Strategic Considerations for Project Risk Management - Literature review Example

Student Name: Student Number: Unit Name and Number: Lecturer/Tutor: Title of Assignment: Date due: Introduction Project risk management has become an integral part of managers who strive to realize a successful project. When proper procedure is followed, the process can help management team mitigate against both expected and unexpected risks. Many established projects have been said to exceed estimated budget, lag behind the planned time of completion or even miss essential performance targets because of poor planning and anticipation of risks. Datta and Mukerjee (2001pp. 45–57) explain that for project managers to have extensive and successful project completion, great extent on the identification of possible risks forms formidable step in achieving the success. Before embarking on key strategic considerations, risk management theories and evaluation of the project environment later in the report, various definitions of terms are needed. A myriad of risk and risk management definitions have been put in place to relate it with projects. However, research by scholars such as Faulkender, (2005 p.932) shows that there are no standard definitions that exist to constitute risk in relation to projects. In business industry for instance, risk is often regarded as presence of potential or real hurdle or opportunities that partly or wholly influence the growth of business RAMP (1998). Other schools of thought have it that risk is any factor that has the potential of interfering with successful establishment, running and completion of any project. Dias and Ioannou (1995) gave a conclusive remark that risks can occur in two different dimensions. There could be what they called ‘pure risks’ which they explained occur in the project when it experiences financial loss with no possibility of gaining. On the other hand, they talked of ‘speculative risks’ which they explain involve a situation a project has both gain and loss of finances. In my view, risk management should mean the established processes and methodologies that are used towards effective mitigation of the risks and even potential threats to project goals. This report intends to critically address project risk management based on various strategic considerations, laid down risk management theories and planning and implementation strategies based on the evaluated environment. Strategic considerations for project risk management Increased worries over risks in organizations have given rise to strategies intended to mitigate these risks. An example of such strategies that organizations have considered include Risk Analysis and Management of Projects (RAMP) which was developed by institute of civil engineers RAMP (1998). The main idea behind this strategy is the incorporation of a given project frameworks which can identify and control certain risks as they appear within the life cycle of the project. Pritchard (2001) and Raz and Michael (1999) also suggested a more modern and very comprehensive strategies that seemed to have captured attention of many managers. They suggested that organization should have a mechanism that can multiply the probability of the risk expected to occur vis-à-vis impacts of the risk. According to their hypothesis, this will lead to the possibility of evaluating every risk expected. A further development was made by Halman et al (1994) who took what can be termed as ‘a risk topography approach’ to suggest strategic considerations for project risk management. Their approaches give emphasis to technological, commercial and organisational risks. In as much as these approaches are dynamic, a more reliable strategy was suggested by Turner J (2008) who came up with five strategic steps for project risk management. According to his book The Handbook of Project-based Management, he suggests: Identification of the potential sources of risk on the project Determination of their individual impact, and select those with a significant impact for further analysis. Assessment of the overall impact of the significant risks Determination of how the likelihood or impact can be reduced and Development and implementation of a plan for controlling the risks and achieving the reductions should be regarded as integral in strategic considerations for project risk management. This report will take turner’s suggested framework while analysing expected actions at each strategy. 1.0. Risk identification This is the first step in strategic considerations for project risk management. An important idea to give a consideration is mutual understanding between the project risks and its evaluation. This simply means that before looking at the source of the risk, it is important to embark on uncertainties the project will encounter. An aspect to be given consideration in this step is to come up with interdependencies generating from these risks and any other consequential risks. William (1994 pp.17-22) explains that this should be given scientific approach whereby interviews, teamwork, researches, checklists and even brainstorming being scientific methods he suggested necessary to identify risks. a. Ways project managers can identify risks Researchers have suggested close to four ways of going about this. However, for a given project, working with any two will be adequate enough to identify potential risks any project will encounter. Process-based: it’s true that sensitive risks are likely to occur at organizational interface. And if this is the case, process-based method will be vital as managers will use the available project diagram designed to show how work flow is intended to flow between organizational departments so as to detect the possible source of the risks. Work-breakdown structure-based: though it has some limitations, Price explains that, “The method is used to detect risks by simplifying structure of the organisation so as to easily tell any emerging risks” Price (1998 pp. 19-24) in his management journal Simplified Risk Assessment. Prompt list-based: there are a times in an organization when a particular type of risk keep on recurring. These are what Prince termed as “reappearing risks specific to certain business” therefore by knowing this and tracking them we can be able to predict when a risk will resurface. For better identification of the risks, William warns that data obtained should be accurate and comprehensive. The same sentiments were echoed by Jiang et al. (2002 pp.30-41) who suggest that the data should not only convince that stakeholders and external opinions were factored in but also bear assurance that it is accurate and coherent with the needs of the project within its working environment. 