Risk Profile in General Contracting

Latest revision as of 16:25, 18 December 2018

Developed by Camilla Flataukan

This article is going to give an overview of Risk Profiling in General Contracting. General contracting is the most common project coalition in the construction site, and preferred by the EU procurement directives. .^[1] The general contractor has a contract with a client for the entire execution of the project, and is responsible for the day-to-day overview on the construction site.

Risk profiling in Construction industry are complicated because these kinds of projects carries complex risks for all involved in the project, not only the stakeholders, but for the process alone. When the construction takes place the risk increases extremely, especially in congested or populated areas.

[edit] Introduction to Risk Profile

To explain risk profiling it is important to define the word risk, this is a well-used term with many definitions. How risk is defined is different from person to person, it depends on experience, attitude and viewpoint. ^[2] Some will argue that risk is something with a consequent negative outcome. ^[3] Other will say that it is both negative and positive, like a threat and an opportunity.^[4] International Organization for Standardization defines a risk as “the effect of uncertainty on objectives” (p. 1) in ISO 31000:2009. The last definition has been adopted in the British Standards Institution (BSI) ^[5] the theory of looking at a risk as a uncertainty of outcome, either positive opportunity or negative threat ^[6] will also be adopted in this article.

Fraser described a Risk Profile as “A periodic documentation of key risks to an organization to achieving its stated objectives over a specific future time” (Fraser 2010: p. 171)^[7] or as ISO defines it “a description of a set of risks” (p. 1) in ISO 31000:2009

Risk Profiling is a document that should contain the overall prioritized assessment of specific risks an organization faces.^[6] This can be used as a method to find the optimal level of risks an individual or corporation are willing to accept. A corporation’s risk profile usually shows how eager a company is to take a risk and how that will affect the firm’s strategy, or it can be an evaluation of a risk the corporation exposes too. ^[8]

[edit] Structure

Simple risk/tolerability matrix [HM Treasury. 2004. The orange book: Management of risk principles and concepts]

There are no standardized way to document a risk profile, but it is vital to have one to keep the risk management efficient ^[6]

The first step in making a risk profile is to document the risks the organization or project is facing. It is important to look at how the risk will affect the company or project, and identify the risks characteristics. ^[9]

Often the Risk Identification separates in two different categories.^[6]

• Initial risk identification: When a organization or a project needs to identify and categorize risks for the first time.

• Continuous risk identification: This is for organizations that have identified their risks and need an update on existing risks or find new risks that has occurred.

In both of the two categorize it should be put down a lot of effort in finding generic risks, especially those who do not appear logical to the business aspect at first, but could have a huge impact.

When the organization has identified the risks, the next step will be to assess the risks. The proses should contain an objective independent view of the evidence, and look at the different spectra from the effected stakeholder’s point of view. A risk assessment should contain, the likelihood of the risk being realized, and if the risk being realized the impact. The possibility for something to happen is categorized, occasionally in three different stages, high/ medium/low. This is the lowest categorizations of impacts and creates a 3x3 matrix. For projects needing higher accuracy a 5x5 matrix is often used. It can be beneficial to use “traffic-colures” to highlight the significant risks. ^[6]

When documenting a risk assessment, it is important to document the process. Especially define the difference between ‘’residual risk’’ and ‘’inherent risks’’. Residual risk is when it has been an internal control, and actions have been taken to take control over the risk, successfully. Inherent risk is before any action has been put in to mange the risk. ^[6]

When this is successfully documented, the company will have a risk profile which states:

• What is and what is not expectable exposure.

• An easier way to get an overview on how to address risks

• Simplifies assessment and monitoring of risks

When the risks has been assessed, it will be easier for the organization to see a prioritizing among the risks. High priority risks, also called “Key Risks” are easier to see, and should be given regularly attention.^[6]

[edit] Benefits

The benefits of Risk Profiling is many. By identifying and assess the risks the risk management gets more efficient.

