Project Risk Management with Reference to the Stage of Planning in Building/Property Development - Assignment Example

Project Risk Management - Part Project Building/property development Stage of Project life cycle Planning According to Chapman, C. & Ward, S., (2003, p.3) “The need to manage uncertainty is inherent in most project which require formal project management”, and they define project risk as “the implications of the existence of significant uncertainty about the level of project performance achievable.” Risk management is about identification of the risk, make an assessment of the risks involved and evaluate the course of action to be taken to minimize the risk after analysis and giving proper treatment to the risks to minimize the cost and maximize the benefits. This paper aims to focus on risk management with reference to the stage of ‘Planning’ in ‘Building/property development’ and deals with the consequences of risk and risk management. Introduction All projects, whether technological project or property development and management project, are fraught with uncertainties and risks. After having assessed the risk, strategies are devised to manage the risks identified. Strategies may include avoidance of risk, transfer of risk, impact mitigation or acceptance of the consequences related to the risk. Acceptance of risk is also a strategy when we take calculated risks under certain circumstances. A planned approach is very important to anticipate the risks and risk levels and be prepared to manage it effectively. Most of the risks associated with the project can be identified at the planning stage. Construction industries in general are facing high level of failure costs. Cost overrun is also rampant in building/construction industries. Another important problem with these industries is accidents which causes loss of life or injuries. A proper risk management strategy in place would improve the prospects of the company greatly. Risk Management The decision adopted for design and construction in a project delivery method is based on the budget, scheduling, mile stones, risk profile of the project and inspection and certification of the work completed for interim payment. The factors such as type of project, size of project and changes or modifications expected during construction stage are taken into account in finalizing the method. Scope creep or focus creep in project management occurs when the project lacks proper definition with regard to its scope resulting into changes in execution of the project, or the issues are not in the control of the management which may lead to a more critical and riskier situation. Identification of risk According to Paul, C. et al., (2006, p.190) observed that “The use of risk meta-language should ensure that risk identification actually identifies risks, distinct from causes or effects. Without discipline, risk identification can produce a mixed list containing risks and non-risks, leading to confusion and distraction later in the risk process.” Identification of the risk is the primary task, where we want to ascertain the uncertainties which could affect the project. The risks involved in a project can’t be appreciated, if causes or effects are associated, because they are subjective and dilute the perspective. Risk Analysis Chapman, C. & Ward, S., (2003, p.3) states that “Many important source of project risk are common to all projects because they are associated with the fundamental management processes that define the project cycle.”There are two types of analyses, qualitative risk analysis and quantitative risk analysis. The risk profile of a project is described in terms of probability and impact. Based on these two criteria, a project is categorized as high, medium or low risk. In-depth analysis of data is made by using quantitative models for complex projects. Planning According to Chapman, C. & Ward, S., (2003, pp.60-61) the planning phase uses all the efforts of the risk management processes to produce a project base plan ready for implementation and associated risk management plans (actions) for the project management process. In dealing with uncertainties, planning process is involved with the question as to what we are trying to achieve. In the Identification process we are trying to ascertain what uncertainties could affect the project. It could affect the project positively or negatively. In the analytical stage we are concerned about the critical and important uncertainties which could affect the project. The measures to be taken for overcoming these uncertainties are taken up in the response planning with the objective to develop suitable strategy consisting of series of activities for increasing the level of opportunities and reducing the level of threats with provision for alternative and contingency plans clearly stipulating the trigger points. Therefore, the entire planning in risk management is about giving risky projects or the risky component of the project a structured approach, taking into account the accepted level of risk, attitude of the management towards risk aversion and its potential impact financially and operationally. The important deliverables in a risk