Course Note

Value and Risk Management [D31VR]

School of the Built Environment  Heriot-Watt University 2004

Address for correspondence: School of the Built Environment Heriot-Watt University Riccarton Edinburgh EH14 4AS UK Tel: Fax:

+44 (0) 131 449 5111 +44 (0) 131 451 3161

Authors: G Bowles and J R Kelly Address of course leader: Dr Graeme Bowles School of the Built Environment Heriot-Watt University Riccarton Edinburgh EH14 4AS UK Tel: +44 (0) 131 451 4626 Fax: +44 (0) 131 451 3161 e-mail: [email protected]

Contents

1: Clients 1.1 1.2 1.3 1.4

Introduction Glossary The construction client Questions

2: An Introduction to Value Management 2.1 Introduction 2.2 Terminology 2.3 Construction orientated value management theory 2.4 The job plan 2.5 Building function 2.6 Conclusion 3: An Introduction to Risk Management 3.1 Introduction 3.2 Learning outcomes 3.3 Risk Management in Perspective 3.4 What is Risk? 3.5 Risk – Something to be Avoided? 3.6 The View of the Professional Bodies 3.7 Risk –Upside or Downside 3.8 Risk, Uncertainty and Events 3.9 Risk – An Event or a Condition? 3.10 Scope of Uncertainty Relating to the Construction Project 3.11 Risk and Risk Attitude 3.12 Background to Risk Management (RM) 3.13 Defining Risk Management

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4: RM and the Project Life Cycle 4.1 Introduction 4.2 Learning outcomes 4.3 The project life cycle 4.4 VM, RM and the project life cycle 4.5 Relationship between VM and RM in the project life cycle 4.6 Strategic Risk 4.7 Tactical risk 4.8 Risk- time, cost and quality 5: Risk and the Nature of the Construction Project 5.1 Introduction 5.2 Learning outcomes 5.3 Why is construction so risky? 5.4 Project Heterogeneity v Homogeneity 5.4.1 Project similarities 5.4.2 Project differences 5.5 Risk and the Project Environment 5.5.1 External Environment 5.5.2 Internal Environment 5.6 Controllable or Uncontrollable? 5.7 A Checklist of Risks 5.8 Risk and the ‘source-event-effect’ chain 6 : Risk and the Client 6.1 Introduction 6.2 Learning outcomes 6.3 Risk and the client 6.3.1 Risk and the client’s investment in a capital building project 6.4 A Client Approach to Evaluating Project Risk – the 3 aspects of risk 6.4.1 Aspect 1: Establishing T, C and Q objectives 6.4.2 Aspect 2: Consequence of failure to meet T, C and Q objectives 6.4.3 Aspect 3: Risk Profile of a project 6 4.4 Summary of risk aspects 7: The Risk Management Process 7.1 Introduction 7.2 Learning outcomes 7.3 RM terminology 7.4 The Risk Management Framework 7.4.1 Risk management planning ii

7.5

7.4.2 Risk identification 7.4.3 Risk Analysis 7.4.4 Risk Response 7.4.5 Risk monitoring and control The combined value and risk management workshop

8: Tools and Techniques of Risk Management 8.1 Introduction. 8.2 Learning outcomes 8.3 Techniques for the Risk identification stage 8.4 Techniques for the Risk analysis stage 8.4.1 The risk grid (probability-impact matrix) 8.5 Quantitative or qualitative risk analysis? 9: North American Value Engineering in Construction: A Critical Review 9.1 Introduction 9.2 The Charette 9.3 The 40-hour value management study 9.4 Advantages and disadvantages of the value management study 9.5 The value management audit 9.6 The contractor’s change proposal 9.7 Variations on the formal approaches to value management 9.8 A North American approach in the UK? 9.9 Conclusion 10: Function Analysis and Function Diagramming 10.1 Introduction 10.2 Examples of element function analysis diagramming 10.3 Element function analysis 10.4 Elemental cost planning 10.5 Implementing element function analysis 10.6 Conclusions 11: Common Briefing Structures and Problems in Briefing 11.1 Introduction 11.2 Glossary 11.3 Clients approach to briefing 11.4 Problems encountered in briefing 11.5 Brief documents 11.6 Questions 11.7 References iii

and

12: Strategic Development of Public Private Partnership Projects 12.1 Introduction 12.2 Glossary 12.3 Key principles of PPP 12.4 Output service specification 12.5 Strategic project procurement and risk pricing 12.6 Key risks in the project life cycle 12.7 Reading 12.8 Questions Appendix 1 Glossary of Risk Management Terms Appendix 2 Office of Government Commerce (OGC) Procurement Guide 04 (2003) “Risk and Value Management” www.ogc.gov.uk Appendix 3 Office of Government Commerce (OGC) Procurement Guide 03 (2003) “Project Procurement Lifecycle: The integrated process” www.ogc.gov.uk Appendix 4: Excerpt from HM Treasury: “The Step by Step Guide to the PFI Procurement Process” (Revised November 1999)

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Overview of the Course

Value Management (VM) and Risk Management (RM) have been combined in this course to demonstrate the power of using an informed team under the direction of a skilled facilitator to recognise and either solve (value management), or account for (risk management), problems occurring on construction projects in their various stages. VM and RM are complimentary “disciplines” which have been described as being 2 sides of the same coin. They are complimentary in their objectives, in that improving value in a project can only be achieved if the risk associated with it is balanced and manageable. They are also complimentary in methodology, or process, terms. The implementation of value management and risk management, in a practical sense, is very similar for each. Both systems require: • The clear identification of a reference point and the client focused definition of the relationship between time, cost and quality. • The discovery of relevant information either through research or the structured questioning of those who have the information. • A team approach to the processing and qualitative and quantitative assessment of strategic and tactical issues. • An outcome in terms of an implementation strategy (value management) or a dynamic risk register (risk management).

Construction value management Construction value management has seen rapid growth in recent years following studies of North American value management procedures. The UK method is maturing with its own characteristics and application points within the life of a construction project. The public sector has embraced its practice and central government has published risk and value management guidance as part of its ‘Achieving excellence in construction’ series (see appendix 1 and 2 of this pack). Significant agreement has been reached with a number of European countries on the proper application of value management in manufacturing, process engineering and construction. In 1998 final agreement was achieved on a European qualification system leading to the qualification Professional in Value Management (PVM). The

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course recognises the strengths of the various value systems world-wide but particularly examines the methodologies of North America and the UK.

Construction risk management Construction risk management is a subject that has been attracting growing attention in the industry over the last decade. The increasing complexity and cost of projects, ever more demanding and sophisticated clients and increasing competitiveness have all contributed to the recognition of risk, the need to do something about it and awareness of the financial cost if ignored. Whilst it is true to say that risk in construction, as in any venture, has always existed and that good project management practice must deal with it, the emphasis on formalised and systematic risk management is more recent. The course gives detailed consideration to the nature of the construction industry and features of construction projects from a risk perspective. Some recent RM research is used to give context to the discussion and help develop the readers understanding of the issues.

Structure of the course This course is concerned with both the strategic and tactical development of projects. Strategic project development Strategic issues are concerned with the “front end” of the construction process and to this end the course examines how a project fits in with a client organisation’s overall objectives, questions its scope and audits the developing brief. At the outset the project can be conceived of as primarily a business problem in most cases. The “front end” is typified by the early steps of any procurement model, usually concept and briefing stages. It is contended that too little attention is often paid to these stages with a consequent rush to technical solution to fulfil a perceived need. Furthermore, the best chance to achieve project VFM will be realised through a deeper understanding of how a project fits into the organisations corporate objectives. Value management applied at this stage aims to define the client value system and express the project in functional terms using a variety of tools and techniques. Strategic level VM does not presuppose a built solution as the best way of meeting clients’ objectives. Tactical project development Tactical project development is concerned with built solution form, structure and asset procurement issues. As such it deals with the “harder” end of the construction process, at which stages the business problem or opportunity has evolved into a construction project, and does not question vi

the motivation to build or surrounding strategic issues. In this context VM studies use Function Analysis (FA) and other problem solving tools and a multidisciplinary design team to suggest alternative elements, materials and components, as well as making small revisions to the project concept to improve VFM. RM is a means of improving project performance by reducing exposure to the many possible risks, threats and hazards that threaten good project performance. Good project performance is achieved if the building or other facility is delivered on time, within budget and to the stipulated quality standards necessary for a happy client and construction team.

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Aims and Objectives

The aim of the value management aspect of this course is to introduce the concept of value management and critically appraise its application to the strategic and tactical decisions taken in construction value management in USA and UK. With regard to the former the course will promote a better understanding of project definition and how it supports the objectives of the client organisation. On the latter, it will promote a good understanding of construction value management as applied to the design of elements and components. The aim of the risk management aspect of the course is to introduce the student to risk and uncertainty in the context of the construction project and develop an understanding of some common approaches to managing and mitigating the risks that its participants are exposed to.

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1: Clients

1.1

Introduction

This unit contains information about the construction client, their characteristic structures and their approach to construction projects. The questions at the end of this unit are intended to promote further reading and analysis.

1.2

Glossary

Business case team

A team of people with an understanding of the objectives of the client organisation, who may be from within the organisation or outside or a mixture of the two. In small projects one person can fulfil the role. This team becomes the decision-making unit. (see investment decision maker below).

Client

The customer for construction.

Client adviser

The independent adviser, with a knowledge of construction, and able to understand the client's business needs and objectives, including any special needs of the users. Engaged very early in the project to give impartial guidance on the best way to proceed.

Client project manager

The individual or organisation supplying the Technical expertise to assess, procure, monitor and control the resources needed to complete the project. The client project manager should act in the client’s interests and report directly to the project sponsor.

Client representatives

Individuals, often heads of department, who make up a project committee. The project sponsor or client project manager may chair this committee.

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Investment decision maker

A term used in Office of Government Commerce documents to describe the business case team. The investment decision-maker may be one person or a committee.

Project owner

A term used in Office of Government Commerce documents to describe the named individual who is accountable to the investment decision maker for the project and the budget.

Project sponsor

A senior executive from the client organisation who is responsible for developing and delivering the project to meet the client’s needs. The project sponsor manages the client’s input into the project, co-ordinate the client’s functional and administrative needs, works with stakeholders and users, resolves conflict on the client side and acts as the formal point of contact for the project team.

Stakeholders

The key interested parties, such as investors and end users, whose views must be taken into account during the development of a project.

1.3

The construction client

The complexity of client organisations forbids modelling of client types on anything other than a simplistic overview. However, the following do address the most common characteristics. 1.3.1 Small/private/owner occupier The simplest case in these terms is the small private organisation that wishes to build for owner occupation (e.g. a small office, factory or an extension to an existing facility). Here, the client body is composed of the management and workforce who will, to some degree, be affected by the new facility. These two comprise the stakeholders. Even in such a simple case, there will almost inevitably be some disagreement on priorities between the interest groups that is between management and workforce and indeed among the management and the workforce. Resolution of these conflicts and final decisions are, however, likely to be the responsibility of the business case team who may be one very senior person who is directly involved in the briefing process. Hence although the client body may be defined to include Unit 1 - 2

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several interest groups, the decision making unit is relatively easy to identify and probably autocratic in style. 1.3.2 Large/private/owner occupier In larger, private organisations building for owner occupation, the problems of identifying and dealing with the client body is that much greater, and in addition to this so is the problem of identifying the stakeholders and the decision making unit. It is extremely rare to find one individual who will have total authority over all decisions during the briefing stage. Instead, decisions are usually taken jointly by a number of individuals representing the interest groups and then this information is channelled into the briefing process by a smaller number of persons designated as client representatives. It is quite common for some of those interest groups which can be defined to be part of the client body to have no representation in the decision making unit, and it is also quite common for the power within the decision making unit to be unequally shared. The function of the project sponsor is to overcome these deficiencies by representing the views of those not represented. The client project manager is often a feature of large commercial organisations that regularly procure from the construction industry. In this situation it is less common to have a project sponsor.
In text question Who should be involved in the business case team from private owner occupier clients?

1.3.3 Large/small private developer The unique position of the property developer, large or small, has been much commented upon. The stakeholders here comprise the developer, the funding organisation, and the ultimate occupiers of the building. The occupiers seldom have representation in the decision making unit, and yet it may be argued that they are the ones who are most affected by the design of the facility. 1.3.4 Large/small public owner occupier The public sector presents yet greater difficulties in some respects. Here, the stakeholders can be defined to include the public sector authority, the people who will operate the facility and the public whom the facility is designed to serve. This is an enormously wide definition of the client body with attendant difficulties in representing all of the interest groups fairly in the Heriot-Watt University

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decision-making unit. To overcome these difficulties HM Treasury has produced guidance documentation formalising the project team organisation. This diagram is reproduced below.

Investment Decision Maker

Project Board

Project Owner

(may not be require: advisory only)

Project Sponsor

(including functional & operational stakeholders)

Client Advisor (may be required by non technical sponsor: generally external consultant)

User Panel

Project Manager (generally external consultant)

Investment Decision Maker

Figure 1:

Contractor

Suppliers

Project team organisation (HM Treasury Procurement Guidance No.1 )


In text question What are the difficulties associated with clients that are made up of a large number of stakeholders?

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1.4

Questions

Question 1

Describe a system for categorising construction industry clients.

Question 2

Consider a construction industry client known to you in the private sector and produce a diagram of the project team organisation.

Question 3

Consider a construction industry client known to you in the public sector and complete the diagram shown in figure 1 by inputting the names and responsibilities of the appropriate personnel.

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Unit 1 - 5

2: An Introduction to Value Management

2.1

Introduction

The aim of this unit is to review the background to value management and outline its application to the construction industry. Simplistically, value management is the name given to an enterprise concerned with providing the product or service demanded by a customer at the required quality and at the optimum cost. The philosophy is based on work undertaken in the manufacturing industry of the USA in the 1940s and defined initially as value analysis: Value analysis is an organised approach to providing the necessary functions at the lowest cost. From the beginning, value analysis was seen to be a cost validation exercise which did not affect the quality of the product. The straight omission of an enhancement or finish would not be considered value analysis. This led to the second definition: Value analysis is an organised approach to the identification and elimination of unnecessary cost. Unnecessary cost is: Cost which provides neither use, nor life, nor quality, nor appearance, nor customer features. In 1954 the US Department of Defence’s Bureau of Ships became the first US government organisation to implement a formal programme of value analysis. It was at this time that the term value engineering came into being for the administrative reason that engineers were considered the personnel most appropriate for this programme. The formation of the Society of American Value Engineers in 1959 established the technique and the name.

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2.2

Terminology

The terms most commonly used are value management and value engineering. In a construction context, value management is generally considered to relate to the business activity of the client and spans individual projects. Value engineering relates to studies undertaken on specific projects between the completion of the sketch design and the completion of construction work on site. These studies tend to be technical in nature dealing with elements, components and construction process. See figure 2.1. CLIENT'S BUSINESS / CORPORATE STRATEGY IMPACTING THE PROJECT

a Project awareness

b Client development

Pre-Brief

A Inception

B Feasibility

Briefing

C Outline proposals

D Scheme design

E Detail design

Concept Design

F Production information

G Bills of quantities

H Tender action

J Project planning

Detail Design

K L Site Completion operations

M Feedback

c 1st use

Site Operations

VALUE MANAGEMENT / VALUE METHODOLGY OPPORTUNITIES

VALUE ENGINEERING OPPORTUNITIES

Figure 2.1: Terminology

Read:

Kelly, Male and Graham – Chapter 6

Question:

Define “Value Management” and “Value Engineering” in terms of what it is and what it is not.


In text question Do the terms value management and value engineering mean the same thing?

2.3 Construction orientated value management theory Value analysis/value engineering was initially a service for manufacturing industries where the aim is to produce a large number of identical products at the highest quality for the least cost. This high production run is not a characteristic of construction. However, construction clients also require the highest quality for the least cost and often within a given time. In the quest for a single building project a large number of problems will

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be addressed and a large number of decisions will be taken. A workable definition for this situation is therefore: Value management is a service that maximises the functional value of a project by managing its development from concept to occupancy through the audit (examination) of all decisions against a value system determined by the client. This service is achieved through the application of the job plan described below. At the core of a value management service is the identification of a function which is defined as: An activity for which a thing is specifically designed, used, or for which something exists. And value which is defined as: A measure expressed in money, effort, exchange or on a comparative scale which reflects the desire to obtain or retain an item, service or ideal. Function and its associated value can only be determined by reference to the client’s value system, a concept discussed later.

2.4

The job plan

All value management studies, in manufacturing and construction, follow the job plan. The job plan is simply a structured method for the logical, sequential, analysis of value and is characterised by the following phases: 2.4.1 Phase 1 - information In this phase all of the available information relating to the project and relevant to the stage under review is gathered together. The objective of the information gathering is to identify the functions of the whole or parts of the project, as seen by the client organisation, in clear unambiguous terms. The information should not be based upon assumption but be obtained from the best possible source and corroborated if possible, with tangible evidence. The reasoning behind this is that the quality of decision making cannot rise above the quality of the information upon which the decision is to be made. However, care should be taken not to spend unjustifiable time and effort in information seeking. There is a dilemma between the dangerous consequences of acting upon inadequate information and the possible missed opportunity when waiting for reliable information to arrive. This dilemma is a critical part of a risk analysis. The types of information being sought are: •

Client needs, which are the fundamental requirements that the project must possess to serve the client’s basic intentions. Needs should not be

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seen solely in terms of utility as the client may have a need for a flamboyant statement or a need for a facility or a part of a facility which heightens the client’s esteem. •

Client wants are the embellishments which it would be nice to have but do not satisfy need.

•

Project constraints are those factors that will impose a discipline upon the design, for example, the shape of the site, planning requirements, regulations, etc.

•

Budgetary limits expressed as the total amount that may be committed to the project in initial capital and life cycle costing terms.

•

Time for design and construction as well as the anticipated period for which the client will have an interest in the building.

Information is the lifeblood of a value management exercise that is obtained under the direction of a value management facilitator using tools and techniques specifically designed to extract information appropriate to the stage of the project. Diagram 1 illustrates the characteristic nature of information at various stages in the project. At the earliest stage, at the point at which the client perceives a problem to which a building is only one solution the information tends to be unstructured. This unstructured information may exist as supply and demand statistics within the client organisation, or information relating to a problem identified but not made explicit by client’s employees or consultants, or the strategy of the client executive for which there is no technical solution. Users of a facility, who are not a part of the client organisation, may also hold information. For example, public buildings such as law courts, libraries, museums and offices offering consultation services are situations where the users do not belong to the client organisation and yet possess valuable information. Concept information is largely produced by the client organisation in terms of a brief and by the design team in terms of initial sketches. Once the outline proposal stage is complete (final sketch design) the design exercise becomes a technical task of answering the client’s brief. At this point the client’s value system is locked in. Technical information is the designers’ solution to the problem described in the brief in performance specification terms. 2.4.2 Phase 2 - creativity In the creative phase the value management team put forward suggestions to answer the functions which have been selected for study. There are a number of creative techniques, for example: brainstorming, the Gordon technique, the synectics technique and many more.

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Brainstorming is the most popular technique used by value management facilitators to generate ideas in the creativity phase. The technique requires a group to consider a function and contribute any suggestion that will answer that function. Every suggestion, no matter how apparently stupid, is recorded. So, for example, suggestions for a butchers’ cold store for the function “maintain internal temperature” could be; ice, cold air curtain, insulation, vary pressure, in fact, any idea that comes to mind. There are various rules which apply to the management of a brainstorming session of which the two most important are: firstly, no criticism of any suggestion by word, tone of voice, shrug of shoulders or any other method of indicating rejection is allowed. Secondly, the exercise is one of generating as many suggestions as possible. The good suggestions will be randomly scattered amongst all suggestions. Research has indicated that in any sample, the number of good suggestions remains fairly constant as proportion of wild suggestions, so the more suggestions that there are, the more good suggestions will be obtained. All suggestions are recorded and none are rejected on the grounds of apparent irrelevance. Research has also shown that original suggestions are as likely to come from those inexpert in a subject as from those who are expert. For example, the interior design consultant may come up with a good original suggestion for the solution to a structural function. One reason put forward for this is that the consultant will not be constrained by professionally determined technical rules or education.
In text question Why is the emphasis on maximising the quantity, rather than the quality, of ideas generated in the Creativity phase?

2.4.3 Phase 3 - evaluation The value management team evaluates the ideas generated in the creativity phase using one of a number of techniques, many of which depend upon some form of weighted vote. This stage forms a crude filter for reducing the ideas generated to a manageable number for further study. 2.4.4 Phase 4 - development The accepted ideas, selected during phase 3, are investigated in considerable detail for their technical feasibility and economic viability. If appropriate for the stage of the study, outline specifications or designs will be worked out and budget costs realised. There is wide scope for the use of cost models and computer aided calculations at this stage.

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At the end of the development stage the team will again consider the worked up ideas and all those which either cost more than the original or are found to reduce quality are rejected. 2.4.5 Phase 5 - presentation The refined ideas are presented by the value management team to the body that commissioned the value engineering exercise, supported by specifications, drawings, calculations and costs. 2.4.6 Phase 6 - feedback It is important that the value management facilitator receives some detail of those ideas that have been put into practice and be given the opportunity of testing the design and cost predictions of the team. Read:

Kelly and Male, Chapters 2 and 3

Question:

Briefly outline the value management job plan stating the objectives of each stage. Consider the resources that would be required for a workshop.

2.5

Building function

The function of a building is to provide an environmentally controlled space suitable for the activity to be carried out within that space. The design of the building is a technical solution to the functional requirements of the space. Herein lies one major difference between the manufacturing industry and the building industry, manufacturing providing products and building providing environmentally controlled space. A building has a number of characteristics: •

It is comprised of manufactured components and assemblies.

•

The components and assemblies are constructed to form elements of a building.

•

The configuration of the elements of a building form spaces which are conducive to the activity to be performed within the building.

•

The building represents a stage in the corporate strategy of the client organisation and contributes to the capital value of that organisation.

Each of the above represents a level at which a particular value management technique is appropriate. The levels are incremental but, as listed above, are in the reverse order of their chronological development. The levels and the points on the RIBA Plan of Work when they are generally considered is shown in diagram 2 and discussed below.