• By having “Key Risks” the company can easy catch up the warning signals, and from that change the companies risk profile.^[7]

• If the management team has a clear understanding of the companies risk profile, they are better suited to take better and more informed decisions.^[5]

• When cooperating with other firms or project, the opportunity to compare the risk profiles will make it easier to choose a company or project that has the same risk tolerance, capacity and requirements as the existing firm.^[5]

[edit] Limitations

Since there is no accurate way of making a risk profile, it depends on the quality from company to company.

• Every organization and project is different from each other. Therefor it can never be a standard way to perform a risk profile. ^[5]

• A risk can be many things. Often it can be hard to identify the risks and never the less understand the impact of the risk.^[7]

• A risk profile should be re-assessed often, to keep track of the adjustments and new threats and opportunities coming.^[6]

[edit] General Contracting

General Contracting is one of most used type of project coalition in the construction industry today. The trend started early in the nineteenth century mostly in the UK, where it quickly got its footing. For the USA and most of Europe, it was not that widely established before 1945. It is now favoured by the EU procurement directives. ^[1]

[edit] Definition

General contracting goes under the traditional separated form of project coalition. Unlike Risk Profile in Turnkey Projects the general contracting have divided the design and construction aspects in two separate organizations with different responsibilities. This does not mean that the different parties do not work together; there is many different variations of the basic system, for example can the main contractor be prearranged for an earlier stage so they can provide suggestions on buildability and construction methods.^[10]

[edit] Structure

Separated coalition: general contracting [G.M.Winch (2010), Managing Construction Projects, Chapter 5.4.1 ,Second edition, Wiley-Blackwell]

The main contractor is responsible for the whole execution on the construction site, and to hire the needed sub-contractors for the different jobs. As shown in "Separated coalition: general contracting" information regarding addendums or modifications should go from the client to the main contractor, and it is his job to communicate with the workforce and the sub-contractors.

The general contractor is often hired on a fixed-price contract. A fixed-price contract is when the client and general contractor agrees on a price for an agreed amount of work. These kinds of contracts usually requires that a large amount of information is accessible. Since a lot of the information should be ready, these kinds of contracts is relatively completed when the two parties have an agreement. Usually they put in a provision for small adjustments in the price incase of inflation or variations in the quality of work. This is the most used contract on the construction site, and is known for competitive tendering between different general contractors. ^[11]

However, a construction contract contains of many document such as drawings, addendum or modifications, project manual, general conditions and an agreement. ^[12] And it often addresses such problems as:

• The responsibility of the contractor and the client

• What happens if the project is delayed?

• Procedures for project close-ups

And other risks and challenges that might come up in a cooperation.

[edit] Advantages

• One contract gives less administration costs and economical responsibility for the client. In addition, the client will have full control over the design and projecting.

• The clear relationship between the main contractor and the client gives less risks for the client, than in trades contracting. This is if the work responsibility is clear defined between the two parties.

• The general contractor can choose his own sub-contractors, and take advantage of his well-established relationships, and their familiarity with the general market situation. ^[13]

[edit] Disadvantages

• High administration mark, and vulnerable against uncertainties and changes. Provides that the early design is well developed and planed, so uncertainties and errors are eliminated. In addition that proper competition and minimizing of tendering is been taken care of. ^[10]

• The clients loses control over the execution phase, and lack of influence on the choice of sub-contractors. ^[13]

• The complexity of this kinds of contracts can result in drawn-out design and construction periods and lack of communication between the client and the general contractor. ^[10]

[edit] Risk profile in General contracting

The construction industry is a highly complex industry, especially if it is compared it to the automobile industry. The high use of machines and mechanical solutions in the automobile industry makes the human caused risks less likely. The construction industry on the other hand, relays a lot on the human beings and its behavior.^[14] Another difference from the automobile industry is that no project is the same. In the automobile business, these large conveyors produce the same product all day long, day in and day out. This makes the costs and challenges for the firm almost the same year after year. While in the construction industry, the projects changes for every time, no project is the same. This implies that the cost and the challenges in each construction site will be different from the last one.^[14]

A construction project have many different stakeholders, from the owner to the sub-contractors. Each of these parties have their own interests and their own risks included in the project. Some types of risk the stakeholders stand for can be:^[15]

• Productivity of labour

• The architect and the consultants hands out the drawings late.