management process are the level of activities, time schedule, utilization of resources and milestones. The cost benefit analysis at every level in the planning stage and comparison of actual expenditure with budget estimates at the implementations stage is the prerequisite in project risk management from the financial point of view. Risk assessment & evaluation According to Garsden, B et al., (2010, p.3.18-19) in civil engineering projects (Construction and property development) “When attempting to assess the value to the community of a proposed development or facing a decision on the investment of capital (e.g. purchase of plant), it boils down to a choice between alternatives. The decision between: • alternative materials • methods of construction • construction procedures • alternative plant offered for purchase all clearly come into this category. The evaluation of the project is based on several factors such as cost, time element and profitability apart from risks involved, and several methods are used for this purpose which includes cost benefit analysis, cash flow, net present value, internal rate of return and discount rate. Consequences of Risk in construction/property development projects Construction projects, especially property development projects are subject to so many regulations. Design of the project takes into account the issues related to occupants as well as issues connected to the approval of the plan by the local authorities or the town planning committee which is related to roads, sewage, common utility space, open space, parking and other matters such as recreation, schools and shopping centers. Therefore, legal risks involved in any project have to be carefully analyzed and dealt with suitably. We have discussed a classical case with regard to the legal issues involved in a project in Part III. The risks in projects are of various types and a strategic planning takes into account the risks involved in respect of a project with regard to the following aspects. Financial loss: Many projects are hampered due to cost overrun. The material and labor cost increases with passage of time on account of inflation. The cost estimates should be based on the historical details of consumption of material and employment of labor, and the time element precisely calculated for completion of the project. When there is uncertainty with regard to cost and time, suitable ‘escalation’ clauses should be incorporated, to take care of cost overrun. Safety: Safety of the laborers employed in a project is an important element of risk. Proper employee insurance coverage would ensure that the risk is transferred to insurance companies. The employees should be properly trained in safety measures and precautions to be taken in work. Since the project involves employment of manual laborers first aid facilities on the site should be ensured. Damage to property: Construction involves movement of materials and equipments in the site. Also, damages could occur due to factors such as electrical short-circuit, fire, floods and substandard quality of construction materials. Constant monitoring at various stages of construction, proper reporting system, quality control system and training and supervision should be ensured through comprehensive planning. Environmental damage: It may be caused due to emissions, sewage, drainage, waste disposal, conditions of roads or poor maintenance results into health hazards to the community in the area. A comprehensive plan will recognize and takes into account all these aspects at the stage of design and cost estimation. Legal issues: It is always advisable to obtain expert advice and guidance in respect of legal issues involved at the stage or process that may include land acquisition, approval of layouts, planning and employment related matters, because extreme steps of obtaining stay in the court of law on account of violations could cripple the project. Also, the legal proceedings are time consuming and may result in punitive damages. Organization’s image: Legal compliances with regard to issues related to employment, environment, safety enhances the reputation of the organizations. Employees and community welfare is considered as an objective in addition to profitability by the modern management as this policy would sustain the growth of the company in the long run. Quality: Risk of failure of assets is associated with the project because of poor quality construction and lack of maintenance in building construction and property development companies. Quality control system should be in place for constant review of the processes and maintenance work undertaken. Quality standards agreed with regard to the project may be supported by a certificate obtained from the independent quality control agencies to avoid any misunderstanding with the customers in this regard. Opportunities in risks management According to Paul, C. et al., (2006, p.185) the risk includes “two distinct type of uncertainty: those that if they occur will have a negative effect on a project objective, and those that would have a positive effect. In other words, risk included both threat and opportunity.” Paul, C. et al. (2006, p,185) state that in the