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2.5.1 Task - level 1 Level 1 represents the first stage wherein the client organisation perceives a problem. This problem may be realised through a study of efficiency, safety, markets, profitability, etc. Currently, if a client sees a building as a solution to this problem, a contact with the construction industry is most likely to be made. The construction industry representative is most likely to assume that the client has correctly identified that a building is the solution to the problem and will advise the client on how best to proceed. The client at this point steps onto the building procurement moving walkway and is virtually prevented from stepping off until the keys to his new building are handed over. As an alternative to this traditional method it is suggested that the first approach be to a value manager, who, with representatives of the client organisation will undertake a functional, structured definition of the project and its objectives. A project is defined here as “the investment of resources for a return” where the return may be social or financial. 2.5.2 Spaces - level 2 Having determined that a building is the most promising solution to the project the value management process moves to level 2 involving the value manager in an exercise with the client representatives and a design team. Normally the design team would be that which was to take over the design of the building, but in situations where the client wished to reserve the choice of an alternative procurement route e.g. design/build, the design team would be commissioned for this exercise only. The exercise would address the definition of the various functional spaces required by the client and performance specification of the spaces in terms of area and height, adjacency, IT and other technical requirements, quality and the heating, ventilation, lighting and sound environment to be maintained. 2.5.3 Elements - level 3 An element is described by the building cost information service as “that part of construction that always performs the same function irrespective of the components from which it is made”. An element is unusual in that it has a function but rarely performs or contributes to a process. Also, by definition, the functional analysis of an element need only be carried out once. Once all of the functions of an element, e.g. external wall, have been realised they can be translated into the specific application envisaged by the project.

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2.5.4 Components - level 4 Components used in building have been subjected to a process prior to their arrival on site. All or parts of this process may be analysed to determine function. Having an understanding of the manufacturing process and the functional requirements of the component may lead to alternative design decisions particularly when dealing with components which are project specific, for example, curtain walling, precast concrete components, windows and doors. For example, a precast concrete cladding panel is subjected to a process of manufacture, transport, lifting and fixing in position, each of which may be viewed as a functional operation.
In text question What is meant by the project task?

2.6

Conclusion

This unit has outlined the basic principles of the generic job plan and has indicated the stages in construction to which this may be applied. Further units in this course will outline the tools and techniques appropriate to the use of the job plan at the elements and components stages.

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2.7

Self assessment questions

Identify the functions of a university built environment department at the strategic level. Do you think a building is necessary to accommodate these functions? Think about a university department at the spaces level. What are the different types of functional spaces required by the university and its users? Consider a project that you are familiar with. Do you believe the finished product would have been different if VM had been applied?

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Unit 2 - 9

3: An Introduction to Risk Management

3.1

Introduction

This unit introduces the concepts of risk and risk management. A number of definitions and perspectives on risk are examined, both generally and relating specifically to project management. Risk within the context of the construction project is developed. The distinction between risk and uncertainty is explained, highlighting that risk on a construction project is not so much about the possibility of certain events occurring, but more fundamental is about the very circumstances that surround typical construction projects throughout their lifecycle- from inception to completion.

3.2

Learning outcomes

The learning outcomes for the unit are to: • • • •

Understand what is meant by risk and uncertainty Develop awareness of a project management view of risk Become familiar with the basic components of risk management Appreciate the distinction between risk events and circumstances.

3.3

Risk Management in Perspective

This section of the unit discusses and defines risk and risk management, both in a general sense and specific to construction project management. This will provide a firm base of understanding for the following sections which look at various aspects of applying risk management to construction projects. Although RM has become firmly institutionalised across industry sectors, it is only comparatively recently that this has extended to include the construction industry. The growth in the practice of risk management has been accompanied by a proliferation of standards and guidance information. There are British Standards, guidance from professional bodies, public sector guidance, research published in academic journals and text books dedicated to the subject matter of RM. A review of some of the more pertinent of these

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will help develop our appreciation of the applications and importance of RM in the context of construction project management. It is useful to identify common themes emerge from all this material to help our understanding of the subject area.

3.4

What is Risk?

Risk means different things and has a variety of implications for different people and organisations in the construction industry. Although this course makes reference in places to client and contractor specific perspectives, the overarching perspective is that of the project itself. If risk is successfully managed and a project is delivered on time, within budget and to required quality standards, then that should be good for all participants in the process. In the modern era of ‘integrated project teams’ all parties should contribute to the success of, and share in the benefits of, good project performance. There is no long term benefit from certain parties to the project gaining at the expense of others. As a starting point it is worthwhile to begin by firstly defining and being clear on what we understand risk to mean, both in an everyday sense and also that specific to the construction professional. It is interesting to see how views of risk and its management has developed over time.

3.5

Risk – Something to be Avoided?

The Concise Oxford Dictionary defines risk as •

“a hazard, chance of bad consequence, loss, exposure to chance of injury or loss”

Although general, we can clearly relate this to the construction project. There are obviously many hazards associated with the construction site itself which can result in injury or loss to the site operatives from engaging in ‘risky’ site activities. Indeed, compared to other industries, the UK construction industry has a particularly poor record in this regard with an unacceptably high number of site accidents, injuries and fatalities occurring each year. Whilst the consequences can be clear (damage to the works, injury or death), the range of sources can be myriad and far less clear. As well as such direct impact from such risks occurring, there are likely to be commercial implications from associated insurance claims, disruption to the programme and consequential effects on other trades and packages. Risk, in this sense, is entirely negative and, in a construction project, may affect one or more parties and will almost certainly involve financial loss. Indeed, no matter what type of risk we are considering, some financial Unit 3 - 2

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impact is almost certain. Such a scenario concurs with Ward and Chapman’s (see supplementary reading) observation that risk is commonly associated with adversity, implying that risks are potential adverse effects on the project performance and that sources of risk are “things that might go wrong” or threats to the project.
In text question Identify some common risky site activities in construction. The BSI Guide 73 (2002) “RM Vocabulary – Guidelines for use in Standards” defines risk as •

“the combination of the possibility of an event and its consequence”


In text question Express each activity identified above in terms of its event and consequence. This BSI guide aims to develop a common understanding across different types of organisation internationally on the terms used in general field of RM. Contrast this with the dictionary definition above, it is undoubtedly more precise but also rather abstract. This BSI view is purely concerned with the possibility of a cause (the event) and related effect (consequence). Notably though, there is no reference to loss, damage or any other notion of a negative outcome of risk.

BS6079 -1 (2000) Guide to Project Management, though not containing a definition, characterises risk from the perspective of a project manager as…. •

“project risk is primarily the likelihood of negative occurrences adversely affecting the project so that its objectives become more difficult or even impossible to achieve”

The BS6079 guide is obviously a key publication for a masters programme in Construction Project Management. It describes risk management as a process which supports the PM process. Their definition is more in line with the common view of risk as being overwhelmingly negative and something to be avoided. It is perhaps unsurprising that this is one which many project managers may subscribe to the most, given the many examples of construction projects, both high profile and every day, Heriot-Watt University

Unit 3 - 3

3: An Introduction to Risk Management

that are delivered late and/or over budget for which one or more parties has suffered. However, the qualifier ‘primarily’ hints that there are consequences and effects of risk other than negative ones which is consistent with the strictly correct definitions of risk.
In text question What are the 3 criteria that any project’s objectives can be measured in?

3.6

The View of the Professional Bodies

Two of the main international professional bodies governing project management have developed their own view of risk. The Project Management Institute (PMI) is a USA based advocate for the project management profession which exists to promote professional standards and practices. They identify project management as having nine knowledge areas, one being Risk Management. The Association for Project Management (APM) is the largest independent professional body of its kind in Europe with members throughout the UK and abroad. The APM’s key objectives are to develop and promote project management across all sectors of industry and beyond. The PMI’s Project Management Book of Knowledge (2000) defines risk as •

“an uncertain event or condition that, if it occurs, has a positive or negative effect on a projects objectives”

This view is more explicit about the possibilities of positive, or welcome, effects of risk i.e. situations or events turning out better than planned or expected. Since this definition relates to a project, the effects of risk relate to the effects on the projects time, cost and quality objectives, either for the project as a whole (the global sense) or some sub-part of the project, e.g. a particular work package or trade operation etc. a negative impact will obviously mean late completion, cost over-runs, or not meeting the required level of quality, either individually or more seriously in combination. The APM defines risk as •

“an uncertain event or set of circumstances that should it occur, will have an effect on the achievement of the projects objectives”

This view is very similar to that above, although in addition to risk being associated with a specific cause (event) or condition- a ‘set of

Unit 3 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

circumstances’ can pose a risk to project outcomes. This is appropriate to construction projects, particularly large and complex ones, where there may be many interdependent parties and activities contributing to the project. In such cases the precise cause (or event) of a cost or schedule overrun can be far from clear and responsibilities not easily apportioned. Rather, it has to be untangled from the ‘set of circumstances’ surrounding the project.
In text question What is the difference between an event and a set of circumstances?

So, although the project management literature recognises, implicitly or explicitly, that risk stems from uncertainty which can lead to better outcomes than expected, the more conventional view is that risk is something to be avoided or minimised where possible, certainly when discussed in the context of construction projects. This is particularly so at the site operations stages of the project life cycle where it seems so many things can (and do) go wrong for projects deemed to be ‘risky.’

Discussion and debate on how risk should be perceived has also been ongoing by practitioners and academics in the field of project management. Hillson (see supplementary reading) states that risk can have a range of effects on the achievement of project objectives, from the total disaster to the unexpected welcome surprise, but is in no doubt that common usage of the word “risk” sees only the downside. The negative connotations are reflected in traditional definitions of the word, both in standard dictionaries and more technical definitions, but some professional bodies and standards organisations have gradually developed their definitions of ‘risk’ to include both upside and downside. Some definitions have the nature of the effect as undefined and could therefore implicitly encompass both positive and negative effects. Others are explicit in naming both opportunities and threats within its definition of risk.
In text question Should all risk be avoided?

Heriot-Watt University

Unit 3 - 5

3: An Introduction to Risk Management

3.7

Risk –Upside or Downside

To summarise the foregoing, both “upside” and “downside” risk is associated with any uncertain situation. Where there is a possibility that things may turn out better as well as worse than planned, risk is usually referred to with negative connotations i.e. downside risk events which are associated with the concept of loss only. The purpose of risk management is to minimise loss by reducing the probability of risk events occurring i.e. making them less likely, or minimising consequences should they occur, or a combination of both. •

Pure risk: normally arises from the possibility of accident or technical failure.

•

Speculative risk: possibility of loss or gain, which may be financial, technical, or physical.


In text question What loss might be incurred from a downside risk?

3.8

Risk, Uncertainty and Events

Construction projects are all about forecasts of future events. Estimators, project managers and quantity surveyors all have to make cost and time related forecasts in what can be a volatile and unpredictable market. The time span for these forecasts may be months or even years in advance. However, most future events are uncertain to a degree since perfect information about the future does not exist. With the application of RM, consideration is given to the types of ‘events’ that this uncertainty might throw up. i.e specific ‘things’ or occurrences that might affect the project. With a little thought, the likelihood of occurrence, and magnitude of possible loss or gain from these events can be assessed. In so doing, uncertain events can be said to become risk events since some expression is being made on their probability, whether this be formally (explicit quantification) or informally (intuitive assessment). It is obviously more desirable to make decisions under risk than decisions under uncertainty since more knowledge is gained about a possible event after it has been considered. The terms risk and uncertainty are often used together and sometimes considered to be interchangeable and synonymous. The concepts are very close and, for the purposes of construction risk management, some writers tend not to differentiate between them. However there is a distinction to be made as explained above, and recent research on project risk

Unit 3 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

management has highlighted a clear difference between discrete risk events and a more amorphous uncertainty.
In text question What is the difference between risk and uncertainty?

Risk, uncertainty and events Uncertainty

Risk

Certainty

Spectrum of Risk Unknown Unknowns No information

Known Unknowns Partial information

Known Knowns Complete information

Figure 3.1 The Spectrum of Risk Traditionally, the distinction between risk and uncertainty has been woolly or non-existent. Increasingly though, there is a view that a clearer focus would benefit RM practice. If it is accepted that the term ‘risk’ encourages a threat perspective, then it follows that risk management focuses on the downside and is preoccupied with minimising perceived threats. Also, risk, having quantifiable attributes (probability and event) encourages a focus on specified, identifiable events. However, experience shows that in complex projects which have performed poorly, it is often difficult to relate the problems to specific events. There are many interdependent factors that can contribute.

3.9

Risk – An Event or a Condition?

A definition of risk at its most fundamental level is the possibility that the actual outcome for a particular event or activity will deviate from the

Heriot-Watt University

Unit 3 - 7

3: An Introduction to Risk Management

forecast outcome. In this sense, an “event” is some tangible, discrete happening. At a global level the “event” may be, for example, the completion of the building which will have forecast outcomes for cost and time at completion. The risk to all parties concerned is that actual outcomes will deviate from those forecast i.e. the building is completed late and over budget. At a more detailed level, constructing a building comprises many hundreds or thousands of interrelated events (each design and construction activity being an event). These events are exposed to varying degrees of risk that they will not turn out as planned for example, prolonged bad weather delaying a concrete pour, failure of a supplier to deliver materials when agreed or the injury of a workman on site from undertaking a “risky” activity. These specific risk events emanate from more general conditions of uncertainty, and there is, of course, a great deal of uncertainty surrounding the design and construction of a building. Ward and Chapman (see supplementary reading) describe uncertainty on a project as including one or more of the following • • • • •

Lack of clear specification of what is required Novelty, lack of experience of a particular project or activity Complexity in terms of the number of influencing factors and inter-dependencies between these factors Limited analysis of the processes involved in the activity Possible occurrence of particular events or conditions which could have some (uncertain) effect on the activity

Note that only the last item really relates to specific events or conditions as referred to in the earlier definitions of a “risk”. The other sources of uncertainty arise from a lack of understanding of what is involved and are less obviously described as threats or opportunities.
In text question Why does uncertainty lead to risk?

3.10 Scope of Uncertainty Relating to the Construction Project It is recognised, then, that risk is not just the consequence of a particular identifiable event, but also a result of the ‘condition’ or ‘set of circumstances’ that exists in the construction project environment. What then are these conditions/circumstances surrounding the project that create risk? Ward and Chapman identify four categories where uncertainty exists in the project.

Unit 3 - 8

Heriot-Watt University

Value and Risk Management [D19CV9]

Uncertainty about the basis of estimates An important area of uncertainty relates to the basis of estimates produced by members of the project team. Both client and contractor make numerous estimates and forecasts in a project relating to budgets, tendering, scheduling and programming. Some will be ‘objective’ and based on hard information and historical data, others ‘subjective’ and based on gut feel and intuition, judgement and assumptions. More likely these forecasts will be a mix of the two. The level of uncertainty will depend on the estimators ability, experience and available resources. Estimating may be both ‘art and science’ Uncertainty about design and logistics At the earlier concept and briefing stages of the project life cycle, the technical design and related construction process for the building or facility are fundamental uncertainties (yet one of the clients earliest questions will be when will it be ready and how much will it cost?). Over time the amount of uncertainty in this category will reduce as the design progresses and these issues are resolved Uncertainty about objectives and priorities At the root of good project performance is clarity about project objectives and their relative priorities, which should be well understood and agreed throughout the project team. Attempting PM or RM when this clarity is lacking is like attempting to build a tower on wet sand. Ward and Chapman recognise the rise of VM in addressing this. As well as being clear, the project objectives should reflect and reconcile the requirements of all the project stakeholders. Uncertainty about the project organisation This relates to the multiplicity of people, business units and organisations involved in a project and the fundamental relationships that exist between these parties (the construction project as a temporary multi-organisation is discussed elsewhere). These relationships are often complex and may or may not involve formal contracts. Conditions` of uncertainty arise from ambiguity in respect of • specification of responsibilities • perception of roles and responsibilities • communication between parties • contractual conditions • mechanisms for coordination and control.

Heriot-Watt University

Unit 3 - 9

3: An Introduction to Risk Management

3.11 Risk and Risk Attitude It is important to appreciate the attitude to risk of clients and contracting organisations in their decision making. Interpretation of the seriousness of risks and their response is not a rational and objective exercise. Different people given the same information on risk exposure for a situation will respond differently depending on their attitude and whether they are risk seeking, risk averse or risk neutral. What is an acceptable risk to one decision-maker will not be acceptable to another. Therefore it is the combination of risk exposure and attitude that will dictate responses to and strategies for dealing with risk. Whilst risk exposure, the extent of maximum possible loss, can be quantified fairly easily, risk attitude cannot. Utility theory is the branch of decision theory dealing with measuring risk attitude, though is not the concern of this course. The figures below are reproduced from Flanagan and Norman and illustrate the different attitudes of types of people according to their propensity to take risks and how these relate to disciples in the construction industry.

HIGH

HIGH

+

+ Challenger Risk taking

+

+ Practicaliser +Synthesiser Modifier + Planner

+ Repeater

Developers

+ Architects

+

Risk taking

+

Electrical contractors

M&E contractors

+

+ Dreamer

LOW

+

+ Contractors

Innovator

+Engineering consultants

Quantity surveyors

LOW FEW IDEAS

Creativity

Figure 3.2 People and risk

Unit 3 - 10

MANY IDEAS

FEW IDEAS

Creativity

Figure 3.3 Construction people and risk

Heriot-Watt University

MANY IDEAS

Value and Risk Management [D19CV9]

3.12 Background to Risk Management (RM) Now that we have defined and investigated various interpretations of risk, we can extend this to look at the background to RM. Full consideration of a RM approach is contained later in the course pack. RM as a recognised service practiced in a structured way, whether as fee-earning consultancy or inclusive part of project management services, has been becoming increasingly popular as the serious consequences of risk become more evident. Clients are becoming more demanding and buildings more complex, both in a technical and managerial sense. Of the more recent influential industry reports, it is Latham who perhaps most effectively communicated to the industry the need for RM. In the UK, the public sector has been particularly progressive in advocating RM and VM, and also incorporating it into their project management systems. The Office of Government Commerce (OGC) Project Procurement Lifecycle (see supplementary reading) states that, for effective construction project management there must always be detailed knowledge and understanding of the risks relating to a specific project and reliable plans for risk allocation and proactive management. (note: A series of OGC procurement guidance has been developed recently, largely in response to the Egan report). This framework for construction procurement identifies required risk management activity at key stages throughout the process, from the business case stage through its design, construction and operation.

3.13 Defining Risk Management Just as there are numerous definitions of risk, there are numerous definitions of RM offered by the various professional institutions and standards bodies. There is perhaps, though, greater consistency as to what constitutes risk management. The differences in definition are largely a matter of semantics and terminology. The key features of a RM framework are extracted and discussed below.

According to BSI Guide 73 (2002) “RM Vocabulary – Guidelines for use in Standards”, risk management is •

‘Coordinated activities to direct and control an organisation with regards to risk…and generally includes risk assessment, risk treatment, risk acceptance and risk communication’

The PMI’s Project Management Book of Knowledge (2000) describes RM as..

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Unit 3 - 11

3: An Introduction to Risk Management

•

‘the systematic process of identifying, analysing and responding to project risk. It includes maximising the probability and consequences of positive events, and minimising the probability and consequences of events adverse to project objectives. It includes processes of RM planning, risk identification, qualitative risk analysis, quantitative risk analysis, risk response planning and risk monitoring and control.’

BS6079 -1 (2000) Guide to Project Management, does not offer an explicit definition of RM as such, but states that •

‘the project manager should take positive steps to identify, assess and ultimately manage all risk inherent in the project, as an integral part of the project management process.

Self Assessment questions 1. What is the difference between objective and subjective probabilities? Which is more commonly found in risk assessment in construction project management? 2. How do we transform an uncertain situation into a risk situation? 3. Does the Office of Government Commerce view construction risk as a negative feature of construction projects

Unit 3 - 12

Heriot-Watt University

4: RM and the Project Life Cycle

4.1

Introduction

This unit explains the project life cycle in terms of its two main phasesthe initial strategic phase where the project is being defined, and the tactical phase which follows and is concerned with delivery. The application of VM and RM throughout these phases of the project life cycle is discussed. Good project performance is achieved if the project which best meets the client needs is correctly and clearly identified in the former phase, and efficiently delivered in the latter. Whilst both VM and RM have a role to play throughout these phases, the nature of its practice and the benefits accrued change as the project evolves.

4.2

Learning outcomes

The learning outcomes for this unit are to: • • • •

Appreciate the distinction between strategic and tactical stages of the project life cycle. Appreciate the nature of strategic risk and tactical risk Be aware of when the business project becomes a construction project in the life cycle Know the relative importance of VM and RM at stages throughout the project life cycle.

4.3

The project life cycle

The Project Life Cycle (PLC) is defined by BS6079 Part 1 as the “sequential phases through which a project passes to reach its objectives”. There are numerous interpretations on what these phases comprise of from the various professional bodies, both in a general project management as well as construction specific perspective. Within construction the Royal Institute of British Architects (RIBA) Plan of Work (PoW) is one of the most widely recognised project life cycle frameworks in the UK. First published in the 1960s and recently updated in 2000, the RIBA PoW is most closely associated with traditional procurement- a sequential design and construction process with lump sum bills of quantities and competitive tendering. More recently, other forms of procurement have emerged such as design build, partnering and prime contracting systems which offer concurrency in design and construction and attempt to integrate the supply chain in the design process. Since the publication of

Heriot-Watt University

Unit 4 - 1

4: RM and the Project Life Cycle

Egan’s “Rethinking Construction” in the UK, much emphasis has been placed on encouraging more collaborative approaches to procurement which bring together the various design, construction and manufacture elements of the process into ‘integrated project teams.’ The OGC Project Life Cycle framework exemplifies this approach in the UK public sector. A comparison of the various project life cycle frameworks shows that the timing and responsibilities for the various design and construction activities involved may vary, the way the various participants are brought together may differ, and the number of steps detailed and terminology used varies. However, fundamentally they all exhibit a number of common features which see the project go through a strategic definition phase followed by tactical delivery phase. This distinction is explained in the next section.

Some Sample Project Life Cycle Frameworks APM BoK

RIBA PoW

BS6079

OGC

CIRIA

Pre-feasibility

Appraisal

Conception

Feasibility

Feasibility

Strategic briefing

Feasibility

Strategic assessment Business justification

Design

Outline proposals

Implementation

Procurement strategy

Scheme design

Contract

Detailed proposals

Operation

Investment decision

Production information

Implementation

Final proposals

termination

Outline design

Tendering

Commissioning

Production information Tender documents Tender action

Detailed design

Construction

Readiness service Benefits evaluation

Operation

Handover Operation

Briefing

for

Construction Completion Feedback


In text question What are the 2 main phases that make up any project life cycle?

Unit 4 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

4.4

VM, RM and the project life cycle

A business project or a construction project? At the earliest conception, the project is essentially a recognition by the client of the need to make some investment for a return, usually to satisfy some perceived business objectives or changing service levels within the organisation. As such the project can be conceived of as some business problem or opportunity, rather than a construction project per se. It is only the point at which the decision to build is made that it becomes a construction project begins. The procurement of a construction project then evolves by establishing the functions the built asset will provide and the form it will take, through to sketch & detail design and construction. In this way the project moves from a strategic to a tactical phase.

