Risk Allocation in Construction Industry

Risk Allocation in Construction Industry
By Tricia Corcuera

This week we are focusing on key considerations in managing risk in industrial construction projects. First and foremost, it is important to realize that risk is unavoidable in the construction industry – there are no perfect engineers, no foolproof project plans, and mother nature is definitely not perfectly predictable (this will not be a great revelation to anyone working in construction). Therefore, it becomes important to consider that there are a range of possible outcomes and each outcome has a possibility of occurrence. Negative outcomes can frequently be minimized or avoided if their root cause can be identified and managed before the event occurs.

Risks are present in construction projects in different ways:

• Pre-project risks – site access, inaccurate estimation bid, sourcing raw materials and heavy equipment, project delivery of choice, faulty architect design and poor contract management.

• Project execution risks – This is a wide area which consists of risks in contractor and subcontractor conduct and performance of work, experience and performance, site management and safety risks.

• Financial risks – Defaulting, inability to produce positive cash flow, unavailability of funds, exchange rates (internationally), price fluctuations and unpredictable interest rates.

• Regulatory risks – These may be governmental or non-government organizations (NGOs) organized at a local or national level.

• Environmental/natural risks – Disasters can hinder the project deadline and use up resources such as time and money causing cost overruns. It can occur unexpectedly and cause billions of dollars in damages.

We recommend managing risk in four stages – identification, assessment, mitigation and monitoring. These four strategies comprise the core of the process of risk management and can help minimize cost overruns, keep projects on-time, deliver exceptional project performance, prevent finger pointing, and protect the relationship between contractor and owner.

In the identification and assessment stage, it is important to study and predict market and economic trends, anticipate technological developments, and attempt to predict the actions of competitors. It is also important to gather estimates of cost – both capital and operating. The difference between the success or failure of a project depends on the effort expended in the identification stage.

In the mitigation and monitoring stages, it becomes important to consider how best to allocate the risk. The best way to allocate risk is to spread the risk to the party best equipped to manage and minimize it. There should be a realistic expectation as to how much should be allocated to the two parties. Excessive risk to one side can have dire consequences. According to Australian Constructors Association (ACA) – Relationship Contracting: Optimizing Project Outcomes, agreement will fail if excessive risk is transferred to the contractor or the contractor is seeking higher returns without accepting a greater proportion of risk (1999). ACA also adds, “even taking a 10 percent share of the project’s risk produces a complete change to the attitude of the client at all levels.”

The table below summarizes the type of risk, the party that it should be allocated to, and its reasoning.

Type of Risk	Allocation	Reason
Project Design	Owners	Owner should seek a qualified engineer or architect capable of designing the project. Factors such as experience, scope of past projects and testimonials may aid in selecting the best candidate.
Non-Governmental Organizations	Owners	NGOs are created at a local or national level. Although this may be unforeseeable, owners have a responsibility to be aware of any potential NGOs that may hinder a project and address their need.
Project funding	Owners	Positive cash flow and availability of funds are the responsibilities of the owner in ensuring the project continues.
Licenses	Shared	Both parties have a responsibility to apply for licensing.
Environmental risks (i.e. natural disasters – storms, floods, earthquakes, etc.)	Shared	These are conditions unforeseen by both parties; therefore, risk should be allocated equally.
Government regulations	Shared	These are also unforeseen issues that can hinder the suspension of work and delay project deadline.
Cost overruns	Shared	Depending on the type of cost overrun, this is a shared cost between the two parties. For example, accelerating the project lands on the owners risk because more contractors and specialty trade contractors need to be hired.
Safety and Hazard	Contractors	Construction managers are responsible for ensuring other contractors and subcontractors are adhering to the safety rules and protocols. Safety is also made to ensure the general public are aware of job site conditions and its potential dangers.
Labor scheduling	Contractors	The amount of contractors and subcontractors on site are the responsibilities of a construction manager or prime contractors.
Subcontractors	Contractors	Hiring and managing of subcontractors are the responsibilities of construction managers. Although some owners prefer to be involved, it is usually the contractors area of expertise.

In the course of our many years working in the industrial construction industry, we’ve dealt with our share of organizations that take a “wing out” or “fly by the seat of their pants” approach. This rarely ends well, and we strongly recommend avoiding the urge to take shortcuts in the risk management process. Ignoring a risk can have a snowball effect – it can turn a small, controllable risk into a larger, out-of-control, unsalvageable problem.

The benefits of spending the time to develop a risk management strategy are many:

• Project issues are clarified, understood, and considered from the start

• A clearer understanding of the specific risks from the start

• Decisions that can be supported by thorough analysis

• A build up of historical data to assist and improve future projects

• A clear understanding of roles and responsibilities between owners and contractors

Tricia Corcuera works at DRAXware Solutions. DRAxware Solutions provides construction management software solutions in field data capture, QC/weld Management, payroll integration and LEM and invoice creation.