PMBOK Guide, Third Edition, both threat and opportunity are treated equitably, and the objectives of risk management are stated as “to increase the probability and impact of positive events, and decrease the probability and impact of events adverse to the project.” The developers face market-based risks in construction and property development. The problems related to production-orientated risks are not considered to be the bigger threats due to advanced techniques and methods increasingly adopted by the industry. A fixed price contract is considered as the common risk in the industry. For example when the probability of completion is very high, it indicates risk is under control or manageable and it denotes opportunity. When the positive probability is medium, it means opportunities may be achievable with reorientation of the management processes, if necessary. In the case of remote possibility of success opportunities have to be studied and investigated for improving the situation or for the purpose of mitigation of its impacts. Role of management system PMBOK Guide (2003, p.68) states “Within the DoD*, the primary resource-management tool is the PPBES, which is implemented through the Planning, Programming, Budgeting, and Execution (PPBE) process. It links short-term, mid-term, and long-term planning. However, the PPBES is much more. It is the structured methodology within which DoD produces a set of prioritized objectives, a prioritized program, and finally a budget.” *US Department of Defense The success of a project hinges on management system. It is essential that an efficient management system with streamlined procedures is in place to exercise control over proper pricing mechanism, budgeting process, variance analysis based on the actual cost versus budget estimates on a continuous basis to initiate corrective measures promptly. Risk reporting and communication plays an important role in the entire gamut. The system of management by objective ensures attention to the critical areas to plug the loopholes on time to keep the project on track and time schedule. Proper utilization of resources is very important for reduction of cost and improvement of profitability. Conclusion and recommendations Risk management is a continuous process. Programs for creation of risk awareness among the employees and all those who are connected to the project such as suppliers and subcontractors should be undertaken. This process also involves training to employees in risk management methods at various levels. Coordination of various activities through interactions, reporting and review meetings as well as adoption of standards and creating proper environment for risk treatment will enhance the effectiveness of the management process. Standards of risk management: The Institute of Risk Management, (2002, p.1) “Some form of standard is needed to ensure that there is an agreed: • terminology related to the words used • process by which risk management can be carried out • organisation structure for risk management • objective for risk management Importantly, the standard recognises that risk has both an upside and a downside.” The standards always aim to set a benchmark for the processes and all the firms and stakeholders can use these standards in relation to the activities and performance for measurement. These standards of risk management promote efficiency in performance and act as a basis for measurement and reward. While setting up the standards, both the external internal factors relating to industries or businesses as well as various risks such as financial, operational, environmental and legal risks are taken into consideration. Risk treatment: The Institute of Risk Management (2002, p.10) states “Risk treatment is the process of selecting and implementing measures to modify the risk. Risk treatment includes as its major element, risk control/mitigation, but extends further to, for example, risk avoidance, risk transfer, risk financing, etc.” Efficiency in operation, internal control procedures, legal compliance, implementation of cost control and budgeting are important to ensure effective risk treatment. Purchase of Equipment – Part 2 (A) Evaluation methods For taking decision in respect of purchase of equipment, there are several methods used for evaluation of the proposals. 1. Payback period method The payback period is the number of years during which the project recoup the investment made with the cash accrual generated by the business. This is the time taken by the business to pay for itself. The basic concept of this approach is that the more quickly the cost of investment is recovered through the business, the more desirable the investment is. Fast recovery of the investment ensures margin of safety to the business. The payback period is expressed in terms of number of years. When the net annual cash inflow is estimated to be more or less constant during the period, the following formula is used to calculate the payback period. The payback period is calculated as per the formula given below: Payback period = Investment required / Net annual cash inflow 2. Simple rate of return method This method is also called as the accounting rate of