The Project Life Cycle

Business project

• Investment/development appraisal • Project brief Decision to build

• Construction project brief Construction project

• Design • Bidding • Construction

time

Figure 4.1 The business and construction project Breaking the project down into its strategic and tactical phases that constitute the PLC, both VM and RM have a role to play throughout, though their relative importance in contributing to good project performance varies. Generally VM is the dominant discipline in the earlier stages and RM in the latter as explained in the following section. Figure 4.2 illustrates how the project develops from concept through to construction. From a VM perspective this is described by Kelly and Male as Levels 1 to 4; dealing with concept, spaces and elements and components issues. VE is the part of VM which considers specific aspects relating to the design and construction of the technical solution, and would be practiced at the tactical phase of the project. Clearly, with both VM and RM, the nature of the study, the information being reviewed and the

Heriot-Watt University

Unit 4 - 3

4: RM and the Project Life Cycle

people involved will depend when the VM or RM study is carried out in the PLC. At the business case or briefing stage a study will deal with quite different issues from that of one held during the detailed design or construction stage for example.
In text question At what point does the business project become a construction project?

Value Management, Risk Management and the Project Life Cycle VM and RM

VE

Delivery

Definition Strategic issues (largely client related)

Brief

Concept Level 1 concept

Level 2 spaces

Broad issues •Investment opportunity •Project type •Size and location

Tactical issues (client and contractor related)

Sketch design

Detail design

construction

Levels 3 and 4 Elements and components

Narrower range of issues •Procurement •Manufacture •Co-ordination •Site works

Figure 4.2 Value Management Risk Management and the project life cycle

4.5 Relationship between VM and RM in the project life cycle RM and VM are said to be two sides of the same coin. They are interrelated activities that should be carried out in parallel on the project. In practice, VM activities are carried out first to determine what it is that constitutes value to the business from delivery of the project. As risk is an inherent byproduct of available project options, it follows that the project (and VM which helps shape it) must come first. Although risk should be assessed at the earliest stages of the project, this exercise is more likely

Unit 4 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

carried out as part of VM rather than a stand alone risk study. A major risk at the outset stems from not properly scoping or defining the project – precisely what VM is intended to address. Naturally then, most effort and attention is given over to VM at the early project stages. It is only as the project progresses and the design and logistics of its delivery become an issue that RM as a separate and defined activity comes into its own. The diagram below illustrates how the boundaries between the “disciplines” of VM and RM are blurred at the outset, becoming more distinct and definable as separate entities as the project progresses. In short VM has its major role at the earlier stages of a project (particularly the strategic phase) whilst RMs major role is in the latter delivery stages.
In text question Why is VM applied before RM at the start of a project?

Definition (strategic)

VM and RM blurred (VM dominant)

VM and RM distinct (RM dominant)

VM

VM

RM

Delivery

RM

(tactical)

time

Figure 4.3 Relationship between VM and RM in the project life cycle
In text question Why is there more emphasis on RM at the tactical (delivery) phase of the project?

Heriot-Watt University

Unit 4 - 5

4: RM and the Project Life Cycle

4.6

Strategic Risk

As stated above the nature and form that the risk management activity will actually take will be quite different depending on its timing within the project life cycle. At the earlier strategic phase it has been contended that there is a lesser role for explicit and structured RM activity of the form presented later in the course pack. During the strategic phase, when the brief is being developed, project risk is not characterised by numerous tangible risk events that threaten project performance, i.e. the type which abound during the tactical phase where structured risk management has a valuable role. To reiterate, VRM activity undertaken at the early stage of a project is more likely to have its emphasis on VM, with the project team considering, “What is this project trying to achieve?” Of course risk has to be accounted for in some way, since solutions of high value to the client will necessarily involve low, or at least known and acceptable, levels of risk- but a structured workshop approach focussed on downside risk is not common.

4.7

Tactical risk

The strategic phase of the project life cycle ends when the client’s value system has been formed. Value management has its major role to play at this time in the project life cycle in understanding exactly what constitutes value to the business from the project i.e. what is the project trying to achieve, what functions does it fulfill and how does it contribute to the clients corporate objectives. At this point the project becomes more recognisably a construction project, requiring technical input from the usual design team consultants to progress. As such the process evolves from ‘soft’ problem solving to ‘hard’ problem solving and risk management is then largely concerned with efficient and timely project delivery. Although modern thinking in project risk management formally emphasises proactively looking for opportunities to exploit (upside risk) as part of the RM effort, in practice the tactical delivery phase is more about minimising downside risks and threats to achieving the identified T, C and Q goals. Whilst risk exposure is partly speculative and commercial throughout the project life cycle, the tactical risk phase also involves considerable hazards and threats present in the physical construction process itself i.e. those threats to safety and welfare of those directly and indirectly involved.
In text question At what point in the PLC has the client’s value system been formed?

Unit 4 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

The tactical phase commences as the design gets underway following the decision to build. The design teams task is to interpret and transmit the brief into a technical design solution that meets the client’s defined strategic objectives. Throughout the sketch and detailed design stages of the various packages the client and design team will work toward progressing the design and exercising cost control with the aim of finalising decisions on design, specification and cost for every aspect of the project. This has to be done timeously to meet the client’s programme and within cost constraints for the project. The numerous activities, involving many disparate but interrelated activities, have to be effectively coordinated and controlled for success- typically a major project management challenge. A major source of construction project risk - and perhaps the most obviously risk-prone part of the whole process - is during construction itself. The unique characteristics of procuring buildings compared to any other service or product, is what leads many to conclude that construction is such a risk-prone venture. It is at this stage where much of the risk management attention in practice has been directed. The overall objectives are to deliver the project on time, within budget and to the required quality as defined in contract documentation. This is to the benefit of all parties concerned, irrespective of how risk is apportioned under the contractual provisions that bind them together. Contributing to these objectives is largely a function of effective project management for the client, design team, contractor, subcontractor and suppliers. Clear lines of communication, strong leadership, supervision and decision making will help ensure effective co-ordination and execution of all the works on site. However this particular phase, unlike the previous, also involves exposure to hazards. This is the particular class of risks that result in physical damage, injury or death rather than just commercial loss, should they occur. The building site and erection of the works is a particularly hazardous environment and the UK industry has a poor safety record compared to that of other UK industries and indeed European construction industries.
In text question What distinguishes hazards from other types of risks?

4.8

Risk- time, cost and quality

Good project performance is achieved if its time, cost and quality objectives are met. Whilst the time and cost parameters are clearly readily measurable and understood, the parameter of quality is not so Heriot-Watt University

Unit 4 - 7

4: RM and the Project Life Cycle

straightforward as the interpretation of quality alters over the project life cycle. At the earliest stages quality is concerned with how well the project is scoped, defined and briefed, and how well the expressed functional objectives actually meet the needs of the client organisation. Quality measures at this stage are largely subjective, and must be defined in the client’s terms. VM has a key role in improving quality by ensuring its purpose and functional need are well considered, understood and defined, as encapsulated in the client value system. As the project evolves, so to do its measures of quality. Moving into the tactical phase, the design team must ensure that they accurately interpret the needs of the project, transmitting the brief into designs and specifications which the contractor undertakes to build into a product conforming to prescribed materials and workmanship specifications. Progressing into the development of a technical solution the definitions of quality become more tangible, measurable and auditable through objective technical standards and codes of practice etc. An important principle to recognise from the foregoing is that, unless the strategic quality issues are properly considered and addressed - all too often rushed in practice - then it doesn’t matter how successful or efficient the resulting technical solution is, overall project success will not be achieved.
In text question At what stage do quality issues become objective and technical in nature?

Self Assessment questions 1. The quality of the investment is the client’s prime concern at the investment appraisal phase of the project. What would a private sector client’s main concerns be here and why is it more of a ‘business’ than a ‘construction’ project at this stage? 2. Increasing specialisation in the industry has seen a decline in traditional general contracting. Why does this create conditions of risk?

Unit 4 - 8

Heriot-Watt University

5: Risk and the Nature of the Construction Project

5.1

Introduction

It has been said that the construction industry is exposed to more risk and uncertainty than perhaps any other industry. This unit examines the features of the process and product of the construction industry that might justify this status. It will also be shown that the amount of risk and uncertainty is largely related to the amount of ‘uniqueness’ inherent in each project. Risks are either controllable or uncontrollable depending on where in the project environment they stem from and elements of the environment are explained. A ‘checklist’ of typical sources of risk to be found in many construction projects is presented.

5.2 • • •

5.3

Learning outcomes Understand the concepts of project heterogeneity and homogeneity and how they influence the amount of risk in a project. Understand the various elements of the project environment. Know the difference in the nature of controllable and uncontrollable risks.

Why is construction so risky?

“The construction industry is exposed to more risk and uncertainty than perhaps any other industry” Professor’s Flanagan and Norman, 1993 If the above assertion is accepted there can be little argument that RM has a very important part to play in project success. However, it is worthwhile reflecting on this statement and the extent to which it is valid. In particular, why is it that construction is so exposed to risk and what is it about the industry that makes it so different from any other? The first part of this unit discusses the characteristics of the construction industry and its projects to give a greater understanding of the extent of risk and uncertainty that prevails. Some recent initiatives that have been proposed for the industry to offset some of the risk and uncertainty are then discussed.

Heriot-Watt University

Unit 5 - 1

5: Risk and the Nature of Construction Management

5.4

Project Heterogeneity v Homogeneity

All construction projects can be considered to have both homogenous and heterogeneous characteristics. That is to say they exhibit both similarities and differences from project to project. It is the degree of “uniqueness” inherent in any given project that strongly influences the amount of associated risk and uncertainty. Project heterogeneity There is likely to be truly different situations and circumstances that arise from project to project, no matter how similar the buildings are that are being compared. In this respect no two projects are the same (even comparing, say, two identical house types). Where such heterogeneity exists in the design, construction and management of projects there will be, by definition, more uncertainty about the outcome of the events or situations. Members of the project team are working in conditions of greater uncertainty because of a lack of directly relevant past experience, information, knowledge and understanding. Correspondingly there is a higher degree of risk. It is more difficult to accurately forecast outcomes relating to the time, cost and quality targets. A simple analogy is that if you are asked to do a task which you have never carried out before, you will be less confident in predicting the time and effort it takes to do this, compared with a task you have carried out many times before. Undoubtedly, any construction projects will have heterogeneous aspects relating to its technical, managerial and commercial aspects.
In text question Why does project heterogeneity lead to risk?

Project homogeneity Contrast the construction project with the product of a high volume manufacturing process. In the latter case there is little variability to affect the outcome. Quality control and productivity are much more predictable, tightly defined and the process can be made to be very efficient. There are no unknowns and there is little risk involved in the production process (whether there is a market for the product is another matter- this would be an example of an external commercial risk). Construction, however, is not a manufacturing process and cannot achieve the same degree of certainty and productivity associated with such a scenario. From the foregoing we can see that the more homogeneity involved in the process (design and construction activities) and the product (the technical solution represented by the building or facility and its constituent parts), the less uncertainty there is about the situation and therefore less risk involved. Following this line it would be desirable for projects to be

Unit 5 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

homogenous since there would be less risk to manage and greater confidence that project objectives could be achieved. (less internal risk i.e. those situations that the project team have influence and control over).
In text question What do we mean by the process and product of construction? Raftery (see supplementary reading) summarised the similarities and differences between buildings that helps provide a framework for the discussion. These are expanded and discussed below. 5.4.1 Project similarities Elements of the building Every building can be analysed in terms of the standard definition of elements that are universal across project types. For example, all buildings no matter how varied will have foundations, internal finishes, services, walls and partitions and so on. The Standard Form of Cost Analysis published by the Building Cost Information Service provides a standard framework of 28 elements into which any building can be analysed and compared with other buildings, allowing comparisons to be made between the cost of achieving various building functions in one project with the equivalent functions in other projects. This is primarily intended for cost managers and quantity surveyors to allow direct and meaningful comparison between similar past projects in the cost database, to that which is being proposed for the purpose of cost forecasting. It makes use of standard features of projects to reduce risk in cost prediction and control. Construction Materials Many of the materials that buildings are constructed from are practically universal and in some cases have been used for thousands of years. For example, we know a great deal about the performance and properties of materials such as concrete, slate, timber, stone and steel. Construction Components As well as many materials being used consistently throughout the industry, standard designs and components have emerged more recently. This reduces uncertainty by reducing design variables and simplifying site and labour processes. The more standardisation that is practiced in construction, the more the industry takes on the characteristics of a manufacturing process. Site Operations Many site operations and activities of the construction process are also the same from project to project, using specific types and capacities of plant Heriot-Watt University

Unit 5 - 3

5: Risk and the Nature of Construction Management

and labour operations. Site engineers and project managers use this knowledge and experience in planning and co-ordinating the works. Management structure and style There are a number of standard forms of procurement and contract conditions which define the roles, responsibilities and communication links for all parties involved. Such standardisation reduces uncertainty and should mean more predictable and efficient management.


In text question Which of the above factors relate to product and which relate to process?

5.4.2 Project differences Site and site conditions An obvious difference- and one which sets construction apart from other industries- is that every project, no matter how similar is built on a different site (or plot of land within a site) and will be affected by surrounding conditions and circumstances. In a technical sense; ground conditions such as soil bearing capacity, existing services, soft spots, old mine workings etc. are never fully known until actual work on site beginsa considerable risk. Site investigation and bore-hole testing will be carried out beforehand to reduce uncertainty and inform the design of foundations. In a management and site organisation sense, issues such as access restrictions, complications from adjacent properties and owners, availability of site storage space will depend on site location. Contrast two hypothetical buildings which are identical in every way except locationone to be built on an out-of-town greenfield site, the other in a compact city centre location with parking, delivery, loading/unloading and storage problems. Although identical, they present completely different construction challenges. Element specifications Although buildings can be analysed in terms of a standard set of elements as discussed above, the actual specification and design for each element is wide and varied. Management structure and style This feature can legitimately appear in both the similarities and differences categories. As argued above there are of course standard forms of contract. However they are many in number and in practice are often adapted with variations and amended clauses as to make the notion of ‘standard’ almost unrecognisable.

Unit 5 - 4

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Value and Risk Management [D19CV9]

A construction project is referred to as a ‘temporary multi-organisation.’ Any reasonably sized project will involve many people, businesses and agencies that come together to contribute their resources to the ultimate end of delivering the project. However, the large and often complex organisation only exists for the duration of a single project, and the individual objectives of all the players are not always well aligned. There is almost an in-built capacity for problems and disputes. The temporary nature means that all the experience gained by the team from working together over the course of a project is lost at the end of it. As such, construction is said to be ‘fragmented’ Sources of labour, plant and material Another distinct feature of the construction industry is the fragmented nature of labour and materials supply. In fact it has been said that there is no ‘construction industry’ as such. Rather, there are a series of local construction industries and markets throughout the country, with varying regional features relating to supply and demand. This discontinuous supply chain makes forecasting and planning difficult. In particular, a reliable, consistent and trained workforce is a real problem in construction. The extent of centralisation and supply chain and logistics management that is evident in other industries is not achieved in construction.
In text question What is meant by the term temporary multi-organisation?

In summary, Raftery observed that despite largely common activities and processes, each construction project is assembled and constructed on its own site with its own physical characteristics, subject to weather conditions depending on the season, with different material specifications and technical solutions to the problem of enclosing space. While a number of materials and components will be identical, many will not. Each project usually has a different labour force of operatives and managers. Hence, there will be differences in the management and interpersonal behaviour on each project simply because people are different. We can see therefore, that any construction project has a mixture of heterogeneous and homogenous characteristics. The balance will depend on the type of project and client and contracting organisations involved. The extent to which it is desirable or achievable to encourage greater homogeneity in construction, which would offset risk and uncertainty, is a moot point. Quite clearly, the Egan report, representing a lobby of powerful clients of the industry, firmly advocates that construction can and must model itself on other industries to standardise and, thus increase the number of similarities from project to project. The following two quotes from the report capture this view: Heriot-Watt University

Unit 5 - 5

5: Risk and the Nature of Construction Management

“we have repeatedly heard the claim that construction is different from manufacturing because every product is unique. We do not agree. Not only are many buildings, such as houses, essentially repeat products which can be continually improved but, more importantly, the process of construction is itself repeated in its essentials from project to project” “Moreover, the conventional processes assume that clients benefit from choosing a new team of designers, constructors and suppliers competitively for every project they do. We are far from convinced of this. The repeated selection of new teams in our view inhibits learning, innovation and the development of skilled and experienced teams” This view, and related proposals within the report, is not without controversy though. The supply side of the industry- contractors, subcontractors, consultants, suppliers- who had little involvement in the report, claim that Egan does not really ‘understand’ construction and many of the proposals are unrealistic. Undoubtedly though, from a risk management perspective, more standard repeatable situations whether in product or process, means less uncertainty about outcomes and therefore less risk. The degree to which this can happen in practice will continue to be debated. To conclude this section of the discussion, a quote from Raftery offers a balanced view: “while it is a cliché and an overstatement to say that every project is unique, it is true that there are large differences between projects”
In text question Why are standard repeatable situations desirable from a RM point of view? The foregoing focussed on the risk and uncertainty that stems from features of the project itself. The next section looks at the environment within which the project exists and the influence this has on exposure to risk and uncertainty. The concept of the project having an internal and external environment is introduced.

Unit 5 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

5.5

Risk and the Project Environment

A construction project can be described as an “open adaptive” system with an internal environment and an external environment. The project is “open-adaptive” system in the sense that it affects, and is affected by, its external environment. Because the internal and external environment interacts, the boundaries between the project and the “outside world” are said to be porous. The internal and external environments are populated by stakeholders who will be affected by the project in some way, either directly or indirectly. This can be either positive or negative i.e. they will gain or lose something from the existence of the project. The various categories of stakeholder in the “project world” are a source of risk which will warrant examination in any RM exercise. All risk can be categorised according to whether it emanates from the internal or external environment. Commercial opportunity/ social need

Project affects & is affected by its external environment “world at large” markets people communities agencies

Environment interacts with people interacts with surroundings construction &operation

External Environment

controllable Internal Environment Project constitution/ organisation

uncontrollable


In text question What makes a construction project an open-adaptive system?

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Unit 5 - 7

5: Risk and the Nature of Construction Management

5.5.1 External Environment No project exists in a vacuum. It is affected by externalities in the way that the demand for the functions that the building is providing is borne out of some perceived need by the client. In the case of private sector clients this is usually some commercial opportunity identified by a business for which expansion or modification of facilities is required. (This should be familiar from the discussion in the previous unit on the strategic issues of a project’s development). In the case of public sector clients it is usually to fulfil some social need or obligation. Whatever the case, the project is a vehicle for achieving the organisations objectives and there is considerable speculative commercial risk attached to the investment. Risks in the political, social and economic environment stem from government policy and world economy events that can affect the construction industry e.g. changing interest, inflation and taxation rates. This form of environment risk affects the whole of the construction industry. A common example of an industry specific risk is that of a national strike by certain trades. In the physical external environment the weather is an obvious example which poses risks that can significantly upset planned construction processes. Prolonged rain, extreme temperatures and high winds are natural phenomena that can delay certain activities and upset construction programmes.
In text question In what way is the project shaped by its external environment? The project also affects its external environment in the way it changes the environment and also affects people not directly involved in the project. The very process of construction itself is a visible, often intrusive process. Many individuals and groups can be affected in some way, positively or negatively, by the project. For example, a new building may be perceived to enhance an area. It may have aesthetic appeal, contribute to the regeneration of an area, provide some service that is desirable to the community or increase employment from the staffing and running of the facility that will be required. In such circumstances it would be considered an asset to an area and be positively received by the local community and members of the public, who represent an aspects of the external environment. Given this scenario, the stakeholders in the projects external environment would not present a problem or risk to the project. Conversely, projects may be received negatively by sections of the local community. Projects which are perceived to be detrimental to an area for any number of reasons- because they degrade the landscape, cause people Unit 5 - 8

Heriot-Watt University

Value and Risk Management [D19CV9]

to worry about the effect on the value of their own property, object to the activities that will be carried out in the building, or object to the nature of the client’s business. Perhaps the noise and disruption from the construction process itself creates objections. There have been several high profile examples of projects severely disrupted by individuals and protest groups for environmental or political reasons. In such circumstances the external environment and its stakeholders pose a substantial threat to the project. Stakeholders have to be taken account of as part of the RM process. Stakeholder mapping is a related aspect of project management which is dealt with elsewhere in the programme.
In text question Can you list some projects which have been threatened by external environment stakeholders?

5.5.2 Internal Environment The Internal environment largely comprises the project team- both demand and supply side. The former represented by the various elements of the client organisation (sponsor, users, employees, design team consultants, project manager) and the latter the production side of contractors, sub-contractors and suppliers). The performance of this project organisation is very important to achieving the project objectives, as the discussion on the project as a temporary multi-organisation in the previous unit has introduced. Somewhere in the interface between the external and internal environment are agencies such as utility companies, local authorities, planning and building control. They are not core part of the project or design team, but nevertheless will directly influence decisions made and affect project success.

5.6

Controllable or Uncontrollable?

Risks can also be categorised as “controllable” or “uncontrollable”. As the terms suggest a controllable risk is one that can be managed and controlled, and its likelihood of occurrence is directly related to competency of management on a construction project and to the performance of site personnel and operatives. Risks in the internal project environment would fall into this category. Conversely an uncontrollable risk is outwith the control of any of the parties to a project. Environment risks such as adverse weather conditions and inflationary rises on material costs are examples of uncontrollable

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Unit 5 - 9

5: Risk and the Nature of Construction Management

risks. Risks from the external project environment would fall into this category. Although uncontrollable, such risks can be foreseen and accommodated for.
In text question Why are risks in the external environment uncontrollable?

Unit 5 - 10

Heriot-Watt University

Value and Risk Management [D19CV9]

5.7

A Checklist of Risks

The following is a generic checklist of risks that may affect any construction project. It is not exhaustive, but gives an indication of the range and sources of risks that can affect construction projects. 3rd Party Risks •

•

•

• • •

Approvals • Planning approvals • Conservation area consents • Environmental impact assessment Legal Agreements • Rights of way • Rights of light • Noise control requirements • Site of special scientific interest Pressure Groups • Local pressure groups • National pressure groups Industrial action Terrorism Changes in regulation

Site specific risks •

• • •

•

•

Ground conditions • Extent of pre-construction investigations • Soil types and variability • Mining works/subsidence • Contaminated land Climate and weather conditions Access restrictions/limitations Existing occupiers/users • Alternative provision • working hour restrictions • maintenance of access roads • Maintenance of services Existing buildings • Need for protection • Need for demolition Security

Contractor risks •

•

• •

Failure to meet programme • Poor co-ordination of subcontractors • Inclement weather • Price changes permitted under certain contracts • Disputes and claims • Poor site management Accidents or injuries for which client retains responsibility • Under contract • Due to client staff Latent Defects Liquidation of contractor

Client Controlled risks • •

•

Inaccurate or insufficient terms of reference Changes in project scope • Occupancy • Usage • Size Delays • Late decision making • Late handing over of site Delayed programme

Design team risks • Inaccurate interpretation of terms of reference • Errors in design, contract documents, drawings • Failure to meet timescale • Estimating inadequacies • Escalating labour, plant, material costs • Taxation changes • Liquidation of design team members

Environment risks • •

Political change Government legislation

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Unit 5 - 11

5: Risk and the Nature of Construction Management


In text question Which of these risks are internal and which external to the project environment?

