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The Owner's Role in Project Risk Management (2005)

Chapter:3 Properties of Project Risks

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Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
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3
Properties of Project Risks

INTRODUCTION

Identification and analysis of project risks are required for effective risk management. One cannot manage risks if one does not characterize them to know what they are, how likely they are, and what their impact might be. This chapter focuses on the general attributes of project risks. But project risk management is not limited to the identification and aggregation of risks, and it cannot be repeated too often that the point of risk assessment is to be better able to mitigate and manage the project risks. Additional effort is needed to develop and apply risk management strategies: Project risk management tools and methods, discussed later, can facilitate this effort.

Inadequate or untimely characterization of risks has a number of consequences, all of them detrimental to the project:

  • Time and money may be spent needlessly to prepare for risks that are actually negligible.

  • The need for contingency allowances may be overstated, tying up the owner’s funds, preventing other vital projects from being funded (opportunity costs) (Mak and Picken, 2000), and resulting in increased project costs, as excess contingencies are typically expended rather than returned to the project sponsor.

  • Contingency allowances may be understated, leading to budget or schedule overruns and often performance and quality shortfalls as well, as quality and scope are reduced in an attempt to keep costs within the budget.

Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
  • Actual significant risks may be missed and result in unwelcome surprises for the project manager and owner—cost overruns, completion delays, loss of functions to be provided by the project, and even cancellation.

GENERAL PROJECT RISK CHARACTERIZATION

The types of project risks addressed in this report include these:

  • Performance, scope, quality, or technological risks. These include the risks that the project when complete fails to perform as intended or fails to meet the mission or business requirements that generated the justification for the project. Performance risks can also lead to schedule and cost risks if technological problems increase the duration and cost of the project.

  • Environment, safety, and health risks. These include the risks that the project may have a detrimental effect on the environment or that hidden hazards may be uncovered during project execution. Serious incidents can have a severe impact on schedule and costs.

  • Schedule risk. This is the risk that the project takes longer than scheduled. Schedule risk may also lead to cost risks, as longer projects always cost more, and to performance risk, if the project is completed too late to perform its intended mission fully. Even if cost increases are not severe, delays in project completion reduce the value of the project to the owner.

  • Cost risk. This is the risk that the project costs more than budgeted. Cost risk may lead to performance risk if cost overruns lead to reductions in scope or quality to try to stay within the baseline budget. Cost risk may also lead to schedule risk if the schedule is extended because not enough funds are available to accomplish the project on time.

  • Loss of support. Loss of public or stakeholder support for the project’s goals and objectives may ultimately lead to a reduction of scope and to funding cuts, and thus contribute to poor project performance.

Although the above types of risks may be encountered in an almost infinite variety of forms and intensity, it is most useful to consider two varieties:

  • Incremental risks. These include risks that are not significant in themselves but that can accumulate to constitute a major risk. For example, a cost overrun in one subcontract may not in itself constitute a risk to the project budget, but if a number of subcontracts overrun due to random causes or a common cause (i.e., a common

Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×

mode failure) affecting them all, then there may be a serious risk to the project budget. While individually such risks may not be serious, the problem lies in the combination of a number of them and in the lack of recognition that the cumulative effect is a significant project risk. An obvious example of an incremental risk in construction is weather-related delays, which are not usually major problems in themselves, but a long run of inclement weather that impedes progress on the project may create a serious challenge to the schedule and budget.

An example of a common mode failure in the nuclear area is the 1975 fire at the Brown’s Ferry nuclear plant. The fire started in the cable trays, caused by a workman using a candle to detect leaks. Three independent safety trains were designed to inject cooling water into the core of the reactor. However, the power cables for all three trains were routed through the same cable trays. Therefore, the risk of all three safety injection pumps failing to operate was just the risk that a fire occurred in the cable tray—the three safety trains were correlated, not independent. This incident led directly to the development of the methodology of probabilistic risk assessment and its required implementation at all nuclear power plants. The lesson learned from this is that independence of risk events is something that must be demonstrated, not merely assumed.

  • Catastrophic risks. These include risks that are individually major threats to the project performance, ES&H, cost, or schedule. Their likelihood can be very low but their impact can be very large. Examples of such risks are dependence on critical technologies that might or might not prove to work, scale-up of bench-level technologies to full-scale operations, discovery of waste products or contamination that are not expected or not adequately characterized, and dependence on single suppliers or sources of critical equipment.