return. The simple rate of return method does not focus on cash flows for calculating the payback. Instead, it focuses on the operating income during the working life, 12 years in this case. The revenue that could be generated by the asset(s) under question during the lifespan of the asset is estimated and the projected expenses in relation to the project including depreciation are deducted from the revenues generated for the whole period. The net operating income is equated to the projected investment outlay of the project, as shown in the following formula: [Simple rate of return = (Cost savings − Depreciation on new equipment) / Initial investment*] *The investment is adjusted for the residual value at the end the period from the sale of old equipment. (B) Depreciation and Sinking fund calculations The purchase price of the equipment is $1,000,000 and a residual value at the end of 12 years is $300,000. 1. Depreciation Straight line method The value of the equipment adjusted with the residual value is divided by the number of years. Depreciation Schedule [42] Year Depreciation Cumulative Book Value 1 58,333.33 58,333.33 941,666.67 2 58,333.33 116,666.67 883,333.33 3 58,333.33 175,000.00 825,000.00 4 58,333.33 233,333.33 766,666.67 5 58,333.33 291,666.67 708,333.33 6 58,333.33 350,000.00 650,000.00 7 58,333.33 408,333.33 591,666.67 8 58,333.33 466,666.67 533,333.33 9 58,333.33 525,000.00 475,000.00 10 58,333.33 583,333.33 416,666.67 11 58,333.33 641,666.67 358,333.33 12 58,333.33 700,000.00 300,000.00 Declining balance method In this method, the value (balance) of the asset is multiplied by a factor. The book value will never fall below the salvage value. Double declining balance factor considered is 200%. The factor applied is 0.16667 (Approximately) as the asset has 12 years of life. (1/12) x 200% Depreciation Schedule [42] Year Depreciation Cumulative Book Value 1 166,666.67 166,666.67 833,333.33 2 138,888.89 305,555.56 694,444.44 3 115,740.74 421,296.30 578,703.70 4 96,450.62 517,746.91 482,253.09 5 80,375.51 598,122.43 401,877.57 6 66,979.60 665,102.02 334,897.98 7 34,897.98 700,000.00 300,000.00 8 - 700,000.00 300,000.00 9 - 700,000.00 300,000.00 10 - 700,000.00 300,000.00 11 - 700,000.00 300,000.00 12 - 700,000.00 300,000.00 Sum of digits method Depreciation rate will decline gradually over the period of years during the life of the equipment in this method. For an asset with 5 years life depreciation rate in the first year is 5/(1+2+3+4+5) = 5/15 = 22.34%, and for the second year it is 4/15 and for the final year it is 1/15. Depreciation Schedule [42] Year Depreciation Cumulative Book Value 1 107,692.31 107,692.31 892,307.69 2 98,717.95 206,410.26 793,589.74 3 89,743.59 296,153.85 703,846.15 4 80,769.23 376,923.08 623,076.92 5 71,794.87 448,717.95 551,282.05 6 62,820.51 511,538.46 488,461.54 7 53,846.15 565,384.62 434,615.38 8 44,871.79 610,256.41 389,743.59 9 35,897.44 646,153.85 353,846.15 10 26,923.08 673,076.92 326,923.08 11 17,948.72 691,025.64 308,974.36 12 8,974.36 700,000.00 300,000.00 Depreciation methods – Graphical presentation The years 1 to 12 are plotted in ‘X’ Axis and the Book value is plotted in ‘Y’ for the three methods of depreciation calculated. Charts comparing methods of depreciation: ________________________________________________________________________ It could be observed that in the declining balance method the asset depreciates faster and in the case of straight line method the decline is uniform. 2. Sinking fund The Sinking Fund is created with the purpose of accumulating specific amount that may be required at a particular point of time in future, say purchase/replacement of machineries or for retirement of debt. In this case the company wants to create a sinking fund for the value (net after salvage) of the equipment $700,000 and the interest rate is 7%. Under the uniform series method, we have to calculate sinking fund factor using the formula which is only present worth factor: (i) is the rate of interest, and (n) is the number of years. Uniform series sinking fund factor works out to 0.05590198865502. For the value of 700,000 the yearly cash outflow works out to 39,131.39 (700,000 x 0.05590198865502). This method is preferred by the companies as it simple and involves payment in equal annual installments throughout the period.  Factors influencing the method of depreciation Repairs and maintenance expenses in the later years will increase considerably. By charging higher depreciation under the Declining balance method is equitable as the burden on account of repairs and maintenance is compensated by lower depreciation in the accounts. Writing down the cost of machineries and equipments in early years is preferable on account of risk of obsolescence. Accelerated depreciation reduces incidence of tax, and cash outflow towards taxes. In the sum of digits method also earlier years suffer more depreciation as in the case of declining balance method. Sinking fund method seeks to provide lump sum at the end of the useful life of the existing machineries by investing the amount set aside in securities which earns interest on compounded basis. The amount set aside is smaller compared to the depreciation on