5.8

Risk and the ‘source-event-effect’ chain

To recap, in construction risk management a risk is any event or occurrence not turning out as planned and affecting some aspect of the project (usually adversely). In practical terms this usually means an increase in cost or time being incurred by parties to the project. To understand this more fully it is useful to analyse risk in terms of its component parts- the various sources of risk, corresponding events and the effects they have.

SOURCE Where does risk come from?

EVENT How does risk manifest itself?

EFFECT

What is impact T, C, Q?

The source of a risk refers to where in the project environment, internal or external, the risk emanates from. At the general environment level, extreme weather conditions such as prolonged rain, frost or high winds are a source of risk that could potentially affect the project - usually negatively. At the project level any of its participants, directly or indirectly involved, are all potential sources of risk. The risk event is the actual manifestation of a risk on some part of the project or the project as a whole i.e. how it occurs. For example, if an unproven supplier is a potential source of risk, the associated event might be late or wrong delivery of materials to the site. If severe frosts are a weather risk, the associated event might be delay to concreting operations. If volatile economic conditions are an example source of risk, the associated event might be serious increase in the cost of skilled finishing joiners later in the project. Generic risk checklists contain potential sources of risk exposure on a project, but the associated risk event is particular to the project and surrounding circumstances. The effect of a risk refers to what impact or consequences it will have for a party or parties to the project. The impact can be measured in time, monetary or quality terms - though ultimately the impact of risk events occurring will be monetary for somebody. Therefore, whilst it is true to say there are many sources of risk on a project, the effects are few.

Unit 5 - 12

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Value and Risk Management [D19CV9]

Self Assessment Questions 1. Consider the aspects of the ‘risk hierarchy’ as described by Flanagan and Norman. Which of these are internal and which external to the project environment? 2. In your view, what type of buildings exhibit most features of standardisation? Think of specific examples you are familiar with.

Heriot-Watt University

Unit 5 - 13

6: Risk and the Client

6.1

Introduction

This unit considers project risk from the perspective of the client. There are 3 main aspects of risk that should be assessed from the outset, and a systematic approach to doing this is described. These risk aspects centre around strategic concerns about how the project relates to the client’s operations, as well as the risks inherent in the project deliverable itself which are commercial, technical and managerial in nature.

6.2 • • •

6.3

Learning outcomes Understand how risk to the clients business from a project can be assessed. Understand how the approaches to establishing a project’s objectives contribute to the amount of risk in achieving them. Become familiar with the technical, commercial and managerial risk factors of a project

Risk and the client

The less information there is about a given situation or future event, the greater the associated uncertainty- and consequently the greater the amount of risk involved. Uncertainty on any project will be greatest at the outset when there is little hard information about project requirements or the nature of the deliverable. If we consider the client’s risk exposure at the outset, some key questions that have to be considered are; • • •

Is there a clearly defined demand for the project? Will a building meet that demand? Can it be built within the cost limit, to the required quality, and within the time constraints required to meet the demand?

6.3.1 Risk and the client’s investment in a capital building project “The client” is an all embracing term in construction and can include anything from a multinational organisation, government department, speculative developer or private individual. One thing they all have in common, though, is that they commission, pay for and in most circumstances use the buildings for a specific commercial purpose. Most

Heriot-Watt University

Unit 6 - 1

6: Risk and the Client

buildings are investment goods- that is to say they are only a means to an end- used as part of the production process but not contributing directly to the generation of profit for an organisation. Even public sector investment in building projects must have a sound business case. For commercial clients the purpose may include furthering the production of goods and services, through the provision of factories, offices or some industrial process. Investing in new/adapted buildings or facilities to house some process or activities will add value to the organisation. Since risk is inherent in all investment decisions an early question is whether constructing a new building represents the best use of funds out of all the investment opportunities open to the client. In commissioning a building a client is committing a substantial amount of capital that could be invested in some non-construction venture that may provide a higher or lower return. Therefore, the risk that is present at this strategic stage is the possibility that there may be a more attractive investment offering better returns. The various investment opportunities will be characterised by varying degrees of risk and associated return. The greater the risk involved, the greater return expected. For example treasury bonds are a long term, low risk financial instrument with predictable rates of return. On the downside the returns are low. The stock market provides potentially much higher rates of return through ordinary shares, but as various financial crashes have shown the value of shares can go down as well as up. Property as an investment is exposing the client to risk since it does not provide a guaranteed return unlike some other forms of investment. Property is also not “liquid” in that transactions take a long time to complete. It is a risky proposition because of the unpredictability of returns. During boom periods the capital growth is very attractive, but when the market is in recession property prices can drop quite dramatically in value. The pre-decision to build stage will include some investment and development appraisal. At this stage the client is striving to determine whether the project provides a satisfactory rate of return commensurate with the level of risk associated with the project.
In text question What is it that makes most buildings investment goods?

Unit 6 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

6.4 A Client Approach to Evaluating Project Risk – the 3 aspects of risk From the perspective of any reasonably sized client organisation in construction, there are 3 main risk aspects at the strategic project level that should be thoroughly reviewed when the project commences. This section of the unit discusses these 3 main aspects with reference to research carried out by Australian public sector agency (see supplementary reading) and published in International Journal of Project Management. The work is of wide reaching interest though as the principles are largely applicable to any reasonably large client organisation. It will also deepens understanding of the risk ‘anatomy’ of construction projects and their strategic importance to the client business. The 3 risk aspects to be reviewed relate to 1. How the T, C and Q objectives are established at the outset and the degree of confidence in them 2. What the impact to the client organisation is in failing to meet these objectives 3. The ‘riskiness’ of the project itself- the risk profile of the building.

6.4.1 Aspect 1: Establishing T, C and Q objectives As discussed in previous units; fundamental issues to be resolved early in the project are its scope and definition, a timescale for its delivery and the budget. (i.e. T, C and Q objectives). It is against these objectives that the success, or otherwise, of the project will largely be judged. If the basis for establishing these objectives is not sound or realistic, then conditions of risk and uncertainty are present from the outset. Remember that a definition of risk is the possibility that actual outcomes deviate from those predicted. If the predicted outcomes are not sensible or achievable, then it follows that actual outcomes are likely to deviate from predicted. The table below shows how risky a project is according to how these objectives are established. As the means of establishing T. C and Q objectives become increasingly unsound and unclear, the ‘risk rating’ for the project increases. Notice how, for all criteria, it is the level of information available which determines the level of risk involved. Projects which have inbuilt contingencies (a form of RM) are the least risky, and those with a higher risk rating indicate more “unknown unknowns”

Heriot-Watt University

Unit 6 - 3

6: Risk and the Client

Establishing T, C and Q objectives Risk Rating 1

Objective Time

Cost

Quality

Benchmarks were used to establish schedule and adequate contingencies exist

Benchmarks were used to establish budget and adequate contingencies exist

Quality requirements have been agreed and documented

2

Benchmarks were establish schedule

Benchmarks were establish budget

to

Quality requirements have been agreed and are being documented

3

The basis for the schedule is clear, but indications are that overruns are possible

The basis for the budget is clear, but indications are that overruns are possible

Quality requirements have been agreed but not yet documented

4

The basis for the schedule is unclear or the budget is likely to be inadequate

The basis for the current budget is unclear or the budget is likely to be inadequate

Some initial discussions with the client on quality requirements

There is no clear schedule or the schedule is clearly insufficient

There is no clear budget or the budget is clearly insufficient

Quality requirements are not known

“known knowns”

used

to

used

- Good PM & cost control - More info across criteria - Explicit contingencies - Less uncertainty

“known unknowns”

5

- Absence of good PM - Less information - Increasing uncertainty

“unknown unknowns”


In text question What characterises a project with a high risk rating, and a project with a low risk rating in relation to this aspect?

6.4.2 Aspect 2: Consequence of failure to meet T, C and Q objectives The second main aspect to be assessed is the risk to the client from not meeting the project objectives. i.e. what are the consequences to the clients business or operations should the project be delivered late and/or over budget. The T, C and Q objectives for any project are always in tension as they are competing for finite resources, and have to be prioritised according to their importance to the client. An early purpose of VM is to help determine these high level objectives and their level of priority. Some objectives, and the consequences of not meeting them, will be more critical than others. As you would expect, as the project value increases, the risk rating of the project increases since the project will represent a larger proportion of the clients overall business. Again, it can be seen from the table that the ‘risk rating’ of the project for this aspect increases as the consequences of failure to meet the objectives become more critical. These range from nuisance value at the lowest level (risk rating of 1), through to complete failure of the business at the highest level (risk rating of 5).

Unit 6 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

Meeting T, C and Q objectives Risk Rating 1

Objective Time

Cost

Quality

Completion date not important (project period <6 months)

Additional funds available (project cost <£25000)

No noticeable effect on client’s business

2

Alternative arrangements available (project period 6 – 12 months)

Some scope for additional funds (project cost £25000 - £250000)

Tolerable effect on client’s business

3

Delays undesirable but could be managed (project period 12 – 18 months)

Request for additional funds would be difficult (project cost £25000 - £1M)

client’s business moderately affected

4

Severe disruption to clients business (project period 18-24 months)

No additional funds available and scope reduced (project cost £1M - £2M)

client’s business severely disrupted

5

Clients business ceases altogether (project period >24 months)

No additional funds available and project will not proceed (project cost >£2M)

client’s business altogether

ceases


In text question What is the riskiest scenario for a client in not meeting the project’s objectives?

6.4.3 Aspect 3: Risk Profile of a project The first 2 aspects of risk described above consider project risk at a global, or strategic level, i.e. considers the project and how it relates to the clients business or operations in overall terms. The 3rd aspect of risk is concerned with the detail of the deliverable itself i.e. assessing the risk characteristics of the project. Understanding all the elements of the risk anatomy of a project helps to heighten awareness of and sensitise the team to risk. Again, although this table relates in particular to a public sector client, it will be recognised that nearly all of the factors described are relevant to any client organisation. Such a checklist of factors can be used to assess the overall riskiness of a construction project. The table below shows a range of technical, commercial and managerial factors against which risks can be assessed. Riskier projects will obviously have a greater number of drivers assessed at a higher risk rating. Notice how there are a mixture of strategic (project definition), tactical (project delivery) and organisation & relationship issues.

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6: Risk and the Client

Risk profile of a project High 5

Factor

Risk Rating 3

4

2

Low 1

Modifications to an existing design

One of a series of repetitions

Supply installation

Supply only

Uniqueness project

of

Prototype incorporating new techniques

Unusual project

Conventional project

Complexity deliverable

of

Outcome based contract (e.g. PFI)

Coordination of services (e.g FM)

Design construct

Private sector funding or joint venture

Capital works not yet approved or requested

Capital works in forward estimates

Capital works already allocated

Recurrent funds in current year

Very likely to be inadequate

Likely to adequate

Adequate with some contingency

Project location

Remote, inaccessible

Remote, accessible

Tight budget, achievable with control Regional but distant

Adequate with generous contingency Metropolitan

Project surroundings

Activities in occupied areas

Staging within occupied areas

Additions to occupied areas

Well clear of occupied areas

Greenfield site

Hazardous materials

Working hazardous materials

with

Possibly involves hazardous materials Brief project description

Unlikely to encounter hazardous materials Feasibility study completed

No known hazardous materials

No project information available

Hazardous materials exist, but not part of works Generic project brief available

Site availability

Site not identified

Several identified

sites

Site identified but not yet purchased

New purchased

Existing site

Project justification

Need has not been justified

Justification questionable

is

Needs justified but may change through project

Project approvals

Unidentified approvals required

Potential approval delays have been identified

Required approvals known documentd

Need justified based on historical information Few approvals required or most obtained

Need fully justified through recognized process No approval required or already obtained

Clients experience

Inexperienced multiple clients

Inexperienced single client

Experienced multiple clients

Experienced single client

Client relationships

Multiple reluctant clients or relationship not established

Mixed experience amongst clients Mixed relationship with clients

Reluctant client or relationship not established

Good working relationship (multiple clients)

Good working relationship

Unknown contractors

Limited number of unproven contractors

Limited number of competent contractors

Adequate number of competent contractors

Abundance competent contractors

Procurement method

No tendering and involving sponsorship

Negotiated tender

Tendered outside agency

Public tender

open

Selected tenderers

Consultant selection

Selection without approved processes High level of political, community or media sensitivity

Design competition

Full EOI and RFP

Period consultant

panel

High profile client or project

Stakeholder groups involved

Project may attract stakeholder or media interest

Consultant selected using approved process Project unlikely to attract stakeholder or media interest

Financing

Adequacy funds

Definition project

Assessment contractors

Stakeholder interest

of

of

of

be

and

are and

and

Regional

site

Detailed project brief available

of


In text question From your own experience, list projects that you know of which would fit into either end of the risk profile spectrum

Unit 6 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

These factors can be grouped according to whether they are strategic or tactical- concepts which should now be familiar from discussion in earlier units

Grouping of Risk Factors 7 funds/financing 8 definition of project 9 project justification 10 stakeholder interest 11 site availability

(Strategic level)

Project related 12 13 14 15 16

17 Project 18 Management 19 related

project location project surroundings hazardous materials availability of contractors uniqueness of product

(Tactical level)

clients experience client relationships consultant selection

6.4.4 Summary of risk aspects Taking these 3 main risk factors together- the means of establishing T, C and Q objectives and the confidence we have in them, the consequences of not meeting them, and the risk characteristics of the project itself- we can build up a complete picture to rate the overall riskiness of a project. At one extreme scenario of low risk we would have a technically simple project of modest cost, where sound information underpins the estimates and forecasts, and with an impact to the clients business which is minimal anyway should they not be met. At the other extreme of high risk we would have a difficult and novel project, where forecasts are based on poor/incomplete information, and it forms a critical part of the clients business. Of course these scenarios are an oversimplification and, realistically, any project will have a mixture of risk ratings across all three of the aspects as described.

Heriot-Watt University

Unit 6 - 7

6: Risk and the Client

Self Assessment questions 1. Clients can be categorised broadly as public sector or private sector- how might they be further categorised according to their demand for buildings? 2. There are many sources of risk, but ultimately few impacts. What are the impacts of risk on any project?

Unit 6 - 8

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7: The Risk Management Process

7.1

Introduction

Previous units discussed the nature of risk and uncertainty and the ways in which it can affect the construction project. The strategic and tactical viewpoint of risk, according to where in the PLC it is being assessed has also been examined. Hopefully, the importance of ongoing RM to project success is now firmly established in the readers mind. This (and the next) unit now turns attention to more specific matters of applying risk management itself. i.e. how it is actually carried out in practice. The RM framework, which sets the agenda for the team based study, is explained. A number of these studies, applied at targeted stages throughout the PLC, would constitute a comprehensive approach to project RM. A study structure for combining both VM and RM together is also presented. The unit which follows explains some of the actual tools and techniques that can be employed by a team within a study.

7.2 • • • • •

Learning outcomes

Be aware of the RM framework Understand risk identification activities Understand risk assessment activities Understand risk response activities and outcomes Understand how a combined VM and RM framework might be implemented.

7.3

RM terminology

As for the definition of what RM actually is, the description of what constitutes the RM process differs slightly from author to author. Again, though, there are a number of key steps recognisable in all which are discussed. It is mainly a difference in terminology and emphases which separates the various explanation of RM, rather than any matters of real substance. The following is an overview of the generic RM process which would fit any application, adapted from the PMI PMBoK

Heriot-Watt University

Unit 7 - 1

7: The Risk Management Process

7.4

The Risk Management Framework

Risk management planning

Risk identification The study

Risk analysis Risk Response

Risk monitoring and control

Define the process to be followed -Agree process for the project -Identify roles and responsibilities -Decide frequency of reviews and reports

A number of techniques available - brainstorming - checklists - interviews - questionnaires

Quantitative or qualitative - quantitative: simulation, scenario analysis… - qualitative: nominal group techniques

What to do about priority risk areas? Action taken to mitigate threats/exploit opportunities

Ongoing evaluation of risk throughout Project life cycle. Updating of the Risk Register

Figure 7.1 The Risk Management framework 7.4.1 Risk management planning The first stage of RM is for the project team to actually define and agree the process to be followed at the outset as part of the overall project management plan. This may already be reasonably well defined where an established PLC framework is being followed. An example would be where the public sector OGC procurement framework is being adopted. This has clearly identified RM application points throughout the PLC, each having a particular purpose. Alternatively, in the case of organisation’s with no recognised approach, this would have to be defined from scratch. This is likely to depend on the level of experience and maturity of the organisation as far as its risk management practice is concerned. In addition to identifying the points at which RM is to be applied in the project, it is necessary to identify roles and responsibilities of the participants involved, agree the methods and approaches to be used and review and reporting frequency. In short, the RM plan defines how RM will be undertaken and implemented throughout the project. For each risk study the appropriate members of the team will come together and work through steps 2] to 4] as described below, within a facilitated and highly structured workshop type setting. It is likely that either the project manager or someone else with specific RM responsibility will facilitate the risk study sessions. An external consultant

Unit 7 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

is often engaged to facilitate the study and effectively manage the work of the group.
In text question What do we mean by RM planning?

7.4.2 Risk identification This is the first step to be carried out within each risk study undertaken on the project. There are a number of possible creativity techniques that can be used for risk identification, but by far the most common is the technique of brainstorming. There is no single “best” technique to be used; only the most appropriate to fit the circumstances. Part of the facilitator’s skill is in selecting the techniques most appropriate to the nature of the study and the team members involved. The purpose of the risk identification stage is to capture all possible range of risks that might affect the project at that stage of its development. The emphasis is to maximise the quantity of possible risks rather than their quality. i.e. no assessment is intended at this stage as this may stifle the creativity process. By generating a large quantity of imaginative risk scenarios, it is more likely that all possible scenarios will be covered. At the conclusion of the risk identification stage the team will have a list of risks that threaten the project (or opportunities to be exploited)
In text question How many risks should be recorded at the identification stage?

7.4.3 Risk Analysis In this step an assessment of the likelihood of each risk is made for its likelihood of occurrence (probability) and effect on the project objectives (impact) if it were to occur This assessment may be a simple descriptive (or qualitative) statement of their perceived likelihood of occurrence, or in a more detailed exercise a numerical probability will be attached to each. A two stage approach may be adopted, with the first stage used to quickly screen out those risks not worth further deliberation (either because their likelihood is so small, their impact insignificant, or a combination of both). The approach to be used will be influenced by the quality of information available and also upon the type of analysis to be carried out by the team. Again, there is no “correct” or “best” approach and the level of sophistication is not necessarily an indicator of the quality of the exercise. There is not normally any detailed ‘analysis’ as such. i.e. there is

Heriot-Watt University

Unit 7 - 3

7: The Risk Management Process

no sophisticated number crunching involved. Such a quantitative approach would not normally be appropriate for use with a workshop setting, though may be carried out separate to the study. An techniques applied within the workshop setting should be simple to understand and easy to apply, so that the team can concentrate on the real issues at hand, rather than being bogged down and distracted with complicated analysis techniques. The amount of effort expended should be commensurate with the needs of the project. At the end of this step the team will have a clear view of and consensus of the risk profile of the project at that point in time, based on the knowledge, expertise, experience and judgement of all those involved. A consensus should emerge on what the priority areas are where attention and resources should be focussed on dealing with the risks.
In text question What features does a good workshop technique have?

7.4.4 Risk Response In this step, planned responses to the most pertinent of the identified risks are developed. Obviously it is not possible, affordable or appropriate to develop responses to all identified risks. The team will focus only on the higher priority areas. Whatever the approach to dealing with each of the identified risks is agreed, it will lead to one of the following effects, and this should be clearly identified as part of the exercise. The following all relate to negative risk, where the objective is always to minimise. Elimination This is obviously the most desirable outcome to completely eliminate the risk. Possible areas may be to eliminate a safety risk by not undertaking a certain type of welding inside a building, but perhaps prefabricating. Reducing probability of occurrence This involves reducing the probability of a risk event materialising. For example, if theft of materials from the site is considered a major risk, the contractor may respond by employing 24-hour security on the site. Introducing education and training programmes in the use of certain equipment for staff will reduce the probability of occurrence. Reducing impact of occurrence Acknowledging that a risk event may still materialise no matter how much effort has been invested in avoiding it, strategies may be put in place to minimising their consequences. Such strategies may include providing a standby generator in the event the main one fails, preparing an emergency evacuation plan in the event of terrorism, fire drills etc and installing a sprinkler system in the building to reduce effects of fire damage.

Unit 7 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

Transfer risk Contractual transfer of a risk perhaps to another party or insurance company is a method of dealing with risks that cannot be wholly or partially eliminated. Of course, transferring a risk does not reduce the effect it would have, or the likelihood of its occurrence- it only passes the responsibility for it to another party.


In text question Will the team develop responses to all the identified risks?

Threats

Opportunities

Eliminate

Exploit

Transfer

Share

Reduce probability

Enhance probability

Reduce impact

Enhance impact

Absorb (accept)

Ignore

Insurance as a risk transfer strategy A common means of risk transfer is through insurance. The effect of obtaining insurance cover is to convert an uncertain exposure to some risk to a known cost, that is to say, the premium to be paid for obtaining cover. It has the advantage of smoothing out unpredictable peaks in losses, in favour of a regular annual liability to the insurance company. Insurance is an easy “sleep soundly” option to risk management, suitable for organisations who could not cope with financial exposure to such losses from time to time. However, it is also perceived as an unsophisticated approach to risk management and should only be used as a last resort or when strictly necessary, such as when required by the contract or for statutory reasons. Insurance often does not represent value for money for an organisation, since the premium will be based on general claims experience of other organisations that may not reflect the firm’s own experience. Also there is a high mark-up to cover the overheads and profit of the insurance company, and also the possibility of disputed claims and delayed payments if the service offered is poor.

Heriot-Watt University

Unit 7 - 5

7: The Risk Management Process

The growing cost of insurance services has been a contributory factor in the development of the risk management profession. Recently insurance cover has proved to be too expensive for some organisations or unobtainable for some risks. This has led to the necessity for more improved management of the risks an organisation carries. Organisations that are more sophisticated in their risk management techniques are less likely to need widespread insurance cover, instead using it tactically where strictly necessary rather than for blanket coverage. A consequence of this is that the insurance market is made up of cover for organisations that are poorly managed, or for risks that are unpredictable and high impact, leading to ever-spiralling premiums. The risk register The results of a risk management exercise should be recorded in a single document, known as the risk register. The risk register is simply a single source of reference for all the risks and their current status for a project. It should be emphasised that the risk register is a dynamic document and will need updating over time as the risk profile changes. Probability of occurrence Source

Owner

Consequence

--Response

Eliminate

EFFECT

---

Transfer

Reduce

A typical risk register
In text question What makes the risk register a dynamic document?

