This paper will study risk management in construction industry in detail. Before anything else is discussed, we need to understand what exactly risk is. Therefore the meaning of the term ‘risk’ will be identified. Once risk is defined and understood in the paper, we will move on to understanding how risk is managed. This is what we call risk management. After the true meaning and definition of all these basic terms have been understood, the benefits and limitations of risk management in construction industry in UK will be discussed in detail. Towards the end, the key points will be summarized and a few recommendations will be given.
Business in today’s world has become very competitive due to many obvious reasons. A few of the major reasons are globalization, increased pace of change, consumer demands and increased vulnerability (Smith, N. J. et al, 2006). All these reasons are responsible for why organizations all over the world are now adopting strategies to remove uncertainty and risks. However, those who cannot cope with the risks fail. WorldCom and Enron are a few of the many companies that have failed recently (Allan, N. & John Davis, 2006).
Similarly construction companies have very high chances of risk because their projects are very highly budgeted and are carried out on a large scale and any little risk can cause the entire project to fail. Because of these risks, many construction companies were forced to close down their businesses. This is the reason why construction companies must have techniques to avoid such risks. Realizing the need, numerous construction companies have adopted risk management techniques since the 1980s (Flanagan, R. & George Norman, 1993). Since risk management has become so common, this rather new concept will be discussed in detail in this paper.
Wat is risk?
The literal meaning of the term risk according to Oxfords Learners Dictionary is ‘the possibility of meeting danger or suffering harm or loss’ (Hornby, A. S., 1995). This meaning makes it very clear that risk is something that has a negative connotation. Therefore there is a need to do something to avoid this negative term.
Risks are faced by every individual and organization at all times. We face risks as individuals when we do something dangerous. Similarly, it is totally natural for organizations face risks when they try something new. In fact it is necessary for individuals and organizations to face risks because this is the only way they can earn a reward. It is very common for an organization to face risks from more than one source. This is the reason why organizations need to manage the different risks that may negatively affect different aspects of an organization.
A construction company, like ours, may face risks from both, its internal and external environment. The internal environment includes everything that is within the organization. For example risks from the labor force, management, etc. The external environment includes everything that affects the organization but is not a part of it. The government, market, customers, and suppliers are all examples of what constitutes for an organization’s external environment. Different parities and factors pose different risks for the organization. These risks may be different in terms of nature, complexity and significance.
As mentioned earlier risk is something that negatively affects the organization, therefore there is a need to manage risks properly. This includes identifying the possible risks, using models to prioritize them, and coming up with contingency plans which will help in avoiding these risks. These are basically all elements of risk management and this brings us to the next section where we will discuss in detail what risk management is.
As mentioned earlier, we face risks from too many places at too many occasions. The number of possible risks that a construction company faces are too many to list and because of this the number of strategies to overcome the risks are also countless. We need a way to somehow predict them, understand them and control them by developing contingency plans for as many as we can. The answer to this is Risk Management. Risk management is a technique in which we identify the risks, assign them probabilities of occurrence, find out their impacts and develop ways in which we should respond.
According to The Software Engineering Institute, risk management is when risks regarding anything are constantly and consistently identified and analyzed (Barkley, B. 2004). The important point of the previous statement is that in order for something to be risk management, the risks must be identified and analyzed not just one time, but all the time and in a routine.
For a company like ours, it is critical that we adopt some kind of strategies to avoid any risk that’s possible. Each of our projects is very highly budgeted and is carried out on a large scale. For example some of our projects involve construction of a power plant. Now the amount of time, money and resources that go into construction of a power plant are too much and because of this we cannot afford to put them all in danger. A failure in any of our projects can result in something harmful for our organization. Adopting risk management will improve the situation to a great extent because of the benefits it brings with it. But before we can discuss the benefits of risk management in detail, we need understand risk management better.
Now the question remains how risks are managed? Different organizations may manage risks differently depending on the costs that they can allot to risk management, availability of know how and specialist, and the need for risk management. However, one general approach to manage risk will be discussed in the coming paragraphs. This is done by various techniques that come under risk management.
There are a lot of things that need to be given thought to other than the cost, need and availability of know how. For instance before risk management is employed in any organization, the authorities need to ensure that any person who will be affected by introduction of something new must be informed. In addition to this, they must be made ready and willing to accept this new work practice. This is very important because until and unless the people who will be most influenced by adoption of risk management techniques are comfortable with the idea of something new and different, they will not be motivated to make the most of it and hence risk management will be a failure. These people need to be convinced that such new techniques will be beneficial for both, the organization and the individuals working in it. This is the reason why something as complex as risk management cannot be implemented overnight. It calls for large scale planning and changes.