However, it is not only the human perspective that causes risks, the construction industry is very vulnerable to financial changes both in a world perspective and a national one. For example:^[15]

• Change in interest rates

• Inflation

The construction site itself can be the most challenging when identifying risks. For example; the groundwork itself is a huge risk, both environmental and geotechnical. If it is emissions in the ground the project can be delayed for months. The site can also be exposed to:^[15]

• Vandalism

• Accidents (Collisions, fire, earthquake and so on)

Even after the project is delivered, the danger of risks is still there. Hidden defects can revile itself after a couple of years and cost the contractor a lot of money. ^[16]

[edit] The contract

The general contractor takes many risk areas from the owner, since the responsibility for the entire execution of the project lays on the contractor. It is therefore important to have a clear risk profile where the risks are clearly identified and assessed. The management team should have a good understanding of the companies risk profile. This is so they can join the strategic work and take risk-informed decisions.^[7] This is an industry with a lot of competition in the tendering phase. It is therefore crucial that the general contractor knows what he is doing. To avoid too many risk threats it is important for the contractor to analyze his risk profile and his capacity to handle risks.^[12]

• Do the firm have the right experience for this kind of work?

• Is there enough experience with this kind of complexity?

• Will the potential profit equalize the project risks?^[16]

• Does the company have a good understanding of what external events that has happen earlier.^[7]
• Have the company worked with the client before?

• Does the client have a staff that is good at problem resolving?

• Are the Design team known for its work?

• Have they design anything similar before?

• Is everything with the payment in place?

• Do the company know the sub-contractors?

• Have the company med the sub-contractors needs?

• Has there been an adequate pre-bid and subsurface investigation?

• Are any environmental permits necessary?^[16]

These are just some of the questions the general contractor must look at before signing a contract. It is therefore very important that the management team is very clear on the companies risk profile and their risk tolerance.^[12] A way to do this is by interviewing the stakeholder to make sure the risk profile to the different parties are is in the company’s interest.^[7])

[edit] Limitations

Since the construction site is such a complex project the Effective Communication in Project Management is really important. Everyone in the process should be aware of the risk profile and its impacts on the company’s strategy, and notify the management team if the accrues new risks or the old once need to be assessed. This is the key to have an up running risk profile.^[7]) Since this is an operation run by people, this will always be a critical point in the risk profile.

[edit] Conclusion

For a professional general contractor who know his area, the financial perspective is not the biggest risk. The Owners usually waits with the tenders, until the planning is almost completed and a guarantee is given.^[16] The contractor often gets a contingency for the normal mistakes in a construction.^[16] If a lower bid comes in later, the general constructor need to look at the scoop of the work, and maybe narrow it down. Which can give a higher risk.

But the significant risk is that the contractor now is the vendor of a product.^[16] It bears the risks of several sub-contractors and operative workers. The work related injuries can for example expand over the insurance cover. Different types of defects can be discovered after a couple of years. Lack of communication and so on. The general contractor carries a lot of hidden risks the Owner now is free of.

Another aspect of risk the General contractor experiences is delays. These are often caused by off-site, for example that the drawings are late or decision-making. ^[17]Here is it important to point out the delays.

The general contractor will face a lot of risks, it is therefore important that he and his team are aware of these risk and the companies risk profile. Before starting a new project they should go through their preferences and find out if they are reconciling whit the project and the stakeholders.

[edit] Se also

• Risk Management in Oil and Gas Industry
• Management of risk
• Risk Profile in Turnkey Projects
• Risk Identification

[edit] Annotated Bibliography

G.M.Winch (2010), Managing Construction Projects,Second edition, Wiley-Blackwell This book is used as class material at DTU. It a good book, that explains all the aspects of managing a construction project. It is easy to understand, and a polite source to the ocean of management definitions.