2.0. Risks analysis This is the step most managers will agree with me that is time consuming. If the analyses of risks are properly done then the other steps and procedures will follow suit since it acts as the foundation of the rest. The main reason why this step is essential is because it helps in gauging among the different risks available, which one is more serious to the project. Risk analysis also involves determination of the causes of risks. To analyse risks in an appropriate way, factors that affect consequences and likelihood should be determined. However, determining levels of risk depend on the organisation and also the type of the risk. It needs to be understood that with the current environment, project might have only a few of risk events or even many at the same time. “As the project proceeds, it will be necessary to put more drivers in place which will ensure analysis of the risks are understood within the differing environment; otherwise, we are likely to have a situation where we are faced with multiple opinion with no concerted action against the risk.” warns. Chapman and Ward (2002) a. Analysis of case study risks Channel tunnel is a good example of projects which can be used validate that projects have risks can be avoided if proper strategies are put in place. This was a government initiated project however the finance from the government was for high-speed rail link, but not Tunnel itself. The project faced a period of standstill between 1964 and 75 when there were changes of six different ministers whose attitudes toward the project were lukewarm. This was the period when risks facing the project were never taken seriously. With an aim of reviving the strength of the project, government invited promoters in 1985 to finance it so that it does not collapse from political turmoil that was surrounding it. One of the promoters who played major role was Eurotunnel finance. Another setback came in 2007 when such a risk project succumbing to financial gearing. Though it never experienced financial problems, running it almost made Eurotunnel becoming go bankrupt. Channel tunnel can be used as a good example of projects that succeed if well financed. It can also be said to be among those projects that ranked as government disaster because they are established by those government who later fails to live up to the promise. Just like modern projects, there were some risks that Channel Tunnel never anticipated. There was a bomb that exploded and caused fire. Some said it was a natural phenomenon that no amount of strategy could capture. However, other serious risks that preparations were not made for included the survival of its ferries, the delay of completing the approved work of which was to make the high-speed rail link to London and lastly the attraction of the budge airlines. 3.0. Prioritise the risk Being the shortest step in the strategic considerations, it manly involves making a decision based on the risks that can easily pull down projects. In other words, it focuses on need to treat risks based on their urgency. Risk prioritization engage making a comparison between levels of risk found during the analysis process with risk criteria which was already established when the context was considered. Therefore managers will opt to treat the risk if its measurement reveals that it does not meet risk criteria. Pyra and Trask (2002 pp. 41-48) add that the decision to do so must consider the context of the risk and be able to tolerate risk borne parties apart from the system that will benefit from the risk. It should be noted that some evaluation or rather prioritization can be done but still managers can opt not to treat the risk identified but maintain it. This decision is always rare and if it exists must be influenced by the organization's needs, attitude of members or even its criteria. 4.0. Creation of an action plan This is the step where risks analysed and identified to be demanding are treated. And from the analysis, lower significant risks can either be ignored or pushed to a later date. However we have different kinds of actions plans depending on the nature of the risks. Other than the two, avoiding, and accepting can preferred. According to Smith and Merrit (1985 pp. 391-405) in the book, Project Management Institute, there are always two types of action plans preferred and these are what they call prevention plan and contingency plan. They explain that the manager can choose to work with prevention plan if s/he does not want the risk to occur again or if it does, the impact should be curbed. On the other hand, contingency plan intend to curtail the severity of the risk that has occurred It is important to note that action plan project manager wants to choose should be catalyst by either time or condition at which the risk should be given an action plan. For instance, if the project is planning cut down the cost of damaged goods in the silo, the manager must start working on the structure before the next order arrives. 