identify and manage those potential and unforeseen problems that might probably occur during the project implementation. And also, it tries to identify as many risk event as possible minimize their impact on the project, manage the responses to those events that are probably to materialize, and provide contingence funds to cover risk event that actually materialize. The essential purpose of risk management is to improve project performance via systematic identification, appraisal and management of project related risks. The focus on reducing threats or adverse outcomes, which we might call ‘downside’ risk, misses a key part of the overall picture. (Chapman, Ward, 2003) Changes cannot be eliminated, however, by applying risk management in project construction participates are able to improve the construction management. The benefit of risk management can be concluded as follows:
- Project issues are clarified, understood and considered from start;
- Decisions are supported by thorough analysis;
- The definition and structure of the project are continually monitored;
- Clear understanding of specific risks associated with a project;
- Build-up of historical data to assist future risk management procedures. (An, 2010)
3.2.4 Project Planning
The control of time cannot be affected insulation from resources and costs. Project planning methods should consider the communication with all the parties in a project in order to identify sequences of activates and draw attention to potential problem areas. Careful and continuous planning contributes to successful construction project. Sequences of activities will be defined and linked to a time-scale to ensure that priorities are identified and efficient use of expensive or scare resources. However, since the uncertainty occurs during construction, the plan will always change and it must be updated quickly and regularly in order to maintain the most efficient way of completing the project. In developing a controlling plan, it is vital to distinguish between different categories of change and to fully instigate the formal aspect of the project. (An, 2010)
All the parties and resources involved in construction have influences on project plan. However, project plan will change when uncertainty occurs. The purpose of planning is to persuade people to perform tasks before they delay. A framework of decision making in case of change occurs should be included in project planning. (Smith, 2006)
3.3 Risk Management in the Construction Industry
3.3.1 Risk Management strategy
Both client and contractor are concerned about the projectâ€™s risk allocation. Generally, the client or the project owner has an overall risk management strategy and policy included in the strategic documents and quality management system. Risk management strategy is shown in figure 3.4.
Management of project risk
Figure 3.4 Risk Management Strategy (Smith, 2006)
The most important issues which the project owner concerned in risk strategy are risk ownership and risk financing. Risk ownership is explained as which party owns the risks and risks expose and transfer. Risk financing can be explained as how to include and use budget of risk allowance or contingency. The participants make decisions, which affect the responsibilities of the parties, to define the organization and procedures of a project. (An, 2010) It influences the construction, commissioning, change and risk of a project and this is how it affects the construction processes. (Smith, 2006)
3.3.2 Process of Risk Management
Risk management is one of the most critical project management practices to ensure a project is successfully completed. (Chapman, 1997) The goal of risk management in construction industry can be stated as following:
â€œTo be competitive in meeting the clients specifications with solutions that are cost-effective at an acceptable level of riskâ€™â€™ (An, 2010).
To successfully achieve the goals in any projects, the following four aspects need to be met:
It is important to consider the four criteria as a whole. There are two major objectives managing risk: one is to avoid the downside risks and the other is to exploit opportunities. Risk management is a process of defining the need for identifying, estimating and evaluating risks in order to control them at an acceptable level. (An, 2010) The risk management system is shown is figure 3.5.
Figure 3.5 risk management frame work (An, 2010)
Four aspects are involved in risk management, which are hazard identification, risk assessment, risk reduce or risk response and emergency preparedness. These will be introduced in the following paragraphs.
188.8.131.52 Hazard Identification
Hazard identification is the first step of the risk management process. It is aimed at determining potential risks which may affect the project. Ideally, all the potential risks and hazards should be identified when the decision is being made so that the participants can deal with before they occur. However, although prevention is better than cure, no risk management system can identify all the risks and hazards in advance. (Martin Loosemore, 2006) In this way, hazard identification needs to be carried out carefully in order to reduce the potential risks in the project.
As the first step of risk analysis, hazard identification is the most important one as it helps to identify the potential risks whose effects act as an impediment to the project, and this process will also help with risk mitigation and control. A general definition of hazard is stated as following:
- ‘A hazard is an undesirable outcome in the process of meeting ant objective, performing a task or engaging in an activity’ (An, 2010).
- The undesirable outcome of a hazard could involve:
- Injury to personnel
- Damage to property
- Pollution to the environment and
- A combination of all the above (An, 2010)
Risk identification is one of the most important steps of risk management because it makes the risks clearer. As a result, Chapman (2001) points out that the success of later risk management phases is directly affected by the quality of the identification phase. Risk identification procedure identifies and categorizes risks that could affect the project. This procedure includes discovering, defining, describing, documenting and communicating risks before they become problems and affect a project. (Barati, S.,Â Mohammadi, S., 2008) Risk identification is a tool for identifying all the significant sources and causes of risk and hazards in a project. Numbers of methods and techniques are used in identifying the project risks (IEC 2001), including brainstorming, expert opinion, structured interviews, questionnaires, checklists, historical data, previous experience, testing and modelling and evaluating other projects.