7.4.5 Risk monitoring and control The final step of the risk management process aims to monitor the status of identified risks, identify new risks, ensure the proper implementation of agreed responses and review their effectiveness, as well as monitoring changes in overall project risk exposure as the project progresses. Risk review meetings maybe held to assess the current status of risks to the project, and project review meetings should include status reports from the project team on key risks and agreed responses.

Unit 7 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

7.5 The combined value and risk management workshop Value management and risk management are closely related, both in their objectives and process of workshop implementation. However, the value management and risk management methodologies have been presented as two discrete entities with separate value management job plan and threestep risk management framework. Traditionally the literature and practice of both value management and risk management has dealt with them separately, but more recently there has been interest in combined value and risk management approaches. A combined service is achieved essentially by integrating the two methodologies. The value management job plan provides the overall framework with a number of “intervention points” for risk management activity. There are benefits and limitations of a combined value and risk management approach as opposed to separate value management (VM) and risk management (RM) activities. Although there is no definitive methodology for value and risk management, the intervention points where risk management stages may be logically carried out within the job plan are shown in the diagram below.

VM Job Plan

RM Intervention points

1. Information Select topics for Function and risk brainstorming from FAST diagram 2. Creativity

Identification Brainstorm risks associated with function solutions. Brainstorm global risks 3. Evaluation

Analysis Evaluate risks, select those requiring consideration 4. Development

Analysis 5. Presentation

Consider remaining risks, weight them and develop a response Response Develop risk register for presentation

Figure 6.5

The VM job plan

Heriot-Watt University

Unit 7 - 7

7: The Risk Management Process

Value and risk management workshop structure Stage

Main Activities

Discipline

Output

Information

Function Analysis

VM

Creativity

“Positive” Brainstorming

VM

Identify Solutions & Construct FAST Alternative solutions to functions

RM “Negative” Brainstorming Evaluation

Crude sort Discard infeasible VM solutions RM Prioritise brainstormed risks VM Refined sort Pairs RM comparison/criteria weighting Risk weighting (prob. & impact)

Development

Presentation

Develop solutions VM into proposals RM Develop response strategy for priority risks Present solutions and VM/RM risks to client

Risks associated with solutions Global risks Solutions consideration

for

Risks consideration (Function Global)

for

Ideas development

and

for

Prioritise risks requiring response strategy Worked up proposals Risk strategy

response

Client report

Self-assessment question What are the practical benefits and limitations of combining value and risk management into a single service? Who would you expect to be involved in a construction RM workshop at the briefing stage?

Unit 7 - 8

Heriot-Watt University

Value and Risk Management [D19CV9]

Who would you expect to be involved in a construction RM workshop during the construction phase? Think of a project, construction or otherwise, that you have been involved with. Would the application of a RM workshop have improved the outcome?

Heriot-Watt University

Unit 7 - 9

8: Tools and Techniques of Risk Management

8.1

Introduction.

This unit introduces some of the more common tools and techniques applied within a RM workshop study. These help the team lend structure to the study for effectively identifying and assessing risks that affect the project. Tools and techniques that are appropriate for a workshop study will be easy to understand and straightforward to apply.

8.2 • •

8.3

Learning outcomes Become familiar with some of the more common RM tools and techniques Be able to apply these in practice

Techniques for the Risk identification stage

The objective of this stage is to compile a list of possible risks that might affect the project. A number of information sources or certain techniques may be used, and some of the more common are described below. Historical data Probably the best means of assessing what the risky aspects of a project are is to draw from direct experience of similar past projects, since most projects contain a number of reasonably standard and recognisable risk situations. Useful historical data for risk identification in the construction project may come from a number of sources. An obvious example of historical data is that of the Meteorological Office for weather forecasting, where prediction of future events is based on many years of recorded past events of rainfall, temperature, wind speed and direction etc. Although this is from outside the construction industry it obviously has its uses in construction management and planning, such is the influence the weather has on many operations. Insurance companies, by the very nature of their business, are sophisticated in risk management and also rely heavily on historical records of the occurrence and impact of past events for risk analysis. Within the construction industry, bodies such as the Building Cost Information Service observe past trends on tender price levels and the Heriot-Watt University

Unit 8 - 1

8: Tools and Techniques of Risk Management

effect that inflation has on the labour and materials markets. Based on this data, predictions for the future are made. Although actual experience, documented in historical records, is the most reliable and desirable source of information for use in risk management, it has to be said that it is also the most wanting in construction management. The types of databases of information simply do not exist in any usable form yet for widespread use. The extent and usefulness of records kept within the organisation itself will depend partly on how sophisticated its risk management operations are. If a register, or log, of the risk profile of previous projects has been built up, this will provide a useful source of information. It may be that these will develop over time as the discipline and the industry matures. On the other hand, much has been made of the “uniqueness” of construction projects [Raftery et al] and the problem may be too intractable to develop any meaningful industry wide databases.
In-text question Why is there a general lack of useful historical data for risk identification?

Checklists Generic checklists are a useful source of information when compiling a list of possible risks associated with a project. A checklist is simply a comprehensive list of risks that could affect any project. Although necessarily general in nature checklists can be used as prompts in determining what the potential risks are for the project under study. Published risk checklists in texts and journal papers can be consulted as part of the risk identification process. Separate ones exist for client, contractor and consultant perspectives. Whilst checklists are undoubtedly a convenient and relatively simple approach to risk identification it is important not to be over reliant on them. There is a danger that they can act as a straitjacket and actually inhibit detailed thought on specific project risks that may not be recorded on a generic checklist. Brainstorming This is one of the most powerful, and most widely used, techniques for risk identification. Brainstorming is a creativity technique extensively used in value management and much can be found written about it in value management literature. Essentially a brainstorming session is a short-term intensive group exercise, where a team of individuals will generate as many ideas as possible for risk events that may adversely affect the project. In a sense, this may be termed “negative brainstorming” as the team of individuals is trying to determine all the things that may go wrong with the project i.e. the downside risks, as compared with more

Unit 8 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

conventional value management brainstorming where the team is trying to generate ideas for fulfilling functions.

8.4

Techniques for the Risk analysis stage

The second phase of the risk management process is risk analysis. The objective of risk analysis is to determine what the impact or consequences would be of a risk event occurring. The impact may not be restricted to the project itself, but could have an effect on the whole organisation depending on how serious a risk, or combination of risks, are. Not all of the risks identified at the risk identification stage will be given the same consideration since there are simply too many to consider. There are an almost inexhaustible number of risks that could affect any project and it would simply be too time consuming to deal with them all. The point is to limit the analysis of project risks to those that are most serious, namely those that have a high impact on the project in terms of time, cost and quality. It is also worth considering risks which may have lesser, but still significant impact, if they are highly likely to occur since the cumulative effect of a number of low impact risks materialising may have serious impact. Ultimately, the effect of all risks directly or otherwise is in increased costs for one or more parties to a project, whether client, contractor, subcontractor or consultant. The assessment of likelihood of occurrence i.e. the probability, may be a simple qualitative exercise where probability of each event is assessed against some descriptive scale. This may be as basic as a three point scale of “low”, “medium” or “high” probability, or it can be refined up to any number of descriptions. The two tables below are examples of probability gradings. Although this may appear to be a subjective or “unscientific” approach to assessing probability of risk occurrence, the use of a common scale gives a measure of objectivity to the exercise. Such intuitive assessment, formalised in this way, is a powerful technique when employed by experienced individuals. It can be seen from the second column of the tables below that an informal, qualitative grading can be quantified and expressed in more formal, numerical terms. This provides a format suitable for any subsequent quantitative risk analysis.

Heriot-Watt University

Unit 8 - 3

8: Tools and Techniques of Risk Management

Assessed likelihood No chance of occurring Unlikely to occur As likely as not Likely Almost certain Certain to occur

Equivalent probability 0% 5 - 45% 45 - 55% 55 - 95% 95 - 99% 100%

Assessed likelihood Loss is not possible Very remote possibility Remote possibility Slight chance of occurrence Slightly less than equal chance Equal chance of occurring Fairly possible More than likely to occur Predictable Very likely to occur Loss is certain

Equivalent probability 0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0

Figure 8.1: From Qualitative to Quantitative, two examples (adapted from Edwards) 8.4.1 The risk grid (probability-impact matrix) In the initial stages, a qualitative risk analysis study will always be carried out. Any further and more detailed consideration of the most serious risks highlighted may then be the subject of more sophisticated quantitative analysis.

Unit 8 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

PROB. RISK MATRIX

MEDIUM PRIORITY

HIGH PRIORITY

PROB

H

LOW PRIORITY

MEDIUM PRIORITY

M

IMPACT

L L

M

H

VHI

VHI

HI

HI

MED

MED

LO

LO

VLO

VLO VLO

LO

MED

Negative impact

Figure 8.2

HI

VHI

VHI

HI

MED

LO

Probability

Probability

“Arrow of Attention”

VLO

Positive impact

The risk grid (probability-impact matrix)

After a risk list is compiled using brainstorming and any other appropriate techniques each identified risk area is gone through and a quick assessment made of its impact and probability of occurrence. This is a group activity and the assessments should be based on consensus. Depending on which “box” on the grid each risk is placed in, based on probability and impact, it can be prioritised as having low, medium or high priority for further investigation and consideration. The advantage of the risk grid approach is that it is quick and easy to apply, and can be readily understood by everyone involved in the risk workshop. Its limitations are that it is a rough technique, and further analysis will almost certainly be required for those risks having a higher priority. However it is always useful as a “first pass” through the list to streamline it and quickly Heriot-Watt University

Unit 8 - 5

IMPACT

8: Tools and Techniques of Risk Management

focus on the most important areas. Hillson (IJPM 20, 2002) developed a risk grid which separately identifies upside risk from downside risk, and termed the high priority area as the “arrow of attention.” The impact of risks can be further qualitatively assessed by some classification of their impact as in the table below. Some subjective estimate may also be made as to the financial loss associated with risk occurring. Grading 1 2 3 4 5 6 Figure 8.3

8.5

Assessment of impact Little impact, nuisance only Medium loss Manageable loss In range of largest previous loss Serious loss Catastrophic

Estimated cost

Risk analysis: severity grading

Quantitative or qualitative risk analysis?

Although the term risk analysis suggests some detailed numerical or statistical work, it is often the case that there is no actual number crunching to be done in a risk analysis exercise. Where some technique has been applied which requires input of numerical data and the carrying out of some calculation work, this is known as quantitative risk analysis. There are a number of standard techniques used in construction risk analysis that you may have come across before. Most are techniques developed in the operational research discipline (also known as quantitative management science) that have been appropriated for use in construction. A quantitative risk analysis study provides some numerical results that allow more informed decision-making by the team. Qualitative risk analysis does not involve any mathematical manipulation or application of numerical techniques. Instead, a subjective assessment based on the experience and intuition of the team may be used to determine risk impact. Although there is no “hard” analysis, a qualitative exercise still requires to be carried out using some structured system or rules in order that that the project risks are made transparent and presented in a consistent manner. Reasons for adopting a qualitative approach as opposed to quantitative may include a lack of resources (in terms of staff expertise and software for carrying out a numerical technique), lack of demand for a more detailed approach, absence of numerical data relating to identified risk e.g. probability of occurrence and its financial implications. On the other hand qualitative and quantitative exercises can be complimentary in the risk analysis phase.

Unit 8 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

At this stage it may be felt that a qualitative exercise is in some way inferior or less professional than the application of some numerical analysis in a quantitative exercise. However, this is an oversimplification since the type of analysis carried out will depend on such considerations as the data available, amount of time available, resources of the organisation carrying out the study and the attitude of management who will be making decisions on the basis of the outcome of the risk analysis. In short, there is no overall “best” technique: those used will depend on what is appropriate for the circumstances prevailing.

Heriot-Watt University

Unit 8 - 7

8: Tools and Techniques of Risk Management

APPENDIX 1 Glossary of Terms Risk

Possibility that an actual outcome will deviate from that forecast.

Risk Event

Actual occurrence of a risk with positive or negative consequences for a project.

Hazard

Risk of physical damage, injury or death.

Upside

Possibility that actual outcome of risk is positive.

Downside

Possibility that actual outcome of risk is negative.

Exposure

Extent of possible loss associated with a risk, usually measured in financial terms.

Risk Attitude

Willingness of an individual, team or organisation to take a risk.

Uncontrollable Risk

Risk whose possibility cannot be influenced by the actions of associated parties.

Controllable Risk

Risk whose possibility can be influenced by the actions of associated parties.

Pure Risk

Hazards that result in loss only. Usually covered by appropriate insurance in the contract.

Speculative Risk

Risks which may result in loss or gain and will be apportioned amongst parties to a project. Initial stages of a project concerned with defining its scope and developing the brief.

Strategic phase

Tactical phase Source

Latter stages of a project concerned with its design and delivery. Origin of the risk in the project environment.

Event

The actual occurrence, or manifestation, of the risk on the project.

Effect

The consequence of the risk occurring for a party or parties to the project.

Hierarchy

Means of classifying sources of risk according to where in the project environment they originate from. Non-numerical assessment of risk based on judgement and experience of individuals.

Qualitative analysis Unit 8 - 8

Heriot-Watt University

Value and Risk Management [D19CV9]

Quantitative analysis

Numerical measurement of risk exposure using RA techniques and processing of hard data.

Risk grid

Graphical technique for qualitative analysis of risk.

Risk register

Document recording the risk status of a project at a particular point in time. Requires frequent updating.

Self Assessment question 1. What qualities does a good workshop technique exhibit?

Heriot-Watt University

Unit 8 - 9

9: North American Value Engineering in Construction: A Critical Review

9.1

Introduction

This unit is a synopsis of the review of value engineering practice in the USA in Value Management in Design and Construction (1993). A follow up visit in 1997 confirmed that the practices reported here remain largely unaltered. In the USA a significant proportion of value engineering is undertaken for public sector organisations. Value engineering consultants obtain this work through competitive fee bidding against a specification drawn up by the public sector authority. This results in a prescribed and relatively standardised value engineering service. Described here in some detail are the “Charette” or 10% stage study, the 40-hour value engineering study at 35% stage, the audit and the contractor’s change proposal.

9.2

The Charette

This method seeks to rationalise the client’s brief through the identification of the function of the spaces specified. This analysis through function at a meeting involving the client’s staff and the design team should ensure that the latter understand fully the requirements of the former. During the research into this subject interviews were held with a client who had commissioned a value management study following a tender in which the lowest bid was 18% higher than the permitted budget. The client stated that a value management study at briefing would be useful: “Just to focus on what are the objectives, what are the primary functions of any given activity. The design team and the client team should meet in a VM study. When we got around the table for the VM study it was clear that what the client team thought were the primary functions differed from what the design team thought and this was after the design was done.” There is a theory which states that the brief given by the client to the design team is an amalgam of the “wish lists” of all of the parties who contribute to the brief. This is particularly so for buildings that are to house organisations comprised of diverse departments such as hospitals, universities, prisons,

Heriot-Watt University

Unit 9 - 1

9: North American Value Engineering in Construction: A Critical Review

owner-occupied offices for complex organisations and manufacturing plants. Even where a project manager is employed, there is a high probability that the brief will reflect data gathered from departmental heads who will seek to maximise their requirements. In a hospital for instance two departments may each have a requirement for a laboratory and the two laboratories may be identical, but this is not likely to be realised unless a study is made of the function of each space. The charette is organised along the traditional job plan lines with the first stage being to gather as much information as is available regarding the function of the spaces defined in the brief. The function of all of the spaces are defined along with performance criteria e.g. this space must be held at a constant 20°C ± 5° where the activity within the space generates heat. The next stage in the process is to be creative in terms of arrangement, adjacency, timetabling, etc. It may be found for example that by siting two particular hospital departments together that they may use the same laboratory with immense savings in capital and running costs (including laboratory staff). The ideas generated are recorded and analysed and the final decisions are incorporated into the brief. The charette has five major advantages. First, it is considered by many clients to be inexpensive. There is of course staff time to consider and the time of the design team. However, if the design team were informed at the time of their selection that this meeting was to happen, the chances are that it would not affect the fee bid greatly. The only real expenditure is the fee of the value manager himself. One client interviewed during this research also stated that it was beneficial to have a cost consultant at this meeting. There is finally the secretary to the team who will either be provided by the client or by the value manager. Secondly, the exercise was considered by some clients to be the best way of briefing the whole team. One industrial client with a large and expanding building stock stated that even if the exercise did not realise any great rationalisation the very fact that all members of the team, the architect, structural engineer, mechanical and electrical engineers, etc, were present meant that all understood fully his requirements. Third, the exercise occurs early in the process, stated by many to be the most cost consequent stage. Fourthly, the exercise can be carried out in a short period of time, only the most complex projects will involve more than two days work. Finally, the exercise cuts across organisational, political and professional boundaries. One central government organisation client stated that a meeting of this kind would not normally be possible since departmental heads would be reluctant to give up the time, the meeting would be politically structured

Unit 9 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

and the design team themselves would not normally organise such a meeting. The fact that it was a value engineering exercise under the chairmanship of an outsider made it happen. The charette is therefore an inexpensive means of examining the client’s requirements by the use of functional analysis and allowing rationalisation and full design team briefing.

9.3

The 40-hour value management study

The 40 hour study is the most widely accepted formal approach to value engineering, indeed the initial training of value managers as laid down by the Society of American Value Engineers (SAVE) is based on a 40 hour training workshop. The study involves the review of the sketch design of project by a second design team under the chairmanship of a value manager. It applies all of the stages of the job plan within a working week and is seen as being quick and effective. The procedure for the study is as follows. The client should inform the members of the design team at the time of their fee bid that the project will be the subject of a value management exercise. This is important both from a human relations aspect and also from the point of view of establishing how the design team are to cover the cost of any redesign work arising out of the exercise. Some clients require the members to cover this cost within their fee bid. Others state at the time of the fee bid that the design team members will be reimbursed for any necessary redesign work on an hourly basis. The client appoints the value engineer, the value manager and in discussion with the design team establishes the date for the study. Normally the value engineer will submit a fee bid that covers the cost of the complete value management exercise described under. The value engineer will appoint a value management team, normally six to eight professionals in a mix that reflects the characteristics of the project under review. So for example, a project with a large amount of mechanical and electrical servicing may attract a team including four members with these professional backgrounds. These team members will be drawn from professional practice and may or may not have any previous value management experience. The team members are paid by the value engineer. The study is normally held near the site of the proposed project, either in a hotel or in a room provided by the client within the client’s office. The date of the study is a key date for the design team and the value management team. The design team must be complete to sketch design stage one week before the date of the study. This includes the architectural design and also the structural, mechanical and electrical engineering designs. The completed drawings are sent to the value engineer for distribution to the team during the week preceding the study. Heriot-Watt University

Unit 9 - 3

9: North American Value Engineering in Construction: A Critical Review

During the week of the study the team will follow strictly the stages of the job plan. It is the logical step by step approach to the generation of alternative technical solutions that makes value management unique. Monday - phase 1 (information) The team have each had the project sketch drawings, initial cost estimate together with calculations and outline proposals for the structure and services for two days and will have gleaned some information from these. At the beginning of the study the architect and the client are present. The value engineer gives an introduction and states the objectives for the week. Often the value engineer will have prepared a timetable and may also have prepared an elemental breakdown of the initial estimate. Following the introduction the client and the design architect present the project, answer questions and the client reaffirms which areas of the project are within the scope of the exercise. This latter point is important since, for example, if the client has already reached an agreement with a trade union that a specific number of men will be employed within a plant, then any ingenuity on the part of the value management team to reduce manning levels will be in vain. After the presentation the client and architect leave. The team now concentrates its efforts on identifying the functions of the various parts of the building. In the study emphasis is given to those functions which are not important, or are secondary, but attract a high cost. Attention will also be paid to those functions that are primary and important but attract a low cost. In one study for the modernisation of a boiler house on a large military site in North America, with an estimated project cost of $71,500,948, the team identified 17 functions of which 7 were selected for study. Tuesday morning - phase 2 (creativity) During this phase the group brainstorm ideas to satisfy the identified functions. In the boiler house example above over 200 ideas were generated during this session. Creativity is a rapid but exhausting process, 200 ideas could easily be produced in one hour. Tuesday afternoon - phase 3 (judgement) At this stage the team decides which of the ideas generated are worthy of further development. For example, of the 200 plus ideas generated above only 42 were thought good enough for development. Before moving on to the development phase some value managers prefer to invite the design architect back to the study at this point to discuss the

Unit 9 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

acceptability of the ideas in principle. This can reduce abortive work if, for instance, the design team had already thought of the idea and rejected it or if the architect would not agree to such an idea under any circumstances. Wednesday and Thursday - phase 4 (development) During this phase the team may split into individual or small groups to work on the ideas in detail. The aim is to develop the ideas into a worked and costed solution. Friday - phase 5 (recommendation) In the morning of the final day the group reconvene to discuss the worked solutions. At this stage those solutions that cost more than the original, reduce quality or are not technically feasible are rejected. In the boiler house case above 15 worked solutions were rejected at this stage leaving 27 viable solutions for presentation to the client and design architect. In the afternoon those worked solutions accepted by the team are presented to the design architect and the client. The formal study is now at an end. The members of the study return to their practice leaving the value engineer to take away the week’s work and write the report. The following week - action and feedback In the early part of the following week the completed report is sent by the value engineer to the client and design architect. At this stage, one North American government department takes all of the ideas, sets them out on a sheet horizontally with vertical columns for each member of the design team who receive a copy. The team members are requested to enter either “accepted”, “rejected”, or “further discussion required” against the suggestions. A meeting is called where all members of the design team gather to discuss the suggestions. All those that have been unanimously accepted are required to be incorporated into the design. In respect of the others discussion takes place to determine which may be acceptable. The client will wish to be convinced of the need for rejection. In the boiler house example above, 11 of the 27 suggestions were incorporated into the final design, leading to $32,868,302 savings on the original estimate of $71,500,948. This remarkable saving of 45% of estimated cost was achieved by demolishing two perfectly satisfactory buildings adjacent to the site and rebuilding them elsewhere. Within the original scheme the design team had used considerable ingenuity to design an expansion in the boiler house facility around the constraint of the existing buildings.

Heriot-Watt University

Unit 9 - 5

9: North American Value Engineering in Construction: A Critical Review


In-text question How many people should be involved in a VM team?