5.0. Monitoring Progress Unlike the rest of the steps, risk monitoring occurs at every point of the project. A number of methods have been suggested that can be used to monitor project’s risks such as Graphical track list which was suggested by Smith and Merritt (1985). This method works just like tracking list working with a bar chart arranged to check risks. The other method is the tracking chart. In this case, one page for each risk is created which will show emerging risks and prevention plan. Despite these two monitoring options, Smith and Merritt (pp. 397-399) suggest that, “the monitoring option chosen by the manager or organization should work coherently with all aspects of risk management process” if this is attained, the project will be able to detect any change in the internal and even external context and also changes to the risk involved. Alongside, it can also ensure that the risk management designs used is effective in its design and operation. Appendix A has an elaborated flow chart showing risk management process. Risk Management Theories Though researches such as that of Smith and Merritt (1985) provide basis to support theories of risk management, much of these have failed because none has been able to be supported with concrete data. And in as much as frameworks of these theories exist, risk managers have been stalled by the ability to make a choice on the existing ones. Luckily, scholars like Dias and Ioannou (1995) who emerged around late 90’s incorporated the already existing frameworks to establish something palatable. The lack of project management skills as explained by Jin and Jorion, (2006), non-derivative hedging by Davies et al., (2006 pp. 217-240) and assumptions about the purpose of derivative use Faulkender (2005) are methodologies that can be said to be behind the established theories of risk management. See appendix B for components of the framework for managing risk. And further appendix C for the relationship between the risk management principles, framework and process. i. The theory of financial economics approach This is the theory that can be said to be the most prolific in terms of empirical studies and theoretical model extensions. The theory is based on classic Modigliani-Miller paradigm developed by Miller and Modigliani (1958). The paradigm explains that hedging can lead to lower vitality of cash in the project which in turn lowers volatility of the organisation face value. Evidence to support how this theory is related to risk management however has not been clear. Though many scholarly articles agree that risk management can indeed lead to lower volatility of project or organisation value, for example as stated by Jin and Jorion (2006), which of course has been major prerequisite for all other impacts, the proof connecting this with the theory is still very deem. An interesting paper is by Tufano (1996) who finds no evidence to support risk management hypotheses vis-à-vis this theory. ii. The theory of agency This theory tries to look at how risk can be managed in an organization if the organization juggles both the interest of managers, shareholders and debt holders within the project or organization. Actually the theory tries to look at a possible mismatch of interest arising between debt holders, management team and shareholders as a result of inequality in earning distribution. According to Mayers and Smith (1987) this asymmetries in earning can cause the project to take unnecessary risks in order to maintain what he called “positive net value projects”. Fite and Pfleiderer (1995) gave a different dimension of this theory by stating that it simply implies the hedging policies (as I have explained in the theory stated above) which have the potential of impacting the firm. Unlike theory of financial economics approach, this theory seems to provide strong evidence for hedging as a response to misunderstanding between interests of shareholders and managerial incentives within the organization. iii. The theory of New Institutional Economics This theory provides different perspective on project risk management. Unlike the other two theories analysed, this theory look at the cause of risk from governance and socio-economic institutions point of view. These institutions are believed to the one governing the processes of projects and as a result can indulge the project in risk taking. This theory was developed by Williamson (1998) when he was trying to offer an alternative cause of risk in establishment and running of projects. It works by predicting that these risks control practices in an organization may be evaluated by organization. Initially before putting this theory into use, William tries to link it with specific assets purchase William (1997). It thus implied that risk management could be vital in contracts which bound two organizations which in turn allowed for diversification. William further argued that if these organizations were indeed playing vital part in hedging, then their effort could be depicted in the data. The most compelling idea about this theory is that managers and shareholders may be interested in attracting what he called ‘block’ ownership by reducing the risks the project could incur. In this context, this theory seems to have the same prediction and approach as agency theory I have discussed earlier. The only extend this one has is that it also suggests that firm activities and practices could be impacted by the ownership structure existing within that particular project. iv. The theory of stakeholder Though many people have contributed to the theory, Freeman (1984) developed it as an instrument to help managers predict risks in an organization. The relationship between the theory and risk management is that it view stakeholders as the people behind policy creation and implementation in establishment and running of any project. Cornell and Shapiro (1987) add that the theory shows that the performance contract created for management team to some extent make these managers to indulge in risky decision. And that these contracts are policies created by shareholders. Since managing risks in any organization or with any project will lead to decrease in expected cost of values, Klimczak (2005) this will also provide an increase in the value of the project. In this regard, the theory gives a different rationale into possible risk management. The biggest challenge Freeman has been facing with this theory is that it has not been adequately tested especially with the current emerging business