CONSEQUENCES OF INCREASED PROJECT UNCERTAINTY

Studies of projects with low and high degrees of uncertainty (see, e.g., Shenhar, 2001) show that as uncertainty increases there is also an increased likelihood of the following:

  • Increased project budgets,

  • Increased project duration,

  • Increased planning effort,

  • Increased number of activities in the planning network,

  • Increased number of design cycles,

  • Increased number of design reviews,

Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
  • Delayed final design,

  • Increased need for exchange of information outside of formal meetings and documentation,

  • Increased management attention and effort (probabilistic risk assessment, risk mitigation),

  • Increased systems engineering effort, and

  • Increased quality management effort.

The use of techniques and skills that are appropriate to low-uncertainty projects may give poor results when applied to high-uncertainty projects, for which a flexible decision-making approach focused on risk management may be more successful. The owner can determine whether a project is very low risk or has significant risks by performing a risk assessment, which starts with risk characterization.

RISK MANAGEMENT STRATEGIES

The effectiveness of risk management strategies varies for different project risk profiles. Following are two examples of the applicability of different strategies:

  • For relatively certain projects, fast decision making can minimize uncertainties from delays caused by regulatory changes, political changes, or economic changes.

  • For projects with a high level of uncertainties, purposeful postponement of some decisions or commitments can reduce risks through acquisition of more or better information that will lead to better decisions. This includes keeping options open as long as possible but explicitly does not include managerial procrastination in the hope that some miracle will happen.

Thus risk management strategies are not one-size-fits-all but need to be matched to the risk profiles and objectives of the project and of the owner’s total project portfolio. Project directors need to be knowledgeable about project risk management tools in order to develop comprehensive risk management plans prior to project approval for design or construction funding.

The major steps in determining the appropriate risk management strategies include the following:

  • Development of risk awareness,

  • Project risk identification,

  • Qualitative risk assessment,

Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
  • Quantitative risk assessment,

  • Risk prioritization,

  • Risk mitigation, and

  • Active, ongoing risk management.

Project risk management starts with the development of risk awareness on the part of all project personnel, suppliers, and contractors. The development of risk consciousness is similar to the development of safety consciousness on construction sites, which requires unremitting attention by the owner’s management and demonstration of the management’s commitment to this issue at every opportunity. One might argue that, considering the constant barrage of safety messages, nothing more remains to be said; the object, however, is not to say something new but to keep repeating the same message over and over until it becomes part of the culture. People on construction sites may initially assume that safety is the responsibility of the safety engineer, but the consistent message has to be that it is everyone’s responsibility. Safety consciousness is achieved when all personnel understand that they cannot ignore any unsafe condition. Similarly, risk consciousness is achieved when everyone on the project knows that he or she cannot ignore any potentially risky condition in the belief that risk management is someone else’s responsibility.

That said, certain aspects of project risk management are the responsibility of particular personnel. Qualified personnel with in-depth understanding of the project should perform risk identification and analyses. Technological risk assessments may be performed by outside consultants with specialized knowledge. Regardless of who prepares the risk assessments, they should be separately evaluated by independent qualified personnel and reviewed by management for a “reality check” of the reasonableness of the assumptions, results, quality, and completeness of the process. If deficiencies are identified, corrective action plans should be prepared and implemented.

Owners and contractors need to jointly develop and implement a coordinated risk mitigation planning process. This point implies that owners and contractors have a common purpose—not an adversarial situation in which each entity tries to shift its risks to another. Adversarial relationships on a project are an indication that risk management is non-existent or has failed.

Project risks and risk management responses need to be reassessed and revised throughout the project’s life cycle. Risk assessments and risk management plans should be part of the documentation for every critical decision point—especially the early ones required by the DOE policies defined in O 413.3. Risk mitigation plans should be documented, inde-

Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×

pendently reviewed, critiqued, and reworked as needed so that management may permit the project to proceed to the next phase with confidence that the project risks are acceptable and are being adequately managed.

Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
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Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
Page17
Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
Page18
Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
Page19
Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
Page20
Suggested Citation:"3 Properties of Project Risks." National Research Council. 2005. The Owner's Role in Project Risk Management. Washington, DC: The National Academies Press. doi: 10.17226/11183.
×
Page21
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Effective risk management is essential for the success of large projects built and operated by the Department of Energy (DOE), particularly for the one-of-a-kind projects that characterize much of its mission. To enhance DOE’s risk management efforts, the department asked the NRC to prepare a summary of the most effective practices used by leading owner organizations. The study’s primary objective was to provide DOE project managers with a basic understanding of both the project owner’s risk management role and effective oversight of those risk management activities delegated to contractors.

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