Once the organization is ready to take a step and adopt risk management, it can move on to the next step. For the next step, the data that is used to manage the project is used. This includes datasheets, projected financial statements and other documents. These have a large number of information regarding the project and the risks involved as well. Other relevant information can also be used to determine any risks that the project is associated with. Now the task is to look at this information from a different point of view. The risks that are involved in the project need to be identified through deep analysis of this information. For example, risk of cash/budget shortage can be identified through careful analysis of the forecasted cash flow statement of the project.
The risks that have been identified through this information calculated must be noted and documented so that it can be available for use and reference at all times. It can be organized in a list form as it is done by Public/Private Partnership and Private Finance Initiative projects in the UK. This is often called the risk checklist. This list not only lists the risks but also categorizes them. The categories are made according to the source type of risk events. The risk can be macro, meso or micro-level (Bing, Li et al, 2004). This organized list of risks must be available at all times otherwise the risk management would not be of much use.
The organization also needs to know to what extent the risk can be taken. It needs to know how risk averse can they afford to be (Kendrick, T., 2003). This will help it in knowing what risks it can and cannot afford to take. The extent to which an organization is risk averse can be done by consulting the higher level of management and from studying previous behavior of the organization in the past.
The next step is using different models and methods to assign probabilities to the risks that have been identified. This is a very complicated and crucial step in risk management. The probabilities that are assigned must be very accurate and calculated. For this reason, a specialist who has experience in something similar before must be hired. Assigning probabilities is crucial because these probabilities determine the degree of riskiness of ever risk on the list. The risks that have the highest probabilities will be of higher priority and thus the solution to the high priority risks must be developed.
This next step is very important because this is where we decide our response to the expected risk. At this stage we have three responses to a possible risk. We can decide to avoid it completely by developing separate contingency plans for each possible risk. Other than this we can also decide to transfer or retain the possible risks.
Next, a risk management plan will be developed which will have all the findings outlined in it. This plan may be formal or informal depending on the importance of the project for the organization. It will include different risk management methods that will be adopted by the organization, the duties and responsibilities of the people involved, the tools that will be used, and anything else that needs to be kept in mind.
Risks must be allocated next. This involves deciding who will take responsibility for what risk. Since there are a large number of parties involved in any project that our construction company undertakes, we have to decide which risk must be allocated to which party.
The last step of risk management is very important. In this step the risk management that has implemented must be monitored. This may seem like a pointless step but it is very necessary to check to what extent the risks are being avoided because of risk management. This will allow the organization to know whether or not the organization should continue with the risk management. It will also help the organization to know what changes need to made in the risk management technique which will ensure better result. The risk management strategy must also be monitored because doing so will allow it to keep its risk profile up to date. The risk management technique can be monitored by assessing and comparing the after risk management situation of the organization with the before risk management situation. The decrease in rate of failures of projects after the risk management strategies have been adopted will indicate that the project was a success.
It is not necessary that an organization follows the steps outlined above. Risk management is very subjective and it must be implemented according to the needs of the project. The steps differ from time to time and situation to situation. An organization may also adopt a more casual risk management approach in which all the steps do not need to be followed. However, the important thing is that this is how risks are generally managed formally in organizations all over the world.
Benefits of risk management
There are many obvious benefits of adopting risk management techniques. All these benefits will be discussed in the following section. However, we must keep in mind that the benefits also depend on how and to what extent an institution applies risk management techniques in their organization and projects.
The major project that we are going to undertake may not turn out to be the way we expect it to be. Why? This is because the external and internal environment in which the project will be implemented will have various factors that may affect the project negatively. After the project has been implemented and if it is a failure, we will realize where we went wrong and that’s when we will conclude ‘if only we have concentrated on this aspect a little more’. We will regret not paying attention to something that will seem so predictable then. Therefore we can say that all the possible risks out there are predictable. We just need to scratch and scratch until we can reach the bottom of them (Barkley, B. 2004).
Once we have identified the risks, we can benefit a lot from them. Risk management technique is a technique which will allow us to predict these obvious risks and help us control these risks in our favour before the project is implemented. The possible options to control of affect these risks include retain, transfer or avoid. The option that we choose depends on the nature of risk and the situation we are in that moment. However the important point is that we will have an insight in the future and this insight will help and predict and prepare. Hence, we can prepare our responses to any kind of risk that will come across us once the project has started.
Without risk management we would be uncertain about what risks are out there and this is a very common reason for projects at such level to fail. This phenomenon is called uncertainty. Risk management identifies the possible risks and puts forward everything in front of the people who are involved and hence uncertainty is removed along with the high chances of failure. The budget that has been allotted to the project is so high already, therefore in order to decrease the chances of failure we should adopt a kind of risk management technique which would ensure that the project would have minimal risks that we would not be expecting.