9.4 Advantages and disadvantages of the value management study A value management study is seen as being effective in that it generates alternative technical solutions to a problem which have been costed in initial and life cycle cost terms. It also ensures the fixing of a date for the completion of a sketch design. Although not a function of the study it has been stated that the setting of a date for the study, forces the design team to complete to a more advanced stage than would otherwise be achieved particularly by the engineering designers. In the majority of cases the costs of the study are a small proportion of the savings achieved. Value managers state that on any project at least 10% of the estimated contract value is within the area of unnecessary cost. They also state that the value manager will achieve a 10:1 return on the investment made by the client and therefore in the majority of cases the study fee, usually quoted as a lump sum, would work out to be not less than 10% of the savings realised. In responding to questions on “How often do studies fail?” value managers stated nil, but one major client stated about 2%. The problems associated with the study relate to conflict, time and resourcing. These centre on: •

The fact that the client may consider that the design team should arrive at the optimal solution without the need for a further exercise at additional expense. This criticism may be countered in two ways, firstly that it is the function of the design team to arrive at a workable solution given the information in the client's requirements. Secondly, that a value management study is an analysis of the ideas which have been generated. A value management study cannot be carried out until there is an idea to analyse and it is therefore truly a second phase of the design exercise. Currently, designers are not expected to carry out nor paid for such an exercise.

•

The interpretation of the exercise by the design team as a critique of their design judgement. This is a difficult problem that is hard to counter unless the original designer plays a part in the activity. The reason given by some value managers for not including members of the original design team is the danger that old ideas are defended and their presence

Unit 9 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

may stifle frank comments on the design. This potential area of conflict can be alleviated through the education of the designers in value management techniques, informing the members of the design team at the time of their appointment that the exercise is to take place and payment of an additional fee for implementing design changes. •

The time of the value management study. It is beyond dispute that the value management study will effectively take three to four weeks from the design programme. That is one week prior to the study for the distribution of drawings and information, the study week and the period of time following the study for the submission of the report, discussion and design changes. In some projects this period of time, during which the design will be at a standstill, will be unacceptable. However, in the majority of cases it is capable of being accommodated particularly in view of the fact that the study itself is a watershed between sketch design and working drawings and provides an immovable date for the completion of the sketch design.

•

The resourcing of a study can pose problems associated with the withdrawal of professionals from their home office for a one-week period. It is a condition precedent to a successful study that members of the value management team are isolated from their home environment for the study period.

The study therefore is not without its problems, but has consistently proved to be a very effective means for the application of value management.

9.5

The value management audit

The value management audit is a service offered by value managers to large corporate companies or government departments to review expenditure proposals put forward by subsidiary companies or regional authorities. The procedures employed follow exactly those of the job plan. Following a proposal the value manager will visit the subsidiary company or regional authority and undertake a study of the proposal from the point of view of providing the primary functions. The study may be carried out using personnel from the subsidiary company or regional authority or from another company within the group or another regional authority. The study is a global review and normally takes one or two days, so is therefore fast and relatively inexpensive. Following the review the value manager will submit a report detailing the primary objective and the most cost-effective method for its realisation. The audit may be criticised on the grounds that it is potentially conflict oriented and that depth is sacrificed for breadth. However, the project’s director of one subsidiary company stated that a value management audit on one proposal revealed a number of shortcomings with the statement of

Heriot-Watt University

Unit 9 - 7

9: North American Value Engineering in Construction: A Critical Review

requirements to the extent that the company now adopts a policy of holding a charette before a proposal is submitted to the parent company.

9.6

The contractor’s change proposal

The contractor’s change proposal (or value management change proposal) is a post tender change inspired by the contractor. The United States government includes a clause in their conditions of contract, which states that contractors are encouraged to submit ideas for reducing costs. If the design team accepts the change, then the contractor shares in the saving at the rate of 55% of the saving for fixed price contracts and 25% for cost reimbursement contracts. For example, if a contractor, on a contract of £250,000 makes a suggestion that the contractor estimates will save £10,000, then following verification and acceptance by the design team, the contractor will receive £5,500. The payment is made by reducing the contract sum by £4,500. The benefit of the clause is that it allows the contractor to be pro-active and use construction/engineering knowledge to improve a facility at on-site stage. The disadvantage of the clause is that the contract may be delayed while the design team investigate the viability of the change. For this reason changes tend to be relatively superficial.

9.7

Variations on the formal approaches to value management

Although the four approaches detailed above are most often described they are not suitable in every case. The following are applications of the job plan which have been used in practice but do not fall within the standard approaches. 9.7.1 The orientation meeting Similar to the charette, this meeting is a part of the value management procedure operated by New York City, Office of Management and Budget. The meeting of client representatives, design team and independent estimator is held when either the brief or the brief and schematic have been developed. The objectives of the meeting include; an opportunity for all taking part to understand project issues and constraints, to give and receive information, to determine whether all information for a 40 hour study is likely to be available by the date set for the study. A full report of the orientation meeting is given in The Practice of Value Management: Enhancing Value or Cutting Cost? Kelly and Male, RICS, 1991.

Unit 9 - 8

Heriot-Watt University

Value and Risk Management [D19CV9]

9.7.2 The shortened study In many cases the estimated project value is lower than the £2-3 million considered the lower limit for a full 40-hour study involving a team of six. In this case the 10% rule of thumb is used to determine how much can be spent on the study. For example, for a project of £500,000 the target savings are £50,000 and the fee for the study £5,000. It is now a question of determining how much professional time can be bought for £5,000. If a rate of £600 per person per day is assumed, including expenses, then 8 person days can be afforded. This could be three people for two days with two extra days for the value manager. 9.7.3 The concurrent study This approach involves the design team themselves coming together on a regular basis under the chairmanship of the value manager to review design decisions taken. The method has much to commend it in that it answers much of the criticism levelled at the standard 40-hour study. The extent of involvement of the value manager needs to be determined in advance so that the fee can be established. The fee bid from members of the design team will also have to account for their extra involvement. The concurrent study is also suitable for construction management contracts in which the design is carried out in stages along with the construction, (fast-tracking). In a study of a $100 million office project in Canada, on which a value management design meeting was held on site each Wednesday, the reference point for the comparison of costs was the elemental cost plan. At initial meetings, the functions of the spaces were analysed and, five adjacency diagrams generated. These were reduced to three for presentation to the client. For the selected plan a number of structural solutions were generated and analysed on a matrix along with solutions for the electrical and mechanical installations. Once the building form was established construction work began. Meetings continued with the construction manager in attendance through to the end of the project. The final cost of the project was $9 million less than the budget. A disadvantage of the concurrent study is the difficulty of proving the value of the time expended, it is easy to say that the budget was too high.

9.8

A North American approach in the UK?

The review of North American value engineering methodologies above demonstrates characteristic approaches, which may be applied in the UK. However, in comparison to North America the presence of a quantity surveying profession in the UK construction industry is one major aspect that should be taken into account in the formalisation of an equivalent service.

Heriot-Watt University

Unit 9 - 9

9: North American Value Engineering in Construction: A Critical Review

In 1997 it was confirmed that the prime method used by the public sector was the 40-hour value engineering study with an independent team. Heavy public sector patronage of value engineering studies in construction suggests a close linkage with public accountability. In respect of the 40hour value engineering study the authors (refs 1987, 1991 & 1993) and Palmer (1992) noted that much of what was purported to be value engineering was equivalent to the traditional specification reduction and component substitution cost reduction exercises undertaken by quantity surveyors in the course of their normal cost planning function. The major difference was in the use of a team approach to problem identification and problem solving. It was quickly concluded by the UK construction industry that where a professional cost consultant was a member of the design team then cost control on the project would be undertaken from sketch design onwards. Therefore, an equivalent 40-hour value engineering study with an independent team would not add benefits equivalent to its costs. However, the Charette, with its emphasis on application early in the design process (not later than outline sketch design) and its emphasis on bringing together key members of the client team and the design team did find favour in the UK. In 1998, at a conference in London, it was stated that the majority of value management studies carried out in the UK were of the Charette type. There are no known examples of the value engineering audit being applied in a UK context. Similarly, it is also concluded that while agreements to share value engineering change proposals at the post contract stage have been made in the UK, the application appears to be informal or based upon an exchange of letters, rather than being incorporated into a standard form of contract.
In-text question Why might a 40 hour study be considered excessively long in a UK context?

9.9

Conclusion

This unit has described in outline the method of value engineering used in the construction industry in the USA. Its use is typified by public sector patronage where it can only be assumed that the use of the technique is for public accountability purposes. In the UK, the professional quantity surveyor is the member of the team who is liable for the correct budgetary control of the project from post sketch design to its completion. This has an impact on the type of study used in the UK. The UK construction

Unit 9 - 10

Heriot-Watt University

Value and Risk Management [D19CV9]

industry has learnt much from the Charette form of value engineering and continues to develop this approach.

Self assessment question Consider an area of work where you could have successfully applied VM. Prepare an agenda for the workshop that you would have run that identifies who would be involved and what the issues needing resolved are.

Heriot-Watt University

Unit 9 - 11

10: Function Analysis and Function Diagramming

10.1 Introduction This unit begins by introducing techniques that may be used in the briefing process to describe the customer or client’s requirements. The concept of Function Analysis (FA) is introduced and its essential principles are described. These principles are developed with the Function Logic diagram and examples are presented to illustrate its application in practice. The unit develops by considering technical orientated FA and its application at the level of a building’s elements. The relationship with traditional elemental cost planning as practised by the quantity surveyor is then discussed.

10.2 Value and strategic briefing Consider the following definitions of value and reach a conclusion as to which are correct. 1. Value to me is getting exactly what I want at the lowest price. 2. Value is obtaining a defined level of quality at the lowest cost, the highest level of quality at a given cost or an optimum compromise between the two. 3. The worth of an item is represented by the lowest cost to provide the necessary functions irrespective of quality. For example, the worth of a solid core mahogany door is the cost of a hollow core, hardboard faced flush door of the type obtainable from any DIY store. 4. You cannot measure value in terms of currency as esteem and aesthetic come into play. 5. The worth of an item is represented by the lowest cost to provide my functional requirements that may include aesthetic and quality aspects. 6.

Quality cannot be measured, it is a personal view of a product or service and therefore the scaling applied to quality is personal.

Heriot-Watt University

Unit 10 - 1

10: Function Analysis and Function Diagramming

7.

Quality has no antonym.

8.

Value and worth are the same.

9. A team can decide on the criteria for value, worth and quality by consensus. In this respect a team acts as an individual. 10. While value is difficult to define, the value system used by an individual or a team is capable of being extrapolated. 11. Value is directly related to the ability of a product or service to satisfy our needs and is inversely related to cost. 12. In a value of management team, the team will develop a concept and a set of values which they will use to control the development of a project.

10.3 Examples of element function analysis and diagramming Function analysis can be performed at various levels of the project life cycle. The procedure for establishing the necessary functions is outlined below.
In-text question What are the main benefits gained by the VM team from constructing a FAST diagram?

10.3.1 Function Analysis (FA) •

Verb/noun definition Most texts recommend that the function of an item or a system be expressed as a concise phrase, ideally one comprising just an active verb followed by a noun.

•

Primary and Secondary functions Primary functions are defined as those without which the project would fail or the task would not be accomplished. Secondary functions, on the other hand, are those that are a characteristic of the technical solution chosen.

When conducting a FA exercise it is useful for the VM team to first question what the project, process, activity, element or components – i.e. whatever the object under study is- will do. Following this a list of

Unit 10 - 2

Heriot-Watt University

Value and Risk Management [D19CV9]

verb/noun functions can be generated for the object under study. Further consideration should see the team distinguish between needs and wants functions. Client needs are those functions the project must possess to serve its basic intentions. Client wants are those embellishments to the project which are nice to have, but not critical to the survival or basic integrity of the project. From the finalised and agreed list of functions, a function logic - also known as FAST (Function Analysis System Technique) - diagram can then be constructed. 10.3.2 Function Logic Diagram As an aid to information gathering and synthesis it is recommended that the workshop team should construct a function logic diagram. This will act as a knowledge leveller and is useful to establish consensus before progressing further. The function logic diagram is used to determine the project task and its justification for existing. It is a very good deepening and focussing technique that describes a project concisely in a visual form. It brings together the value criteria of a project, highlighting the strategic issues that represent the client’s value system. The usual process for preparing a function logic diagram in a workshop is for the team to brainstorm functions, then group and structure them into a hierarchy. Once the hierarchy has been established it is useful to pose the question, “What if we go one level higher?” and then establish the resulting function or objective. This will force the participants to step back from the project and place it in a wider context i.e. linking it into corporate and business strategies. The examples below are used to illustrate the principles of the function logic diagram. Example 1 Consider the construction of function logic diagrams for the following simple project. The project came into being when a local authority decided to extend an existing country park to incorporate land on the far side of a river. The project involved the investment of resources to transport pedestrians, including disabled and children in prams/buggies, safely across the river. Generation of functions The functions were generated by the team in a random fashion on post-it notes and placed on a large sheet of paper.

Heriot-Watt University

Unit 10 - 3

10: Function Analysis and Function Diagramming

Maintain Facility

Position People

Meet Demand

Minimise Wear Reduce Downtime (due to flooding)

Non slip Surface

Establish Rules (of passage)

Minimise Labour Support Peopler

Protect People

Cater for disabled

Direct Routes

Control People

Facilitate Passage

Prevent Falling (into river)

Cater for children

Educate people

Span River

Focal point

Figure 10.1 Generation of Functions

Sorting of functions Following the generation of functions, undertaken as a brainstorming process, the team are invited to order the functions by putting the highest order need at the top left hand corner of the paper and the lowest order want at the bottom right. This is illustrated in Figure 8.2 below.

Unit 10 - 4

Heriot-Watt University

Value and Risk Management [D19CV9]

Facilitate Passage

Span River

Support Peopler

Protect People

Educate people

Prevent Falling (into river)

Focal point

Cater for children

Meet Demand

Cater for disabled

Control People

Reduce Downtime (due to flooding)

Establish Rules (of passage)

Direct Routes

Position People

Maintain Facility

Minimise Wear

Non slip Surface

Minimise Labour

Figure 10.2 Initial sorting prior to diagramming

Diagramming A diagram is constructed from the ordered post-it notes. The type of diagram will depend upon the focus of the study being undertaken. To gain a technical appreciation of the problem a function diagram with a technical bias will be constructed. If the focus of the study is of a strategic nature, such as a strategic briefing, a client orientated function diagram will be constructed. The figures below illustrate the two types of diagramming technique for the problems outlined above.

Heriot-Watt University

Unit 10 - 5

10: Function Analysis and Function Diagramming

Minimise Wear Design Objectives Desired Objectives

Support Peopler

Span River

Maintain Facility

Educate people

Minimise Labour

ec

tiv

bj

ec

da ry O

bj O

Se c

on

Pr im e Facilitate Passage across River

Cater for disabled

tiv

e

Non slip Surface

Meet Demand

es

Reduce Downtime (due to flooding)

Cater for children

Position People

Protect People

Direct Routes

Prevent Falling (into river)

Control People

Establish Rules (of passage)

l rra Pa le bj lO ec tiv e

Figure 10.3 - Technical FAST It should be noted from the above diagram that the prime objective is a technical objective and the brainstorming of ideas following the construction of the diagram will therefore lead to the exploration of technical solutions. The brainstormed solutions, for example, a suspension bridge, a simply supported span bridge, stepping stones, etc, will be audited back against the diagram to determine the extent to which the ideas meet the functions. The diagram is structured such that the prime objective of the project is situated on the left-hand side of the scope line. The prime objective " support people" is situated immediately to the right of the project objective. Parallel objectives are below the prime objective in this case "span river". Secondary objectives appear to the right of the prime objective and design objectives are situated immediately above. Desired objectives are located on the top right of the diagram above the secondary objectives.

Unit 10 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

It is the structuring of the diagram that prepares the team for brainstorming. For a client or customer orientated situation the same postit notes will be ordered in a slightly different manner. The diagram overleaf illustrates a client-orientated diagram that takes the form of a tree laid horizontal. In a very general sense the logic of the diagram answers the question "how?" when working from left to right and "why?" when working from right to left. Highest order needs are placed at the top of the diagram and the lowest order wants at the bottom of the diagram. A scope line divides the primary function of the project from the functions that may form the basis of brainstorming. It should be noted that there is a high correlation in terms of the post-it notes used but the emphasis, as judged by the team, has been altered somewhat. In the case of this particular project the final solution might not a bridge but an old fashioned cable stayed ferrying boat which used the power of the river acting on the rudder to move the ferry across the river. A full-time ferryman working between two covered shelters one of which might be an exhibition centre could operate the ferry.

Heriot-Watt University

Unit 10 - 7

10: Function Analysis and Function Diagramming

HOW

WHY Support People Prevent Falling (into river)

Span River

NEEDS

Protect People Establish Rules (of passage) Control People Position People Direct Routes

Cater for children Create a focal point for the park which educates and facilitates the crossing of the river

Meet Demand Cater for disabled Reduce Downtime (due to flooding) Minimise Wear

WANTS Maintain Facility

Minimise Labour

Figure 10.4 Client or Customer orientated FAST

•

Value and Tactical Project Development

10.4 Element function analysis This section will outline the principles of cost planning using cost data organised in the form of elemental cost analyses. This will be followed by a debate on element function and put forward the idea that elements may be defined by a list of characteristic functions which are not project specific. A method of element function analysis is described.

Unit 10 - 8

Heriot-Watt University

Value and Risk Management [D19CV9]

10.5 Elemental cost planning In 1969 the Building Cost Information Service (BCIS) of the Royal Institution of Chartered Surveyors defined an element as follows: An element for cost analysis purposes is defined as a component that fulfils a specific function or functions irrespective of its design, specification or construction. The introduction to the BCIS document, The Standard Form of Cost Analysis goes on to state that the list of elements, however, is a compromise between this definition and what is considered practical. However, apart from the elements within the subsection building services the definition works well. This is fortuitous for all those involved in value management exercises that have a cost plan in elemental format as, by definition, the building costs are distributed according to element function. Elemental cost planning is one of a family of techniques based upon parametric modelling. The technique relies upon an extensive database of building costs broken-down into elemental costs. In the UK it is normal practice for lump sum fixed price contracts to be tendered based upon detailed bills of quantities. The bills of quantities are normally arranged in elemental format such that following the selection of the lowest tender, an elemental cost analysis of the project is prepared. The elemental cost analyses are submitted by quantity surveyors to the building cost information service. In this way, quantity surveyors share tender data for a wide range of construction projects. The cost planning methodology is comprised of: • • •

A frame of reference. A means of checking. A method for remedial action.

The frame of reference comprises an elemental cost plan for the project under review. For example, assume that a quantity surveyor is required to compile a cost plan for an office building of 2000 square metres floor area. The surveyor will select from the database of cost analyses an analysis that bears the closest resemblance to the project. For example, the surveyor may find a cost analyses for a 2500 square metre office building with similar characteristics to the proposed project. The cost analysis is presented as a list of element costs expressed as element costs per square metre of gross floor area. The surveyor multiplies the element costs per square metre of the analysis by 2000 square metres to arrive that the first elemental cost plan for the proposed building. Obviously, the surveyor will need to make a large number of adjustments, for example:

Heriot-Watt University

Unit 10 - 9

10: Function Analysis and Function Diagramming

• • •

• •

Inflation in prices between the date of tender of the analysis and the date of tender of the proposed project. Difference in prices between the location of the project represented by the analysis and the proposed project. Any major differences between the likely specification of the proposed project and the analysis, for example, the type and extent of airconditioning, inclusion of car parking and access roads, etc. Differences in the market prices due to demand for construction work. Differences in risk costs brought about by choice of a particular procurement method.

After these and a large number of other adjustments are made the surveyor will have an elemental costs plan which displays a high degree of cost certainty. This is the point when the cost plan becomes the frame of reference. The cost plan figure is given to the client for the building and therefore, generally, may not be exceeded. It should be noted that the cost plan compiled in this way could precede sketch design but rarely does. With the sketch design the surveyor will measure the elements and revise the costs plan figures based upon priced measurement. In the event, and it should be emphasised that generally only in the event of an increase in costs the surveyor will ask for a design team meeting to address the overspend. This highlights the use of the frame of reference, and the method of checking. The overspend is generally rectified by examining each element in turn to determine whether a less expensive solution is available for one or more elements based upon a change in specification. This can result in a lowering of quality. This is the remedial action. The method of elemental costs planning and cost control described above is appropriate to design where a high level of certainty has been established, i.e., at the completion of the final sketch design. The advantage of a value management exercise prior to the final sketch design is that it ensures that sketch design fulfils the performance specification of the brief and in accordance with the clients value system. The important point to note here is that while value management will address the functions of all elements, cost planning only triggers action in the event of an overspend.

10.6 Implementing element function analysis While the concept of elemental analysis was derived for the cost planning function described above two ingredients are essential to the undertaking of elemental function analysis. These ingredients are:

Unit 10 - 10

Heriot-Watt University

Value and Risk Management [D19CV9]

• •

A database of costs which may be used for benchmarking projects. A common understanding of the costs which are contained within a particular element. For example, the BCIS definitions will include the costs of forming the opening for a window in with the cost of the window element.

Element function analysis comprises the stages listed below: 10.6.1 Stage 1 - List all the functions of the element As elements are defined as being components of construction that fulfil a specific function or functions irrespective of its design, specification or construction it is logical to deduce that a definitive list of functions can be derived for each element in the BCIS list. For example, an internal wall will have one or more of the following functions irrespective of the project context. • • • • • • • • • • •

Support load. Divide space. Separate environments. Dampen noise. Transmit light. Secure space. Support fittings. Facilitate finishing. Restrict fire-spread. Demonstrate hierarchy. Minimise distraction.

Heriot-Watt University

Unit 10 - 11

10: Function Analysis and Function Diagramming

Debate The above is not intended to be a definitive list, but one that indicates the functions a team may brainstorm as being functions of an internal wall. There is an argument that the list of element functions need only be generated once. However, there is a more convincing counter-argument that the list is better generated as a team event during a workshop. Although this is time-consuming it results in a list of functions owned by the team. Some facilitators keep a definitive list in order to prompt the team.

10.6.2 Stage 2 - Select functions for project context In this next stage of element function analysis the list is reviewed and functions deleted which are not relevant to the project situation. An internal partition is a particular case of an element that may have a number of different functions within the same building. Therefore it would be necessary for the team to undertake a study of internal partition type before proceeding further. For example, such a study of a university department building may reveal the following partition types: • • • • • • •

Division between lecture rooms. Division between laboratories. Division between storerooms. Division between a lecture rooms and a corridor. Division between offices. Surround to lift shaft. Division surrounding the computer room.