Perry (1992) points out the most popular methods of hazard identification. They are:
- Checklists prepared by experienced people that are involved in the project.
- Brainstorming sessions where groups of people are trying to come up with potential risks through conversation and exchange of ideas.
- Historical data of previous similar projects that can assist in the portraying of risks.
- Interviews of key participants of the project or experts involved with it.
These techniques are to provide a systematic approach for identifying potential hazards in construction industry. (An, 2010) Empirical studies of risk management practice (Lyons, Skitmoreï¼Œ2004) show that the checklists and brainstorming are the most useful techniques in risk identification. And they also point out that risk identification often rely on individual judgments of the project participants.
Another method applied for the identifying risk events is the HAZOP study (Hazard and Operability). This is a technique using â€œguide-wordsâ€? in order to study deviation from the design objective of a project and its elements. (An, 2010)
A helpful action would be to group the risks and separate them into specific categories after the first stage of risk identification. This would benefit the risk assessment process by applying a suitable technique to each category and furthermore in the selection of a risk management response for each type. (An, 2010) in construction industry three main types of hazards which need to be taken into account are the followings:
Management Hazards: Associated with management and organizational issues, such as policy, commitment of funds for training, and the project of specific equipment and schedules to be met.
Commercial Hazards: Arise from commercial considerations, and particularly associated with decisions on spending. A typical example is the selection of a less expensive material that just meets the minimum standard required instead of opting for the more expensive item with huge specification and a track record of high quality. Sometimes a contract is accepted as a cost below the desired level, and savings have to be made in order to complete the work. This in turn may lead to potential hazards due to commercial factors.
Time Hazards: Many projects need to be completed by an agreed date. Delays due to the factors such as late delivery of materials, unforeseen production difficulties or failure to meet specification would affect the ability to meet deadline. As a consequence of failure to meet the deadline, it could affect future contracts and disrupt the schedules. All these events can be considered as hazards or time hazards.
Each project has different associated hazards, which differ from various technology or organizations or anything else applied in the projects. A checklist of construction hazard drivers is shown:
- Financial Hazards
- Legal Hazards
- Political Hazards
- Social Hazards
- Environmental Hazards
- Communications Hazards
- Geographical Hazards
- Geotechnical Hazards
- Construction Hazards
- Technological Hazards
- Demand/product Hazards (An, 2010)
After hazard identification, the potential hazards can be listed and grouped. Then, risk assessment method can be applied to build the risk level.
184.108.40.206 Risk Assessment
Once risks have been identified, they must then be accessed. The sources of risks should be identified first, and then the effects of the risks should be assessed or analyzed. Risks can be assessed either using a quantitative or qualitative analysis. (Thompson, Perry, 1992)
Qualitative Methods: The first step of the qualitative analysis is also the first step of risk assessment — risk identification, which is described above as the first step of risk management. Then, an assessment of the probability of occurrence and impact of the risks should be taken out. Qualitative risk assessment usually includes the following issues:
- A brief description of the risk
- The stage of the project when it may occur
- The elements of the project that could be affected
- The factors that influence its occurrence
- The relationship with other risks
- The likelihood of its occurrence
- How it could affect the project (Smith, 2006)
Using qualitative methods is the first step of risk assessment. Then, a quantitative assessment is only for the risks whose further information is required. These risks are usually serious and can jeopardise the project.
Quantitative Methods: According to Barrow (2007), there are four reasons why risk should be managed: to minimize delays, to reduce cost, to improve return on investment, to increase the number of opportunity. Possible consequences of risk occurring are defined and qualified in terms of:
- Increased cost such as additional cost above the estimate of the final cost of the project
- Increased time such as additional time beyond the completion data of the project through delays in construction
- Reduced quality and performance such as the extent to which the project would fail to meet the user performance based on quality, standards and specification. (Smith, 2006)
Several methods can be used in risk assessment and risk metrics method is going to be introduced. Risk metric is a two-dimensional presentation of likelihood and consequences using qualitative for both dimensions, event modelling is a systematic way to identify accident scenarios and quantify risk. (Ayyub, 2005)
Estimating the probability and impact of risk in simple scales, such as from 1 to 5 or from high to low, is the most common way, and boundaries can also be numerically defined. Risk can be characterized by probability and consequence, and examples are given in table 3.3 and table 3.4.
Probability of Occurrence
Table 3.3 Probability of Occurrence (An, 2010)
Rating of consequences
Table 3.4 Rating of consequences (An, 2010)
As mentioned in pervious paragraph, Table 3.5 shows that risks can be allocated in three regions.
Table 3.5 Risk Matrix (An, 2010)
And this can also be replaced by two curves, as it’s shown in figure 3.6.