the straight line method. The important factors here are the rate of interest and the lifespan of the assets. If the lifespan of the asset is longer, sinking fund installment payment will be considerably less. (c) Hourly rate calculations Hourly rate for hire in respect of the equipment is worked out based on the following additional data: • maintenance costs are $35,000 per year • operator wages are $90,000 per year • storage, transport and other miscellaneous costs are $15,000 per year • money costs 9% per year • profit margin is 25% While working out the hourly rate, we have considered two shifts per day and 5 days per week in 8 hour shift with allowance of one hour break for lunch and refreshments. We have considered only 5 days a week considering the factors such as Government holidays, annual maintenance of the equipment, emergency repairs and overhaul of the equipments and labor absenteeism. Administrative overheads cost not included under miscellaneous costs has been considered at 10 of the total works cost. Workings: in $ per year Direct Labor 90,000 Direct Overheads Storage 15,000 Maintenance 35,000 ----------- 50,000 ------------ Total Direct Cost 140,000 Depreciation (taking equipment lifespan @ 8 years) 87,500 ------------ Total works cost 227,500 Administrative overheads @ 10% 22,750 ------------ Total cost (excluding financial overheads) 250,250 Financing charges @ 9% 22.523 ------------ Total cost 272,773 Contingencies @ 5% 13,639 ------------ Total Cost of operating the equipment per year 286,412 Profit margin @ 25% 71,603 ------------ 358,015 Total working days considered 260 Total number of hours per day 14 (2 shifts @ 7 hours each) Total hours available during the year 3,640 Operating cost per hour $98.36 per hour Say $98.50 per hour Note: Depreciation considered for the finalization of accounts is a policy decision. However, practical considerations warrant equitable method to be adopted for pricing due to profitability on the one hand and competition on the other. Contingency @ 5% is added in line with the pricing practice, which will serve as a margin for negotiation also. Estate Development – Part 3 Statement of the facts Risk in a project has several dimensions and in respect of the estate development project under discussion, we take up the environmental risk, safety risk and legal risks involved in the project. From the statement given “At the moment, the development has been cleared and a number of roads and storm water drains constructed. This work has increased the frequency, volume and speed of runoff from the estate. There has been no work started yet on flood mitigation to minimize this runoff,” it could be inferred that the estate development project is not affected by the storm or floods. However, as a result of the work undertaken in respect of the estate development project, properties along the watercourse, including houses close to the watercourse and their contents have been damaged. While giving clearance to the project, the council has failed to assess the risk involved in the project and take necessary measures or make arrangements to clear the trees and other obstructions that resulted into damages to the properties and endangered the safety of the community and serious environmental and legal issues affecting the estate development company as well. • The engineering and/or technological issues involved. Considering the statement given in respect of the project “This design incorporated a number of features such as retention basins and the strategic placement of weirs to minimize the effect of any increased flooding. The expected resulting increase of about 500 millimeters in the water height of the estimated one in one hundred year flood was not likely to threaten homes. This figure had been based on an expectation that residents would need to keep the watercourse free from excessive growth and other obstructions”, the question of engineering and/or technological issues involved have to be viewed in the context of the responsibilities involved with regard to all the parties concerned. • The legal principles involved in this case. When the design and technology is dependent upon the requirement that the residents would need to keep the watercourse free from excessive growth and obstructions, the question is whether it is unreasonable and legally untenable to bring any action on the part of the company. However, it is also stated that “The council had passed the plans for the estate on the expectation that this would occur, but had not so advised the property owners, who from the councils point of view were expected to abide by council requirements. At the moment, the development has been cleared and a number of roads and storm water drains constructed. This work has increased the frequency, volume and speed of runoff from the estate. There has been no work yet on flood mitigation to minimize this runoff.” Garsden, et al., (2010, pp.5.4-5) states that “Everyone has a duty of care towards those with whom that person comes in contact… A breach of our duty of care to others is a civil wrong, which is legally known as ‘a tort’… Professional advisers (including engineers), builders, consent authorities and