Another benefit of risk management is that this allows us to respond to risk in a way which will not be as detrimental as it would have been if we had not expected them. There are many types of risks. Some of these risks can be avoided and some risks are such that can not be avoided. These types of risks are called ‘pure risks’ (Klemetti, A., 2006). The organization will have to face them no matter what. However, the degree to which this risk affects the organization depends on whether or not the organization was prepared beforehand to face this risk. Risk management strategies prepare the organization to face such risks and hence the impact that it has on organizations is not that detrimental.
Another benefit is that adopting risk management techniques will give our organization a competitive edge over others in the industry. Our construction company is based in UK where there a very large number of construction companies operating. According to a source, in UK, the largest industrial sector is of construction. It is three times bigger in size than the agricultural sector of the country. In addition to this, more than 50 percent of the companies that are registered are construction companies (Bower, D., 2003). All the statistics mentioned above confirm the fact that the competition is very strong for our organization. Therefore we need something that will make us better off and different from the others in the industry in order to survive. Despite the fact many organizations have already adopted risk management in their projects regularly; there are still many organizations that are not willing to change their common practices. These organizations are too hesitant to change their common operation practices. These organizations have not adopted risk management techniques yet. If we take a step now, we will be better off than them. We will have an advantage because we will have an insight in the future. We will know what situations to avoid and how to tackle other risky ones. This will become our strength which will ensure that we are ahead than other construction companies in the country.
Another benefit of deploying risk management in our construction projects is that investors, stakeholders, bidders and staff would have a higher level of confidence in the project (Swansea University, n.d.). When the investors would have confidence in the project’s success, they would be more willing to invest more and hence finances will be easily available. When stakeholders would have confidence in the project, they would not interfere in the matters regularly which is often considered as a hassle by some organizations. And lastly when staff has confidence in a projects success, they are more willing to put in an effort in the project to ensure that their performance ratings increase etc. The employees would be motivated to work harder and hence the efficiency of the project will increase.
Risk management will also allow a large number of data to be collected throughout the time it is employed in our organization. This qualitative and quantitative data can be very useful in future decision making (Smith, N. J., 2006).
Risk management also allows the resources to be used more efficiently. When risks associated with a particular resource investment are very high, the organization may decide to not invest in that and hence the resources which would have been invested in a failed project would be saved.
Risk management will also improve the planning phase of the project that we undertake. Planning is a very important phase in a project and when a proper procedure is used in the planning phase, the findings would be more accurate and hence the project will have higher chances of success. Risk management will improve the strategic planning of our construction company. Risk management is all about analyzing the scenario in detail. This puts the organization in a better position to take up techniques like SWOT Analysis when making decisions. Risk management allows the organization to understand what the situation is and hence through the findings of the risk management, the organization can identify its strengths, weaknesses, threats and opportunities (Swansea University, n.d.).
Besides this, we know that supply chain management techniques have become really common in construction projects like ours. This has become a necessity nowadays because of the benefits that supply chain management brings along with itself. These supply chains connect us with our customers and suppliers. This means that there are more parties involved in any construction project that is undertaken by this. More parties mean higher risks. Therefore we can conclude that supply chain management gives rise to another risk factor and hence this raises another need for adopting risk management techniques. Why is this so? As mentioned earlier that supply chain management connects us with our suppliers and customers. This means that whatever our supplier does will affect us. For example, if a supplier is not following certain rules and regulations that have been set by the government of that area, this will directly have an impact on our business. Our reputation and project success would be at stake. Another example of the risk associated with supply chain management is that if there is an increase in prices by the suppliers, our cost of construction would increase. Since we depend on the suppliers so much, if our supplier increases the prices of the raw material so much that our budget runs out, our project will have to stopped and we would not even have time to find another supplier. Also, supply chain management is a very risky technique and if everything does not go as coordinated as planned, the project can come to a halt and fail. Even if a single party from the entire supply chain cycle fails to coordinate, our project will not be able to succeed. Let’s take an example of a situation where we use the cash paid by customers to pay the suppliers. This means that we are keeping zero working capital with ourselves. This strategy is very efficient however if anything goes wrong, the strategy can backfire. For instance if the customers do not pay on time for any reason, we will not be able to pay our supplier and our project will shutdown. Therefore, we must be ready for such a situation. Risk management will allow us to determine relationships between risk and the supply chain. Once we have understood these relationships, it will put us in a better position to adopt supply chain management. We will enjoy the benefits and would not have to be worried about the drawbacks.