Figure 3.6 Graphical presentation of risk regions (An, 2010)
During risk assessment, identified risks are evaluated and ranked. The goal is to prioritise risks for management. The assessment of the risks leads the hazards to be classified in a region, which would determine the importance (risk level) of each hazard, and the possible regions are the intolerable, tolerable or the negligible region. Figure 3.7 shows the risks listed in the appropriate regions.
Figure 3.7 Output of risk assessment element (An, 2010)
The risks are allocated in three regions, after that, the risks should be selected the risk response to them.
220.127.116.11 Risk Response
Once the risks are identified and assessed, the next step of the risk management procedure is to response to these risks. The nature of the response depends on the decisions made by the management team. In order to respond correctly, the team has to process the information available for the risk. There are two types of responses to risks: immediate response and contingency response. The immediate response mitigates or eliminates the risks through alterations of the project plan. The nature of contingency response is preparing a plan for an alternative course of action and implementing it when the risk arises. (An, 2010)
There are four basic ways of responding to risk and they are risk retention, risk transfer, risk reduction and risk avoidance. In order to effectively manage a risk, it is necessary to adopt a combination of strategies to treat it. The selection process can be iterative until the most effective treatment strategy is developed. (Smith, 2006)
Risk avoidance deals with the risks by eliminating the risks through changing the project plan or certain features. Another way of risk avoidance or reduction is re-design or changing the method of construction. (Perry, Hayes, 1985) However, there are only a few situations this response can be used.
Risk reduction aims at reducing the probability and consequences of a risk event. The measures should be taken with consideration of the value for money. Reducing the level of risks could raise the cost. Only when the value of the reduced risk is beyond the cost it caused, this method can be taken. Risks can be reduced by:
Obtaining additional information
Performing additional tests/simulations
Allocating additional resources
Improving communication and managing organisational interfaces(An, 2010)
After risk assessment, hazards are allocated in the intolerable, tolerable and negligible regions. There are some guidelines for risk reducing.
Hazard in the intolerable region: risks in this level should be eliminated or cost-effective cannot be achieved. As a result, the project should be considered for abandoning.
Hazard in the tolerable region: to reduce risks in this region, two aspects should be considered. One is whether the risk is close to the intolerable region, the other one is whether it is a cost-effective reduction process. It is better to reduce the risk no matter how expensive it might cost in dealing with the first situation. For the second consideration, it is better to reduce the risk and checking carefully of its allocation.
Hazard in the negligible region: it is recommended that these hazards should be left alone, since they are not worth to reduce. (An, 2010)
Risk transfer is to transfer risks from one party to another. This would happen between parties in a project or between one party in the project and one outside. (An, 2010) Some contractual obligation can also be used as risk transfer method, because no one is willing to accept a risk without any form of compensation. Generally, it is better to transfer the risks to the parties who can best control them.
Acceptance or Retention:
If the other methods fail to adequately or fully treat the risk, the project has to be prepared to accept the risk or any residual risk remaining after some initial treatment. The party which is holding a risk may be the only one that can manage the risk or accept the consequences. If the risk is under control of this party, the likelihood of happening or minimise the impact of the risk could be reduced.
It is possible for a risk to have a number of potential treatment equally suitable but varying in cost. The selection of a final treatment must be made as cost-effective. The cost of managing the risk should be commensurate with the benefits obtained. The risk response process is directed at identifying a way of dealing with the identified and assessed project risks. Risk reduction is the most frequently used technique within the construction industry. Managing the risks of a project is a rather difficult task. Choosing any form of treatment may itself expose the project to additional risks. In this way, attention should be paid to ensure that the treatment strategy does not expose the project to greater risk than what the original risk was designed to treat.
18.104.22.168 Emergency Preparedness
Even when the pervious risk management processes have been well applied, accidents happen occasionally. The goal of emergency preparedness can be concluded as the following:
‘To be prepared to take the most appropriate action in the event that hazard becomes a reality so as to minimise its effects and, if necessary, to transfer personal from a location with a higher level to one with a lower risk level.’ (An, 2010)
Regarding the management of risk, an emergency preparedness is the preparation of contingency plans and courses of action in case the risk arises during construction. The emergency preparedness could also be an alternative course of action prepared as a contingency plan.
Risk management intends to identify and manage those potential and unforeseen problems that might probably occur during the project implementation. And it could identify as many risk event as possible, minimize their impact to the project, manage the responses to those events that are probably to materialize, and provide contingence funds to cover risk event that actually materialize. ‘Precaution is better than cure.’ The same principle can be applied to risk management which should be a proactive approach rather than a reactive one. Risk management is a preventive process to ensure that negative impacts are reduced and that harmful consequences associated with undesirable events are minimized. Generally, the risk management process should include: risk identification, risk assessments, risk response and emergency preparedness. Once risk has been identified, they must then be accessed on their potential severity of loss and the probability of occurrence. Then through the following stages such as risk avoidance, reduction, retention or risk transfer, the risks can be dealt with and its impact can be decreased to a certain extent.
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