Fraser J (2010) ENTERPRISE RISK MANAGEMENT. John Wiley & Sons, Hoboken The author of this book, John Fraser is the Vice President, Internal Audit & Chief Risk Officer of Hydro One Networks Inc in Canada. He had over 30 years of experience with risk management and a past member of the Risk Management and Governance Board of the Canadian Institute of Chartered Accountants. In this book he takes the reader tidy through the definitions and key terms in risk management, and has a especially good section about risk profiling.

The Orange Book; Management of Risk - Principles and Concepts https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/220647/orange_book.pdf This is a good book or website to visit to get an overview of the risk definitions and concepts. It is a lot of good examples and some very good figures with it. This is the perfect book to start with, if you want to understand the many terms in the risk universe.

[edit] References

1. ↑ ^{1.0 1.1} G.M.Winch (2010), Managing Construction Projects, Chapter 5.4.1 ,Second edition, Wiley-Blackwell.
2. ↑ Walewski J, Gibson GE, Dudley G (2003) Development of the international project risk assessment (IPRA) tool. Construction Industry Institute, Austin.
3. ↑ Baloi D, Price ADF (2003) Modelling global risk factors affecting construction cost performance. Int J Proj Manage 21(4):261–269
4. ↑ Segal S (2011) Corporate value of enterprise risk management. Wiley, Hoboken
5. ↑ ^{5.0 5.1 5.2 5.3} Zhao X (2015) Enterprise Risk Management in International Construction Operations. Springer, Singapore
6. ↑ ^{6.0 6.1 6.2 6.3 6.4 6.5 6.6 6.7} HM Treasury. 2004. The orange book: Management of risk principles and concepts.
7. ↑ ^{7.0 7.1 7.2 7.3 7.4 7.5 7.6} Fraser J (2010) ENTERPRISE RISK MANAGEMENT. John Wiley & Sons, Hoboken
8. ↑ Risk Profile, Available from: www.investopedia.com, (20.09.2015)
9. ↑ Library of Congress Cataloging-in-Publication Data (2013) A Guide to the Project Management Body of Knowledge (PMBOK® Guide) – Fifth Edition. Project Management Institute, Pennsylvania
10. ↑ ^{10.0 10.1 10.2} J.W.E (2003)Masterman An Introduction to Building Procurement Systems, Categorization og procurement systems, EFN Spon
11. ↑ G.M.Winch (2010), Managing Construction Projects, Chapter 5.3.4 ,Second edition, Wiley-Blackwell
12. ↑ ^{12.0 12.1 12.2} Surety Learn (2014) A Quick Introduction to Construction Risks and Contracting Practices, http://suretylearn.org/ (25.09.2015)
13. ↑ ^{13.0 13.1} Bjørk Sørby L (2012) Hvordan priser entreprenører risiko, og hvilke vurderinger ligger til grunn? Available from: http://brage.bibsys.no/xmlui/bitstream/handle/11250/188907/Final_master.pdf?sequence=1 (20.09.2015)
14. ↑ ^{14.0 14.1} Vestergaard F (03.2012) BIM at major engineering consultant, DTU Byg Danmarks Tekniske Universitet, Bygningsstyrelsen
15. ↑ ^{15.0 15.1 15.2} Designing Buildings (30 Sep 2013),Available from: http://www.designingbuildings.co.uk/wiki/Risk_in_building_design_and_construction
16. ↑ ^{16.0 16.1 16.2 16.3 16.4 16.5} STRANG W (2002)THE RISK IN CM “AT-RISK” Available from: https://cmaanet.org/files/risk_in_cm_at_risk.pdf (28.09.2015)
17. ↑ R.F.Cushman, J.D.Carter & A. Silverman, Construction Litigation:Representing the Contractor, New York: Wiley, p 382)