The above illustrates a number of partitions which display differing functional characteristics. For example, a division between two lecture rooms is required to “dampen noise” transmission to an absolute minimum. A division between stores needs only to “divide space” and perhaps “support fittings”. In many situations designers will choose a single technical solution to meet all partition situation which, as shown above may be inadequate and/or wasteful. To take the functions of a partition between lecture rooms as an example of function selection, the process would be to first delete those functions that do not apply in this situation.

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Heriot-Watt University

Value and Risk Management [D19CV9]

Support load Divide space Separate environments Dampen noise Transmit light Secure space Support fittings Facilitate finishing Restrict fire-spread Demonstrate hierarchy Minimise distraction

Framed building Required function Heat, vent etc – same requirement either side A primary requirement Not required Lecture room contains IT equipment Boards, screen, display panels etc Hard surface finish, easy to clean Required function Not required No visual or other sensory transmission is permitted between lecture rooms

On completion of the above it may, in some circumstances, be necessary to undertake a weighting and scoring exercise to heighten the team’s awareness of those aspects which are of primary importance. 10.6.3 Stage 3 - Brainstorming solutions The brainstorming exercise will be undertaken following the analysis complete analysis of the elements. The reason for undertaking brainstorming as single exercise on the 34 elements lies in the dynamics of the brainstorming process. Once the brainstorming has commenced it is relatively easy with the 34 element functions defined to undertaken a satisfactory and fulfilling session. The rules relating to brainstorming are described earlier. 10.6.4 Stage 4 - Evaluation and development The evaluation and development stage will be undertaken in exactly the same way as described earlier. Element function analysis is normally undertaken by a team that is capable of completing the majority of the development exercise during the workshop. This has an advantage in terms of simplifying the implementation stage.

10.7 Conclusion The understanding of the functionality of projects, whether at concept, physical spaces, construction elements or components level, in a value management context, is critical to the strategic and tactical stages of a project’s evolution. The unit has considered FA and function logic (or FAST) diagrams at the strategic and tactical project levels. At this point in time relatively little academic work has been undertaken in the development of procedures, tools and processes to properly understand

Heriot-Watt University

Unit 10 - 13

10: Function Analysis and Function Diagramming

and evaluate elements and components. In manufacturing considerable resources are expended on the accurate functional definition of components. The prime manufacturer then feeds these definitions evolved from benchmarking and market research activities to the suppliers. The suppliers are requested not to supply a given piece of kit at the lowest price but to innovate ways of satisfying the primary function which adds value to the product as a whole. This is rarely done in construction. Further analysis is required in relating element functions to the primary functions of the building. For example: • • • •

The frame, floors and substructure exist to support and transfer load. Lifts and escalators exist to minimise walking. Heating and air conditioning exist to maintain comfort. The external walls, roof, windows and external doors protect the space and express aesthetic.

Only the internal walls, internal doors, floor wall and ceiling finishes, and fittings and furnishings overtly serve the client function. In traditional cost planning it is likely that these elements will be targeted for cost reduction. In other words the very elements that the client requires service from in order to achieve the strategic objective are often those that, from a value perspective, are mismanaged.

Self assessment questions Think about the value of a motor car to you personally. Prepare a FAST diagram that captures all the functions it fulfils. What is the prime function? Is there any other solution that meets the require functions? At which stage of the project life cycle might a customer oriented FAST diagram be prepared in a VM workshop?

Unit 10 - 14

Heriot-Watt University

11: Common Briefing Structures and Problems in Briefing

11.1 Introduction This unit investigates identifiable briefing structures and the commonly identified problems in briefing. The questions at the end of this unit are intended to promote further reading and analysis. The text is taken from Kelly J, MacPherson S and Male S, “The Briefing Process; A Review and Critique” RICS, 1992, ISBN 0 85406 541 5.

11.2 Glossary Project brief

The full statement of the client’s functional and operational requirements for the completed project.

Project execution plan

The statement of policies and procedures designed to ensure that every aspect of the design and construction of the project is properly undertaken within the client’s constraints, and to achieve the stated objectives.

Statement of need

A document which defines the objectives and needs of the client organisation.

Strategic brief

The statement of the broad scope and purpose of the project and its key parameters including overall budget and programme, agreed at an early stage of the project.

11.3 The clients approach to briefing For owner occupation, the decision to build follows the identification of a need. In large projects, this need is usually revealed as a result of long term studies and forms an integral part of the client's long term strategic plans, however small projects are frequently a response to unanticipated changes in the client organisation or in the environment which rendered existing facilities inadequate. Public sector clients reported that their long term building strategy was closely linked to the means of securing Heriot-Watt University

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11: Common Briefing Structures and Problems in Briefing

finance, however private sector clients did not report the same concern over funding, and there appears to be an assumption that money could be found if it were needed. For developers, on the other hand, the decision to build is opportunistic and based on the availability of desirable sites. Following the identification of the need or the opportunity, the way in which the client proceeds depends upon the size of the client. 11.3.1 Large clients Large clients frequently proceed to develop a brief prior to approaching the industry. They perceive the architect (and the rest of the design team) as technicians who will translate their stated requirements into a built solution. Most large and regular clients of the building industry now employ in-house project managers (although the precise meaning of this term varies from client to client). Alternatively they may call upon the services of outside consultants to act as project managers to provide the interface between them and the design team (Franks, 1990a). It should be recognised that the appointment of a project manager results in a gatekeeper situation arising in that those wishing to influence the client must pass there information first to the project manager. The converse is also true for client representatives wishing to influence the design team. Therefore, the influence that the actual design team has on the brief under these circumstances is limited. Highly sophisticated clients often retain their own design consultants who participate in the briefing process and so provide some design advice at the early stages. They may also take the advice of letting agents about the design of commercial buildings so that their 'purpose built' properties are not designed so specifically to their particular requirements as to compromise their asset value and be difficult to dispose of should this be necessary at some future time. Such clients will often have developed model briefs for certain generic types of building such as an office, a school or a leisure centre. A rather dated example of this is the system described by IBM (AJ, 1987a). The brief for a project is developed by an in-house project manager who consults with a facilities manager and representatives of the user groups, with advice on the design and cost implications of decisions coming from in-house design consultants. The extremely rigid brief is then passed to the design team who will work on the project. The project design team must then liaise exclusively with the project manager. They never meet the users of the building, and if they wish to deviate from the brief they must present an extremely good case for doing so. 11.3.2 Small clients The approach taken by smaller clients reflects the limited expertise available to them in-house. They tend to rely more heavily on the design advice of a consultant architect at the briefing stage. The way in which these clients present their requirements to the architect can vary Unit 11 - 2

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Value and Risk Management [D19CV9]

considerably. Some clients have highly detailed preconceptions of the project, while others have only the vaguest notion of what they want, and consider it to be the architect's task to develop the brief. The architect's involvement in the early stages can sometimes extend to locating sites (AJ, 1986a).

11.4 Problems encountered in briefing Architects have long complained that many clients do not appreciate the importance of the brief. This problem is particularly serious among smaller, less sophisticated clients, but is by no means restricted to them (O'Reilly, 1973). The identifiable problem areas are: •

Client experience with the building industry.

•

Representation of client interest groups.

•

Identification of client needs.

•

Solution focused thinking.

•

Buildability.

•

Provision of sufficient time for briefing.

•

Incomplete briefs.

11.4.1 Experience with the building industry Smaller, inexperienced clients often do not understand the structure of the building industry, nor do they have an appreciation of the technicalities of buildings. This lack of understanding frequently leads to the inappropriate selection of sites given the type of building project envisaged, an unrealistically low expectation of project costs, and a failure to appreciate the roles of the various parties in the design and construction process. These difficulties can be made worse if the design team find themselves dealing with a forceful client business case team who are unwilling to compromise on their preconceived ideas (Goodacre et al, 1982). For unsophisticated clients, the initial approach to the industry can present a problem. Most initially contact an architect and subsequently rely on his advice for the selection of other design team members and contractors. It has been observed, however, that this approach results in the client being steered down the traditional procurement route without the option of considering alternative methods (Newman et al, 1981).

Heriot-Watt University

Unit 11 - 3

11: Common Briefing Structures and Problems in Briefing

11.4.2 Representation of client interest groups Identification of the client body is extremely difficult as has been pointed out already. Even assuming that all of the interest groups can be identified, the problem then is deciding if and how they should be represented in the business case team. For owner occupiers, the usual way of doing this in all but the smallest of organisations is to appoint representatives for each of the user groups (e.g. departments affected by the building project) and form a committee to draft the brief. There is little information available on how clients select these representatives, but there is some evidence to suggest that many client organisations, in underestimating the importance of the briefing process, appoint representatives of relatively low status (O'Reilly, 1986). Consequently, their ability to access information quickly and to make decisions is limited, and this can slow down the briefing process. It can also be frustrating for the design team, because they are effectively denied access to the business case team. These representatives do however have the power to influence the briefing process by their interpretation of information between the client interest groups and the design team, and between the design team and the other more powerful members of the business case team. If this interpretation is not faithful, the brief can become distorted in relation to the real client needs and decisions. The use of facilities managers and project managers by larger client organisations is an attempt to address this problem, however some architects are sceptical about the effectiveness of these new professionals. The facilities manager is much more aware of the technical implications of client needs, and in that respect is certainly better qualified to translate the needs as expressed by the user groups into terms which are meaningful to the architect (Duffy, 1986a; Duffy 1986b). However, fears have been expressed that the increasing professionalisation and technical orientation of facilities managers might lead to the situation where they take decisions based on their own judgement in the name of the users. Consequently, the architect could never be sure that the user needs were not being distorted in the interests of smoother technical facilities management (Cave, 1987). The project manager is likewise held to be a more effective interpreter of user needs, and in addition to this, a more effective person to manage the project, freeing the architect of his management role and allowing him to concentrate on design. Some architects have pointed out, however, that on all but the very largest projects, the project manager often limits his role to handling the legal issues of site acquisition, project funding, procurement method etc. They claim, therefore, that in these circumstances the architect’s role in managing the briefing and design process is in fact undiminished (AJ, 1986b). Design teams commissioned by property developers have the unique problem of designing a building for users who are usually unknown at the

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time. Moreover, the interests of the members of the client body can be quite diverse. Traditionally, the developer’s objective has been to make a profit by selling the building once complete (or even before that). The funding institution’s objective has been to have a building which cost as little as possible to construct but could command a relatively high rent. The user’s objective has been to find a suitable building, with economical running costs, in which to carry on his business. Although similar conflicts of interest still exist, recent changes in the property markets and in the way in which property development is being carried out are tending to modify the attitudes of the developers and funders, making them more sympathetic to the needs of the users. Nevertheless, in general the users cannot be directly represented in the business case team, and designers remain extremely uncomfortable with this position. 11.4.3 Identification of client needs Even assuming that there is fair representation of the various client interest groups, identification of the true needs of these groups can be problematical. There is a tendency to assume that in approaching the building industry, the client has at least correctly identified that a building project of some kind is the correct solution to the problem which gave rise to the needs in the first place. Larger and more sophisticated clients are generally assumed to have investigated the need to build quite thoroughly, however there is a consensus among writers in this field that the same cannot be said of smaller, less sophisticated clients. The statement of a need will tend to be influenced by the envisaged nature of the solution, and so brief writers can find themselves attempting to solve the wrong problem. Allen (1984) gives three examples of client groups who had wrongly defined their needs. In these examples, more detailed questioning of the stated requirements by the design team lead to fundamental re-thinking of the project by the client. The result in all cases was a more appropriate building and, in two of the cases, a lower cost solution for the client. Another difficulty facing the brief writer is the competition for resources within the client organisation. When asked to state their requirements, it has been found that user groups tend to maximise their 'wish list' in anticipation of being bargained down from this (Kelly and Male, 1988). The problem confronting the brief writer is then to understand the priorities of the user groups such that high priority needs are not sacrificed for lower priority wants. A third difficulty facing brief writers is the changes that can occur in the client organisation and the environment during the briefing and design process. A brief can only reflect the needs (and anticipated future needs) of the client at a particular point in time, however these needs can change during the course of the project. These changes can be sudden and Heriot-Watt University

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11: Common Briefing Structures and Problems in Briefing

unpredictable, however Morris and Hough (1987) demonstrated that in larger projects, history shows that the greater danger is the failure to recognise gradual changes which subtly alter the needs of the client organisation and render the project, as initially conceived, inappropriate. Duffy (1987) and Cave (1987) both comment on the tendency for clients to 'change their minds' which frustrates design teams, but point out that change in the client organisation is a fact of life, and as such efforts must be made to accommodate it. Dealing with the above problems is an exceptionally difficult task for the brief writer, and it is all the more difficult for him if he is unfamiliar with the client organisation. This is one of the reasons behind IBM’s briefing. They maintain that it would be impossible for a consultant architect to reach an understanding of IBM’s corporate culture in the short time available at the briefing stage. Finally, there is the position of the architect who is designing a building for a developer and is unable to consult the ultimate users regarding their needs. Indeed the users will normally be a number of different groups who will change during the life of the building. Here, assumptions must be made about the user requirements, and the building designed to be flexible enough to satisfy most of the requirements for most of the time. Until recently, the needs of the users have been largely ignored in development. It has been suggested that where demand has outstripped supply, as in the London office market during certain periods in its history, users placing exceptionally high priority on location have been forced to accept what buildings were available. In the absence of any consumer pressure therefore, bad design has gone unchecked during these periods. When there is a relaxation in demand, however, design becomes more important and users can be seen to exercise their judgement by renting those buildings which they consider better designed (McIntosh, 1984). Agents are now arguing that this brings the longer term requirements of the funders and the users closer together. They believe that although the users are not part of the business case team, commercial pressures will force the funders to take user requirements more seriously in future, placing pressure in turn on the developers to build better buildings (Ellis, 1984). Of course, funders have always had criteria for office building design, but as Duffy (1986a) points out, the basis for these criteria laid down by the “anonymous, far seeing gnomes” within the funding institutions was never clear, and has since proved disastrously wrong as witnessed by the growing number of obsolete office buildings constructed in the boom of the 1960s. Consumer research is therefore on the increase among funders and developers, as they make an effort to understand the requirements of their customers more clearly (Evans, 1989).

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11.4.4 Techniques for ascertaining client needs Specific techniques used in eliciting and evaluating client (or more specifically user) needs are rarely ever referred to in the literature on current briefing practice. It would appear that the most commonly used method is to hold a series of meetings with the representatives of the client body during which they are questioned on their requirements, and then produce the brief document based on notes from the meetings (Goodacre et al, 1982). It has been argued that this approach is not sufficiently rigorous, as the client representatives themselves may not have a sound enough basis for stating their requirements. More formal procedures for appraising existing buildings and accounting for the value judgements made by individuals is advocated by researchers, and a discussion on these is presented in chapter 4. 11.4.5 Solution-focused thinking As pointed out above, a client’s expression of needs can be influenced by the envisaged building solution. However, it is also common for the expression of needs to be modified as possible design solutions are developed, i.e. after the briefing stage has supposedly passed. This can be another reason for client (or more precisely user) representatives “changing their minds” during the design process - because it is only by seeing designs that they come to a fuller understanding of what is possible in construction (Lawson, 1980; Canter, 1984). This is the same process of understanding design problems by attempting solutions which designers go through (see chapter 2). Some user representatives are also unable to conceptualise well enough to imagine the effects of design decisions on their organisational function or the aesthetics of the building (Carrington, 1979; Goodacre et al, 1982), and so mismatches between their needs and the design can slip through until quite advanced stages in the design, or perhaps never be noticed at all until they occupy the building. 11.4.6 Buildability The issue of “buildability” in relation to early design decisions is also much written about. Ever since the Tavistock report of 1966 there have been calls for contractors to be involved at the earliest opportunity to provide advice on the practical construction implications of design decisions. The traditional separation of the design and construction processes has been described as “a division of responsibility not meant for this world”(Quantity Surveyor, 1982). The design and build procurement method is supposed to allow greater integration in this respect, although to what extent design practice is truly influenced by procurement method is not clear. However, the design and build procurement method (although the fastest growing method) only accounts for about 10%-15% by value of all work in the UK (Franks, 1990b), furthermore there is no universal agreement that it is an appropriate procurement route in all cases, and so the debate over how to introduce buildability advice into early design continues. Gray (1985) suggests that the only way to accomplish this is to involve a contractor at the early stages or to employ a “buildability” consultant. However, there are actually very few people within a contractor’s organisation who have the skills to analyse Heriot-Watt University

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design decisions and give advice of this kind. The same skill shortage applies to buildability consultants, and as a result, states Gray, there are very few good ones. 11.4.7 Provision of sufficient time for briefing By the time most projects get as far as the briefing stage, the client group is anxious to proceed as quickly as possible. As a result, there is usually not enough time allocated to the briefing stage (Lera, 1984; Carrington, 1979). The research action referred to in section 2.4.1 requires investment of time and money, and when resources are limited, the client business case team and the designers may be forced to act without proper consultation simply in the interests of making some tangible progress (Duffy, 1987). 11.4.8 Incomplete briefs In a case study analysis (Mackinder and Marvin, 1982) evidence was produced to support the conclusion that incomplete briefing and lack of information at an early stage of the design process tended to complicate the design process and in some cases was the cause of abortive work. One conclusion drawn from the study was that clients, especially those inexperienced at commissioning buildings, required more assistance in the delivery of proper briefing information and in being decisive.

11.5 Brief documents As indicated above, smaller, less sophisticated clients often do not have a formal approach to briefing. Under these circumstances, there is unlikely to be any brief document per se, and any documentation produced will originate from the architect recording information in meetings with the client representatives (Goodacre et al, 1982; Mackinder and Marvin, 1982). Newman et al (1981) found that in larger client organisations the brief document tends to develop in two stages. The first stage (strategic brief) is often the result of high level, informal discussions within the client body, stemming from the identification of a need, where general agreement is arrived at on the form of building project required. This document generally comprises a functional description of the building, its scale etc, with a rough adjacency diagram to illustrate the building concept. In the second stage (project brief), the general statement above is developed further, usually in a series of committee meetings of some kind and a more detailed document produced in the form of room data sheets with a budget cost for the project and a target completion date.

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Questions Question 1

Outline the differences in the processes used by large and small clients in briefing.

Question 2

Tabulate the problems encountered in briefing.

Question 3

How many stages are there to a typical briefing process? Draw a diagram representing these stages and enter the point where the decision to build is made.

Question 4

What is solution-focused thinking and how can it be avoided?

Question 5

Who should be involved in drafting the project brief?

References AJ (1986a) Development economics series No 2: Sites Architects' Journal, 23 April 1986, pp 49 - 50 AJ (1986a) Development economics series No 5: The architect's role Architects'Journal, 30 April, 1986, pp 55 - 56 AJ (1987a) Management by design Architects' Journal, 19 & 26 August 1987, pp 68 - 71 Allen, D. Towards the client's objective Quality, and Profit in Building Design, P S Brandon and J A Powell (Eds), Spon, 1984 Canter, D. Beyond building utilisation Designing for Building Utilisation, J A Powell, I Cooper and S Lera (Eds), Spon, 1984 Carrington, D. Briefing Encounters Architects'Journal, 23 May 1979, pp 1058 - 1063 Cave, C. Not least the users Architects' Journal, 19 & 26 August 1987, pp 80 - 81 Duffy, F. (1986a) A case for more collaboration Estates Gazette, 18 October 1986, pp 276 - 278 Duffy, F. (1986b) Development economics series No 1: Form or substance Architects' Journal, 23 April, 1986 pp 45 - 46 Duffy, F. (1 987) Change is importunate Architects' Journal, 19 & 26 August 1987, pp 34 - 37 Heriot-Watt University

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Ellis, P. The impact of changing office production processes on office quality for the user Quality and Profit in Building Design, P S Brandon and J A Powell (Eds), Spon,1984 Evans, P. Developers must try harder to please tenants Estates Times Supplement, September 1989, pp 45 - 48 Franks, J. (1990a) Building Procurement Systems Second Edition, CIOB, 1990 Franks, J. (1990b) Procurement in the 1990s Chartered Quantity Surveyor, February 1990, pp 11 - 12 Goodacre, P., Pain, J., Murray, J. and Noble, M. Research in Building Design Occasional Paper No 7, University of Reading, 1982 Gray, C. Achieving American levels of productivity in the UK Estates Gazette, 4 May 1985, pp 459 - 464 Kelly, J. and Male,S. A Study of Value Management and Quantity Surveying Practice RICS Occasional Paper, Surveyors Publications, 1988 Kelly, J. and Male, S. Value Management: Enhancing value or cutting costs? RICS Occasional Paper, Surveyors Publications, 1991 Lawson, B. How Designers Think Architectural Press, London, 1980 Lera, S. Architects design strategies: some justifications for current practice Designing for Building Utilisation, J A Powell, I Cooper and S Lera (Eds), Spon,1984 Mackinder, M. and Marvin, H. Design Decision Making in Architectural Practice Research Paper No 19, Institute for Advanced Architectural Studies, University of York, 1982 McIntosh, A. J. P. The influence of the property market on building design Quality and Profit in Building Design, P S Brandon and J A Powell (Eds), Spon,1984 Newman, R., Jenks, M., Dawson, S. and Bacon, V. Brief Formulation and the Design of Buildings Oxford Polytechnic, 1981

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Value and Risk Management [D19CV9]

12: Strategic Development of Public Private Partnership Projects

12.1 Introduction This unit is intended to provide the framework for the undernoted topics, but reference to further reading and consideration of the questions is required for a fuller understanding of the unit’s subject matter. It should be noted that, prior to 1997, Public Private Partnership (PPP) was formerly known as Private Finance Initiative (PFI) under the Conservative government administration and is often still referred to as PFI. This includes official policy and good practice documentation produced by the Treasury. Therefore the terms PFI and PPP may be thought of as being synonymous. PPP projects provide a particularly good means of introducing project risk issues at the strategic stage and, although PPP is particular to the UK, its generic form of BOOT (Build Own Operate Transfer) procurement exists throughout the world. This unit relates to the following topic areas: • • • • •

Essential principles of the Public Private Partnerships (PPP), formerly known as PFI. PPP project procurement during strategic development. The principle of Output Service Specifications and payment mechanisms. The key risk areas associated with PPP projects. Questions for the reader.

The learning outcomes for the unit are: • • • • •

Understand PPP philosophy and how it differs from traditional capital procurement. Know the steps in the strategic development of a project through the PPP process. Appreciate and interpret a projects requirements in terms of its output specification. Know the risks associated with major projects over their whole life cycle. Understand approaches to payment mechanisms for service delivery.

Heriot-Watt University

Unit 12 - 1

12: Strategic Development of Public Private Partnership Projects

12.2 Glossary PFI

Private Finance Initiative. The procurement policy introduced in 1992.

PPP

Public Private Partnership. Labour government’s preferred title.

Public Sector

The government department client body procuring a PPP project.

Private Sector

Commercial organisations in the private sector responsible for providing services under PPP.

Consortium

The body of financiers, contractors, facilities managers, operators and any other private sector organisations formed for the purpose of a PPP project.

