Study of Risk Management Techniques for Construction Projects – PSRB-D

Study of Risk Management Techniques for Construction Projects

A Study of Risk Management Techniques for Construction Projects in Developing Countries.

The purpose of this assignment is to discuss the role and function of risk management as it relates to construction projects in developing countries. The paper first presents a brief discussion of project performance measurement, followed by an examination of various techniques used as part of the risk management process for construction projects.

After discussing the different significant risks associated with such projects, an overview of various risk management techniques such as insurance, hedging and transfer tools is provided. Following this, a comprehensive assessment of the role and function of risk analysis in relation to key risks associated with construction projects will be presented.

Risk Definition: Risk is defined as “the chance that an event might occur”. All forms of project activity are subject to risk. Risks can be classified as external/environmental risks, internal/organizational risks, and technological or operational risks. However, a distinction between these classifications is unclear in practice.

A study by the American Institute of Certified Public Accountants found that environmental and technological factors have been referred to as “risk” in about 40% of the cases. In addition to this, internal organizational factors account for 20% of the remaining cases. Thus, environmental and technological risks have been referred to as risk in about 60% of the cases.

Organizational Risks: Organizational risks are those associated with management functions of a project or entity such as organization structure, strategy, relationships with external environment, administration and management controls.

Key risks that are often associated with projects include political factors, financial risk, demand fluctuations, performance deviations, technological uncertainty etc. Many of these are also related to the macro-economic climate in which projects are being implemented .

The risk analysis process involves identifying key areas or dimensions of project activity that may be subject to risks/uncertainties. For instance, in the construction industry, the following key areas may be subject to risk:

Construction projects in developing countries are affected by a wide range of external factors such as random demand fluctuations and exchange rate volatility which have an adverse effect on project performance.

The World Bank’s report titled “Doing Business in 2005” shows that the majority of low income countries have not been able to access credit markets as a result of their high default rates. In addition, default rates from micro-credit tend to be higher in low income countries compared with lower middle and upper middle income economies. This can be attributed to a number of factors including:

Micro-credit is characterized by high default rates and borrowers in the informal sector who have limited and unpredictable incomes and little collateral. It may also be difficult to establish a legal framework for lending and recovery of loans, especially when it involves informal sectors who do not embrace strict enforcement procedures.

Evolution of Risk Management: The risk management process evolved from property insurance and the concept of “insurable interest”. Property insurance emerged as a result of increased trade and commerce in early 19th century Europe.

The risks recognized as insurable were those related to physical property such as ships, cargo and buildings . However, with time, risks recognized as insurable evolved from physical risks to broader social and economic risks.

 Corporations and other institutions began to insure their operations against financial losses resulting from internal factors such as employee dishonesty, internal fraud etc. In addition to this, risks related to the organization’s clientele also emerged as insurable interests.

In the 1920s, Lloyd’s of London introduced contingency fees for business interruption due to political risk. The concept of insurable interest was then extended to non-physical risks such as product liability and other business risks.

Risk management techniques for construction projects: A number of risk management techniques have been developed and used by organizations such as insurance companies, multinational corporations (MNCs), banks etc. These include the following categories:

  • Operational Risk Management
  • Risk Transfer and Risk Enhancement.

Operational Risk Management: This category includes activities such as scenario planning, disaster recovery planning etc. Scenario-planning aims at identifying potential internal and external factors that may adversely affect a company’s business plans.

Disaster recovery plans are developed to ensure the continuity of an organization in case one or more facilities are severely damaged. The company may consider updating its plans on a regular basis to incorporate changes in internal and external factors that may affect the business .

In addition, Operational Risk Management includes establishing internal control mechanisms such as independent risk assessment, use of questionnaires to conduct exit interviews with employees re-joining a company etc.

Monitoring and controlling changes in value-at-risk is also important for organizations that are exposed to market risk . This allows the organizations to monitor current exposures and take appropriate measures if the risks are not within specified risk limits.

Risk Transfer and Risk Enhancement Techniques: Methods of transferring or enhancing certain risks are an integral part of any program of operational risk management.

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