others may be sued in tort when their lack of care in actions or advice results in death, personal injury, damage to property or financial loss.” As far as the company is concerned, the question is whether the company has been negligent in duty of care. In Donoghue v Stevenson (1932 AC562) Lord Atkin ruled that “You must take reasonable care to avoid acts or omissions which you can reasonably foresee would be likely to injure your neighbour. Who then, in law, is my neighbour? The answer seems to be persons who are so closely and directly affected by my act that I ought reasonably to have them in contemplation as being so affected when I am directing my mind to acts or omissions which are called in question.” (Garsden, et al., 2010, pp.5.4-5) Whether the company can reasonably foresee, while getting clearance to the project from the council, that the council would take necessary steps to avoid the risk to the community? The council has failed to advise the property owners, though it is stated that there is requirement from the local council that they (residential property owners) keep their section of the watercourse clear of trees and other obstructions, they have failed to comply with the requirement. However, the interpretation of law in courts with regard to the liability or otherwise of the company and the council may depend upon equity and other considerations. • Whether negligence was involved, and if so by whom. Going by the statement given “The development spans a watercourse, which has only been known to flood once (in 1967) since records were first kept in 1880, and even then the flooding was quite minor, and little or no property damage was recorded,” we can’t say that there is any negligence involved based on the historical facts. The question of liability on the part of the company due to negligence is subject to interpretations in the court of law which may differ from case to case. As far as the public is concerned, it is a collective responsibility, which again is guided by the government, and in this case, the council. However, changes in climate in the recent years due to global warming have resulted into unexpected natural disasters worldwide and the Governments world over are initiating several mitigation programs, and the council has the responsibility to warn and guide the community. • The potential legal position of each of the respondents to the class action. Public lacks awareness in this regard. But, ignorance of law (in this case, the requirements) is not an excuse, and that is the basic legal tenet. The company has obtained clearance from the council and followed the guidelines as expected from them. Under the circumstances explained, it is a question of interpretation by the court of law as to whether there is any negligence involved on the part of the company/council, based on the other legal and social factors concerning the issue in addition to the points mentioned above. As far as the company (including head designer and project manager) is concerned, prudence warrants that this should be treated as a potential legal risk till it is absolved in the court of law. Conclusion The risk profile is described in terms of probability and impact. On both these counts the ‘flooding’ scores too low prior to the disaster in relation to historical facts. The natural disasters are aptly called as ‘acts of God’, and historically it has been very difficult for the humanity to foresee natural disasters in spite of the scientific developments in the field of meteorology or astronomy. Insurance industries would like to exclude acts of God from the purview of insurance for obvious reasons. In this case, the area was subjected to a freak storm, which caused severe flooding and substantial damage to the properties along the watercourse, including houses close to the watercourse and their contents. It highlights the importance that the community projects have to be coordinated at all levels to ensure safety not only during the project period but also thereafter for the years to come. Project risk management principles seek to address these issues, but it has to be understood that the companies engaged in the project management have their limitations too, due to several factors which are beyond their control. The project we have discussed is a classical one with regard to its implications on the community, when it is not coordinated, discussed and effective steps taken at all levels with long term point of view since the benefits or the hardships with reference to such projects are also passed on to the generations. References Chapman, C. & Ward, S., 2003. Project risk management: processes, techniques and insights, Wiley, Chichester, UK. Garsden, B., Thorpe, D & Ayers, R., 2010, Technology management practice, University of Southern Queensland, Australia. Paul, C. et al., 2006. The AMA Handbook of project management, 2nd Ed. Amacom, American Management Association, New York. US Department of Defense, 2003, A Guide to the Project Management Body of Knowledge, (PMBOK Guide) First Ed. DEFENSE ACQUISITION UNIVERSITY PRESS, Virginia. The Institute of Risk Management, 2002. A Risk Management Standard, AIRMIC, ALARM, IRM: 2002. Read More