Concession

The long term contract between public & private sector for providing services.

Concessionaire

The private sector operator responsible for providing the services as contracted.

Purchaser

The public sector client who wishes to purchase specific services from the operator.

Operator

As Concessionaire.

Output Specification

A statement of the services to be provided that define the PPP project.

Reference Project

A costed notional project used by the public sector as a benchmark in assessing PPP bids.

Treasury Taskforce

The Treasury body formed to co-ordinate and develop central PPP policy.

Base Estimate

Estimated cost of the project excluding any allowance for risk.

Investment Appraisal

Financial model of a PPP project’s cost and revenue stream over its life to assess viability of project.

VFM

Value For Money.

Service Charge

Operators remuneration for delivering the agreed service.

Payment Mechanism

Contractual basis linking payment with the service delivered.

Note: Technically the term Public Private Partnership (PPP) replaced PFI in 1997. However, PFI has become so established that it remains the most commonly used term to date. Indeed, emerging Treasury publications refer to PFI rather than PPP. In practice the terms are interchangeable.

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The relevance of PPP to this course is laid out below. A key principle of PPP is that of risk transfer. The transfer of risk over the lifetime of projects from the public sector client body to private sector provider is one of the main motivations for the client’s decision to procure through the PPP. It has also proved to be one of the most controversial feature of PPP to date. Risk transfer necessarily involves identifying key risks at the earliest phases of the project, and allocating them to public or private sector. PPP projects are based on output specifications, rather than technical solutions, which are developed through the briefing process. This is closely aligned with the principles of VM, which is based on explicit analysis and articulation of project functions before development of solutions that meet them. The PPP has had a major impact on the UK construction industry since its launch in 1992 through the wide ranging changes it makes to a large sector of the industry and the value of work it will affect. The scale of PPP means that the construction professions, consultancy and contracting organisations and government departments are all having to develop awareness of and expertise in dealing with PPP procurement. In the future most government funded projects are likely to be procured through the PPP as the industry and the government gets to grips with the policy. Major infrastructure projects and projects requiring substantial capital investment typically associated with the public sector including transport, schools, health, water and sewerage treatment works are already being delivered through PPP. In addition, major client organisations in the private sector who invest heavily in the construction industry are becoming interested in PPP style procurement for their own property and facilities needs.

12.3 Key principles of the PPP The PPP is a policy for procurement of services which the government, through its sponsoring departments, are responsible for providing to the nation. The aim of PPP is to increase the flow of capital projects and “government” services in the face of restraint in public sector capital expenditure. It involves the private sector in the provision of these services in a way far more reaching than “mere” privatisation. Typically, the PPP makes the private sector responsible for providing the services and infrastructure e.g. health, transport, sewerage treatment works schools etc. that would normally be regarded as “public”. Whilst PPP is about involving the private sector in provision of services, this invariably requires substantial investment in the construction industry in designing, constructing and operating the buildings and facilities involved in providing the services.

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12: Strategic Development of Public Private Partnership Projects

It is important to stress that the PPP is not a form of contract or procurement for the construction industry, it is a policy initiative and there is no fixed or rigid definition of a project. Although the government intends it to be “deal driven” rather than “rule driven” it is likely that standard contractual conditions and clauses will emerge and become common as experience in the PPP grows. Indeed much of the teething problems and criticism of the PPP is that the lack of guidance and contractual blueprints leaves all the parties to a PPP project unsure of their positions and unwilling to enter into contracts in the face of so much uncertainty. This has resulted in protracted negotiation periods and huge tendering costs for private sector bidders. The uncertainty surrounding PPP increases the risk associated with projects and the allocation of this risk has been a major stumbling block in the progression of PPP deals.

12.4 Parties to a PPP project Essentially there are only two parties to a PPP project: 1. The public sector client. 2. The private sector provider. 12.4.1 The public sector client This is the “purchaser” of services in the form of the government department responsible for providing the services e.g. Highways Agency, NHS Trust, Scottish Office, East of Scotland Water. The public sector identifies the need for the services and develops the project for providing them in the form of output specifications. 12.4.2 The private sector provider This is the “operator”, a consortium of companies who will bid to provide the services over a long period (typically 25 years) in return for annual remuneration. The operator must raise the finance, develop and design solutions for providing the service, and then operate the contract over its lifetime.

12.5 The output service specification PPP procurement involves the public sector identifying services for which the government is responsible, and purchasing them from the private sector who contracts to provide them. The public sector largely transfers responsibility for providing services, and with this, whatever built assets and facilities are required as a vehicle for their provision. This changes the whole nature of project specification from inputs, basically prescriptive specification typical of traditional procurement, to outputs, which are akin to performance specification. The rationale for this is to give the private sector maximum flexibility to innovate in meeting the service specification by whatever means they choose.

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The relevance of value management is clear here, in that functional analysis seeks to identify functions the project has to fulfil without reference to technical solutions. Arguably the most important phase of VM is to clearly and unambiguously define the project in functional terms, before attempting to develop and assess the most efficient alternative solutions that meet these functions. Similarly, the public sector prepare an output service specification in the briefing of a project without presupposing the built solution that might meet the needs. This is left up to the private sector during negotiations. i.e. what is required rather than how it is to be provided. Technical solution School gymnasium Heating plant Aircraft simulator Office building Computer system

Output Regular access to sports facilities Reliable supply of heat/ occupant comfort Pilot training service Serviced accommodation information service

12.6 Strategic project procurement and risk pricing One of the most important and detailed guidance notes issued by the Treasury is the “step by step guide to the PFI procurement process” (Revised April 1999) which is essentially a project delivery framework. As the title suggests, this guidance describes the stages, and required activities, for developing a project from earliest establishment of need through to contract award stage. Although, PPP procurement specific, the process described has much in common with any project delivery guidance, with the familiar identification of need, development of the brief and technical design stage. Contrasting this document with the VFM guide will confirm this. Indeed Stage 3-Options to Meet User Needs of the VFM guidance, dealing with strategic options, requires the consideration of PPP as a form of procurement. Identification, allocation and costing of project risk is carried out with the development of a Reference Project by the client which will be used to guide their negotiations with the private sector in ascertaining VFM. Stage 3 deals with this and risk management activity is defined below.

12.7 Business case and reference project The business case for the project is the first step in determining whether a PFI solution is the best way forward and provides the best value means of investing for providing the service. The steps prior to this involve establishing that the perceived service requirements actually do contribute to the objectives of the client, and that substantial investment is required to achieve this (rather than a reorganisation of the existing business). A necessary part of preparing the business case involves the development of

Heriot-Watt University

Unit 12 - 5

12: Strategic Development of Public Private Partnership Projects

a reference project, basically a costed notional project which serves as a benchmark for comparison with bidders solutions in subsequent negotiations. The costed reference project is used to determine whether the service is affordable on a year on year basis. Although the reference project is in essence a possible technical solution to the service requirements the Treasury stress that it should not be used as an input specification for the project, only as a comparitor for assessing bidders solutions Costing of the reference project has to be in whole life terms and includes capital investment, operation, maintenance and FM costs of the project over its life i.e. all the costs that a bidders PPP solution would include. These would constitute the base estimate. Significantly, the reference project also has to include costing of the risks so that a true comparison can be made with private sector bids which will include a pricing of the risks that they absorb. This is comparable to the VFM guide which requires explicit pricing of risks from the outset, and no sanctioning of funds for general contingencies. All risks transferred under the PPP option, but which would not be transferred under traditional procurement have to be costed. Further on in the process, when a shortlist of bidders is being drawn up, the selection of preferred bidders involves ascertaining the willingness and appetite for taking on the risks the client has allocated to the private sector. Furthermore the guidance stresses the need for the client to seek evidence that the risk allocation agreed upon within bidders offers is acceptable to their funders, underlining the importance of financiers to the whole process.
In-text question What is meant by the Reference Project?

12.8 Key risk areas in the project life cycle 12.8.1 Risk transfer A fundamental objective of the PPP for the Treasury is to transfer risks in service delivery to the private sector, particularly those connected with constructing, owning and maintaining any built assets associated with the service. At the outset, when the public sector sponsor is determining whether a project should be procured through the PPP route as opposed to the traditional the project should be “tested” as to whether transfer of most or all of the risks associated with it will be borne by the private sector. Risk transfer test clearly involves the explicit assessment of project risk and establishment of where it should be allocated- either public sector client or private sector procurer. This will involve, at the early stages of

Unit 12 - 6

Heriot-Watt University

Value and Risk Management [D19CV9]

the PPP procurement process, drawing up a matrix of project risks and stakeholders which will form a basis for negotiation on where final allocation will lie. The second main test to determine PPP suitability of projects is the Value for Money test, although the two are inextricably linked- the VFM case is strengthened if risk is substantially transferred, and undermined if it is not (see Unit 8). There are a number of key risk areas to be considered from the earliest stages: 12.8.2 Bidding risk Bidding involves the consortia proposing solutions for meeting the public sectors service requirements, for a specified period of time (typically 20 or 25 years) in return for an annual remuneration (the service charge). PPP is an attractive investment opportunity for investors as it involves tapping into a long term revenue- and profit- stream provided the risks have been adequately assessed and provided for in the bid. Profit is generated from what is left over after subtracting debt servicing and operating costs from service charge remuneration. The pure performance nature of the output specification puts all the responsibility on bidders for developing solutions for meeting those service specifications. This is part of the philosophy of PPP, that the private sector should have the flexibility to innovate in designs and proposals for the project, and not be constrained by prescriptive specification. The thinking behind this is that the private sector driven by commercial considerations can provide the service more efficiently than the public sector, thus providing greater value for money than the traditional approach. Risk inherent in bidding has been a major contentious issue in the evolution of PPP as many industry reports and journals will testify. Risk lies in investing time, money and effort researching solutions and preparing bids and negotiating with the client with no guarantee of success. The process is lengthier and investment is greater than for traditional tendering, which essentially involves pricing a ready defined solution by the client. As the private sector have a long term interest (the duration of the concession) and responsibility for the project, there is far greater uncertainty and therefore risk associated in trying to account for future variables that must be assessed as part of the investment appraisal. In general terms variables include design and construction risks, cost of finance and operational and management costs. 12.8.3 Design, construction and operating risks These are the responsibility of the private sector. The concessionaire does not earn any return on their investment until the facility has been commissioned and is delivering the service. Design and construction is solely the responsibility of the concessionaire who will have to absorb any cost overruns in meeting the agreed service. As many of the solutions are expected to depart from design norms of traditional facilities, in order to

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12: Strategic Development of Public Private Partnership Projects

achieve VFM and operating efficiency, there is greater uncertainty and risk associated with the built facilities. There are cases where responsibility for, and therefore operation risk associated with, certain core services will be retained by the public sector for policy reasons. In prisons, prison officers will always be employed by HM Prison Services, the public sector department. Likewise, core clinical services in hospitals will be the responsibility of doctors and nurses employed by NHS health trusts, not the private sector operator of the hospital. As a PPP principle, though, as little operating risk as possible should be retained by the public sector 12.8.4 Volume risk This relates to the long term availability and demand for the service which the operator is providing. Volume risk is an area which has caused a number of difficulties in negotiations relating to who absorbs the risk, namely, what happens if actual demand in the future turns out to be less than that forecast, with resulting overcapacity and unrecovered expenditure. The question is, who pays? Although there are no hard or fast rules governing volume risk for all projects, some principles are emerging as a result of precedents set in deals which have been structured. The volume risk held by the private sector relates to availability of the service i.e. ensuring that a minimum capacity of service can be delivered throughout the concession. For example, this could be ensuring a certain number of hospital beds, or prison cells are available at all times, or that a sewerage treatment works guarantee that a certain volume of sewerage can be processed at all times. The availability of a service is distinct though from that of actual usage. The public sector retain the risk of demand falling below a certain level yet still having to pay the concessionaire for having the service available. Clearly, this leaves considerable risk with the public sector and is not really true to the principles of risk transfer. However, experience to date has shown that the private sector have robustly refused to absorb demand risk since the PPP does not provide an attractive investment opportunity under this condition. The risk is simply too great to bear as there are so many uncertain variables which could affect projections. For example, with school buildings, a distinct PPP sector, demographics, educational performance and local population movements could all affect future demand for places. These are factors over which the private sector has no control.
In-text question Who is the concessionaire in a PPP project?

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Heriot-Watt University

Value and Risk Management [D19CV9]

12.8.5 Quality risk In addition to quantity, quality of the service to be provided has to be considered. The risk here is that the quality of service will fall below the standards set out in the brief and payment penalties will be incurred. The operator has to ensure the quality and consistency of core and non-core services provided are maintained throughout the length of the concession. 12.8.6 Residual value risk At the end of the concession period there is the question of what happens to the built facility used to deliver the service. It is likely that the service being provided will still be required and the project will be put out to tender and a new deal negotiated, either with the existing operator or a new bidding consortium. The residual value (positive or negative) of the asset will have to be included in subsequent concessions. 1.

If the asset has significant residual value at the end of the concession, future bidders will want to take ownership of it and its value will be reflected in a lower bid to for the next concession.

2.

If the asset has no residual value, the successful bidder for a succeeding concession may dispose of the asset and provide the service by another means.

3.

If the asset has substantial liabilities then clearly no future bidder would be interested in taking them on, the current service provider would have to meet these.

12.8.7 Finance risk The successful PPP consortium has to raise the finance required for the substantial capital investment in asset procurement. The Funding will come from a combination of debt and equity raised by the bidders. Most of the funding will be debt finance, secured against future revenue generated by the project or secured against bidding consortium member’s assets. Only around 5-15% of the project finance will typically come from equity although there have been cases where has been zero equity from the bidding company. Lending institutions are traditional risk averse organisations and finance has been difficult to attract for a number of the riskiest PPP projects (It has been said that there are more projects than there are consortia). The risk here is that future revenue stream will not be enough to service dept repayment. It is 12.8.8 Regulatory risk Regulatory, or legislation, risk should lie with the party best able to manage it. Logically, this would suggest the public sector retain all regulatory risk. However, an argument against this is that commercial markets are subject to regulatory risk and function without assurances

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12: Strategic Development of Public Private Partnership Projects

from the government about the effects of regulatory change- so why should PPP be different? There are some exceptions to this: •

Certain specific legislative changes which could affect the procured service by changing the service requirements of the public sector. The private sector has been unwilling to accept these risks in PPP deals.

•

The need for specific legislation or planning permission for the asset which would be a prerequisite to enable the PPP contract to take effect. For example, if outline planning permission is required for buildings or facilities then it is unlikely the private sector will take on the risk for securing this. In the experience of PPP procurement of prisons, the public sector obtains outline planning permission, leaving the private sector to obtain detailed planning permission for their design solutions.

12.8.9 Obsolescence risk Developing technology means there is a risk that newer and more efficient solutions will become available in the future, yet the public sector is signing a contract which commits them for decades based on the technology of today’s solutions. If it is likely that obsolescence will make a project redundant at some stage during its life, then it is in the public sector’s interests to be able to terminate the contract if it feels more able to secure better value service elsewhere, although this would obviously involve a payment to the operator for termination. Another option is to include incentivisation clauses in service contracts to improve efficiency, i.e. upgrade in the light of new technology or better solutions emerging. This could involve sharing in any benefits of improved efficiency. Obsolescence risk will obviously apply to some projects more than others e.g. compare hospitals with roads and consider which is prone to greatest risk in this area.

12.9 The payment mechanism The terms of the payment mechanisms agreed that dictate the service charge are fixed from the outset. Therefore if the operating costs turn out to be greater than expected in the future, the responsibility lies with the concessionaire who must absorb these costs. The bidders investment appraisal will involve forecasting what they expect the cost of the service being supplied to be, and using this as a basis for its service charge. When dealing with such long planning horizons there are obvious difficulties involved in forecasting cost of service delivery many years in advance. The operator bears the risk of future income not meeting the costs of providing the service due to inadequate planning, or unforeseen circumstances impacting on the financial forecasts. Although payment of the service will generally be index linked to general price rises (RPI), Unit 12 - 10

Heriot-Watt University

Value and Risk Management [D19CV9]

there are still risks posed by the long term movement of prices. For example, sector specific wage rises or an underestimation of the effects of general inflation would not be correspondingly compensated for in the payment mechanism.

Reading PPP is a fast evolving area with new policy and procurement procedures emerging regularly as the industry tries to improve its performance, and address the many problems (not least risk transfer) that exist. As such, there is no definitive text book on the matter. Instead journals and web based sources are the best means of keeping up to date. The following are good examples. HM Treasury web site (www.hm-treasury.gov.uk) As the centralised public sector ‘client’ (or more accurately, sponsor), the Treasury publishes briefing notes and policy information on its web site. These are aimed at improving the procurement and project management processes to deliver VFM. Papers published in construction journals Peer reviewed journal papers are regularly published which provide critical analysis and research into many aspects of PPP. Recent relevant papers have also included an overview of PPP and key stages in its development. See; Bing Li, A. Akintoye, P. J and Edwards, et al. (2005) Critical success factors for PPP/PFI projects in the UK construction industry. Construction Management & Economics, Volume 23, Number 5/June 2005 Ahadzi, M and Bowles, G (2004) Public-private partnerships and contract negotiations: an empirical study. Construction Management & Economics, Volume 22, Number 9/November 2004 Akintoye, A, Hardcastle, C, Beck, M et al. (2003) Achieving best value in private finance initiative project procurement Construction Management & Economics Volume 21, Number 5/July-August 2003 Note: These (and other) papers are available for download as PDF files through the University library web site. See the ‘electronic journals’ section for details.

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Questions 1. Consider the range of PPP “type” projects being procured. In view of the risks discussed, what would you consider to be the least and most risky type of projects on a whole life basis and why? 2. What quantitative and qualitative aspects could be included in the payment mechanisms for schools, roads, hospitals etc? 3. In your view, has the PPP been a success to date and will it succeed in the future? 4. With reference to articles in recent industry journals, what are the private sectors main concerns with PPP based on their experience to date? 5. Examine the “Step by Step Guide to PFI Procurement Process.” How does the client’s approach to risk assessment differ from that of traditional procurement? 6. What variables have to be considered in the Reference Project and how is the RP priced to allow objective comparison with alternative solutions?

Unit 12 - 12

Heriot-Watt University

Value and Risk Management [D19CV9]

Case Study: Prisons The procurement of prisons under the PPP is a sector where experience has been gained and at least two major projects completed and within their first few years of operation. The (now defunct) Private Finance Panel published a report on two prisons procured through PPP, and summaries of further case studies are emerging on the Treasury Taskforce website. Some of the more important points and principles of PPP are discussed below in relating to procurement of two prisons at Bridgend and Fazakerley. Prison A 800 category B places at Fazakerley on Merseyside. Securicor, Siefert and W S Atkins consortium with construction partners Costain and Skanska. Prison B 600 Category B places at Bridgend, awarded to Tarmac and Group 4 consortium.

The PPP tests Risk transfer The public sector were satisfied that design, planning, construction and operation risks were substantially transferred through the terms of the contract, payment mechanisms agreed and the output specification developed for the project. Some risks were retained as outlined below. Value for money The projects were compared to reference projects of a traditionally procured prison with both public and private sector operator. The greater transfer of risk through PPP was assessed as supporting the VFM principle. In comparing their costs, the NPV of PPP procurement was assessed as providing savings in excess of 10% compared to that of tradition risk-adjusted public sector procurement. Features of deals The concession periods are for 25 years, after which ownership of the prisons is passed to the public sector. This is NOT the usual structure of PPP deals, where there is no reversion of ownership to the public sector. It was an unusual feature of these deals due to substantial difficulties in obtaining outline planning permission for new prisons. The public sector client (HM Prison Service) do not recommend this for future deals if possible, as an asset designed today may not be suitable for service provision in 25 years and may simply become a liability. The normal route is for the service contract to be re-bid, with the facility offered to the

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successor service provider if it is of any value (which bidders will have to take into account at the time).

The payment mechanism is based on availability of prisoner places. The operator is paid an index linked daily rate for places available. A place is not simply a cell or prison bed, rather it is a number of functions that constitute a place such as the provision of healthcare services, food and adequate staffing levels. The operator must ensure a minimum number of places are always available. Although this does not transfer demand risk to the private sector, pressure on prison places and expected growth of inmates means there is no real risk of falling demand and overcapacity. The public sector may therefore be fairly relaxed about not transferring this. However, demand risk was an early goal of the public sector to pass, but this proved wholly unacceptable to the private sector due to the way prisoners are allocated and the way policy is made dictating their numbers. Clearly the operator has no control over this. Quality of service risk is also absorbed by the operator who must undertake effective prison management. In practice, this means there are a number of measurable performance indicators covering this, including number of escapes and provision of out of cell activities. Contract termination Should the operator become insolvent or be in serious breach of obligations the Prison Service can terminate the contract. Alternatively, the consortiums lenders can provide an alternative operator if there is outstanding debt. Other risks transferred to private sector: •

Responsibility for obtaining detailed planning consents.

•

Construction cost and time overruns. No payment was made until the projects were actually operating.

•

Maintenance and upkeep of the facility, monitored through regular dilapidation surveys.

•

Changes in general legislation, but not legislation specific to custodial services.

Unit 12 - 14

Heriot-Watt University

Value and Risk Management [D19CV9]

APPENDIX 1 Glossary of Risk Management Terms Risk

Possibility that an actual outcome will deviate from that forecast.

Risk Event

Actual occurrence of a risk with positive or negative consequences for a project.

Hazard

Risk of physical damage, injury or death.

Upside

Possibility that actual outcome of risk is positive.

Downside

Possibility that actual outcome of risk is negative.

Exposure

Extent of possible loss associated with a risk, usually measured in financial terms.

Risk Attitude

Willingness of an individual, team or organisation to take a risk.

Uncontrollable Risk

Risk whose possibility cannot be influenced by the actions of associated parties.

Controllable Risk

Risk whose possibility can be influenced by the actions of associated parties.

Pure Risk

Hazards that result in loss only. Usually covered by appropriate insurance in the contract.

Speculative Risk

Risks which may result in loss or gain and will be apportioned amongst parties to a project. Initial stages of a project concerned with defining its scope and developing the brief.

Strategic phase

Tactical phase Source

Latter stages of a project concerned with its design and delivery. Origin of the risk in the project environment.

Event

The actual occurrence, or manifestation, of the risk on the project.

Effect

The consequence of the risk occurring for a party or parties to the project.

Hierarchy

Means of classifying sources of risk according to where in the project environment they originate from. Non-numerical assessment of risk based on judgement and experience of individuals.

Qualitative analysis

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Quantitative analysis

Numerical measurement of risk exposure using RA techniques and processing of hard data.

Risk grid

Graphical technique for qualitative analysis of risk.

Risk register

Document recording the risk status of a project at a particular point in time. Requires frequent updating.

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