Lastly, we must understand that the advantages of risk management are not only short term. These advantages will benefit us in the long term as well. If we adopt risk management, we will be aiming for continuous improvement. When risks are identified through risk management, our organization will come up with responses which it will use in future for a certain risky situation. It will therefore learn how to cope with the environment better and sort of evolve into something stronger than ever. Therefore we can state that another benefit of risk management is that it brings along with it continuous long term improvement which is beneficial for our organization (Swansea University, n.d.).
Limitations of risk management
Now that all the values of using risk management techniques are in front of you, I believe that there is a need to know the limitations of risk management techniques.
The first limitation is that it is not possible for risk management to manage and control all the risks that are involved in a project. These risks come from many different places and risk management cannot identify all the risks. Therefore we need to understand that our project will not be completely risk free after these techniques have been adopted. There will be risks present however the level of risks would be a lot lower than the risks that we were exposed to before risk management techniques were adopted (Barkley, B. 2004). Risk management therefore will not be able to eliminate risks completely because that is impossible.
The second limitation of risk management is of course the cost, effort, resources and energy that it requires. It will not come to live itself. We will have to allocate time, money and resources to implementation of risk management. These costs might seem irrelevant to people who are not aware of the benefits of risk management. Only after we once understand how risk management benefits projects like ours, these costs will start making sense to us. The costs that are associated with specialized risk management software are too high because these are custom made for each organization according to its needs. In addition to the introduction costs, the people who will be using these software will need some sort of training therefore there will be training costs involved as well. These costs might seem high at first but the risks that are avoided because of this investment will definitely cover the costs.
The next limitation of adopting risk management techniques is something that organizations face whenever something new is implemented. This includes the resistance to change (Barkley, B. 2004). Whenever anything new is introduced in the organization, the employees, management and every other element of the organization is not willing to change the way they used to operate. This can be because of many reasons. For example, in our scenario, the project manager and team would not be willing to adopt risk management techniques because this is something new that they would be undertaking. If the key people who will be involved in the project will not be motivated to accept this new concept, it will never be a success. Therefore before it is implemented, it is equally important to make sure that the key people involved in the project realize that this new concept will prove to be beneficial for them. They need to have confidence in project risk management and then only the concept will prove to be a success. Different strategies like holding workshops, seminars and including the employees in decision making can be employed by the organization’s management to help introduce change more smoothly.
Another very important limitation of risk management is that because of many reasons projects just seem to get more complex and complicated with time. It is becoming more difficult than ever to analyze the risks accurately. The models that are present to assign probabilities to risks cannot possibly consider each element of a risk therefore the probabilities become inaccurate as the complexities involved in projects increase. Also the risk sources are becoming too many. Because of this the risks that a project or an organization is faced with are becoming difficult to predict and identify. Because of these reasons, people have started doubting the reliability of risk management. However, if carried out correctly, risk management can prove to be beneficial for organizations even in this time where projects get more and more prone to risk and hence complicated to study.
Risk is a very natural phenomenon is any kind of business. Every organization faces risks from many sources. However, the construction industry faces more risks than most industries because of the nature of projects that are undertaken. The nature of these projects is very risky because they are large scale, highly budgeted and inflexible. The construction projects normally have a large number of stakeholders (Klemetti, A., 2006). All these stakeholders will get affected by the outcome of the project therefore there is a higher need to make sure that the outcome is successful. This is the reason why organizations like us need to realize that in order to be successful we must adopt risk management strategies. These strategies identify, analyze, avoid, transfer and allocate all the possible risks. This may prove to be very beneficial for a construction company like ours. We can become prepared for any kind of possible risk that we may face once the project has been implemented. Therefore, our immediate response to a negative factor would not be spontaneous and hence more accurate. Risk management strategies also help reduce the risk.
However, we must keep in mind that like everything else risk management techniques also have their own drawbacks. It is impossible to identify all the possible risks through project risk management. It is impossible to undertake projects that have no risks whatsoever. Risk management techniques help us reduce these risks to a minimum level. It decreases the chances of failure by a great extent. For example if before risk management the chances of failure were 66 percent, after risk management the chances of failure will become, say 33 percent. Even though after risk management techniques were employed, the chances of failure are still there, but these chances are 33 percent less than the chances before project risk management were undertaken.
This report discussed the benefits and limitations of risk management. Now these need to be applied in our situation so that we can see to what extent we need risk management in our operations. The construction industry is very important for any nation. There is a very high demand for our services therefore companies like us need to make use of this demand as an opportunity to grow. However, this can only happen if we manage to survive. Risk management ensures that companies like ours are less prone to risks and hence have a higher chance of survival. This is the reason why risk management techniques should be adopted in construction projects undertaken by our company.
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