environment. For instance, the only valuable test we can count on is that of Smith and Stulz who carries out came out with the hypothesis of financial distress to support the theory Smith and Stulz (1995). In fact, the argument has it that this test could only provide indirect evidence to the theory Judge (2006). Project planning and implementation strategies One of the most challenging tasks for managers is planning and implementation of projects. Actually getting what is written on paper to come to have life and achieve the objectives is task that needs to be well thought for. Project planning and implementation strategies can follow various formats depending on the project and the environment Dooris et al. (2004) for instance suggest that the strategy must consider communication, engagement of all parties, alignment of emerging issues and setting of priorities. They argue that for planning to be effective, an organization needs to communicate about the process as soon as the project is identified. They also state that for successful planning and implementation, all representatives must be engaged and their contributions taken into consideration. These groups may include task forces, surveys, and shareholders. The next proposal is alignment and they claim that an effective project can never be done in a vacuum. Mangers must be aware of trends and changes within the operating environment. It must be ensured that the project plans and implementations are aligned with strategies and objectives. Setting out priorities reminds the project managers that not all strategies and objectives of the projects can be implemented at the same time. All activities need to spread out the entire life of the project. And when this is done, the most pressing one should be considered first. Summary and conclusion In as much as the suggested points sound perfect for risk management in an organization, it is paramount to note that over time, risks and their effects have been having greater tendency to change from time to time. An organization or a project may realize that some risks have been constant while others realize that the risks can be modified and each time they are faced with new challenges. Improvement of the project performance can only be achieved here if there is recognition of risks across the entire project life cycle and the risks emerging given due consideration. It can also be realized that few managers and owners of projects have failed to develop a process to optimize what I can call the portfolio of emerging risks that of course has been across the entire life of the project. As a consequence, the current environment risks or what is commonly known as international risks is often not given enough consideration to how they may change with the changing trends and expectations. From the extensive reading I have on project risk management, I wish to stress that risk analysis and management may be said to be almost complete if the above discussed strategic considerations for project risk management can moderate the risks associated with international rated project constructions. Secondly, if an organization must take risk assessment and management, it needs to be known that it not be a substitute for pre-project planning or even control. Instead, proper risk management must have coordination with all project development and management team. Reference Lists Chapman, C. and Ward, S. (2002). Managing Project Risk and Uncertainty, John Wiley & Sons. Cornell, B., Shapiro, A. C. (1987), “Corporate Stakeholders and Corporate Finance”, Financial Management, Vol. 16, pp. 5-14. Dias, A. and Ioannou, P. (1995). Debt Capacity and Optimal Capital Structure for Privately Financed Infrastructure Projects. ASCE Journal of Construction Engineering and Management, Vol. 121, No. 4, pp. 404-414. Davies, D., Eckberg, C., Marshall, A. (2006), The Determinants of Norwegian Exporters Foreign Exchange Risk Management. The European Journal of Finance, Vol. 12, No. 3, pp. 217-240. Datta, S. and Mukerjee, K. (2001). Developing a Risk Management Matrix for Effective Project Planning—An Empirical Study, Project Management Journal, 32:2, pp. 45–57. Dooris, Michael J., Kelley, John M., and Trainer, James F., (2004). Eds. Successful Strategic Planning, New Directions in Institutional Research, #123. Faulkender, M. (2005). “Hedging or Market Timing? Selecting the Interest Rate Exposure of Corporate Debt”, The Journal of Finance, Vol. 60, No. 2, pp. 931-963. Fite, D., Pfleiderer, P. (1995), “Should Firms Use Derivatives to Manage Risk?”, in Beaver W., Parker, G. (Ed.), Risk Management: Problems and Solutions, McGraw-Hill, New York, pp. 61-76. Freeman, R. E. (1984), Strategic management: A stakeholder approach, Prentice-Hall, Englewood Cliffs, NJ. Geczy, C., Minton, B.A., Schrand, C. (1997), “Why Firms Use Derivatives”. The Journal of Finance, Vol. 52, No. 4, pp. 1323-1354. Halman, J. and Keizer, A. (1994). Diagnosing Risks in Product Innovation Projects, International Journal of Project management Vol 12 No 2 pp 75-81. Jiang, J., Gary K., and Selwyn, T. (2002). A Measure of Software Development Risks, Project Management Journal, 33:3, pp. 30–41. Jin, Y. and Jorion, P. (2006). Firm Value and Hedging: Evidence from US Oil and Gas Producers, The Journal of Finance, Vol. 61, No. 2, pp. 893-919. Judge, A. (2006), “Why and How UK Firms Hedge”, European Journal of Finance, Vol. 12, No. 3, pp. 407-441. Klimczak, K. M. (2005), “Corporate Risk Management from Stakeholders' Perspective”, TRANS’ 05, SGH, Warszawa, Poland, pp. 371-380. Mayers, D., Smith, C. W. (1987), “Corporate Insurance and the Underinvestment Problem”, The Journal of Risk and Insurance, Vol. 54, No. 1, pp. 45-54. Miller, M. H., Modigliani, F. (1958), “The Cost of Capital and the Theory of Inverstment”, American Economic Review, Vol. 48, pp. 261-297. Myddelton, D.R. (2007) They Meant Well. Government Project Disasters. London: The Institute of Economic Affairs. Price, J. (1998). Simplified Risk Assessment, Engineering Management Journal, 10:1 pp. 19–24. Pritchard, C. (2001). Risk Management, Concepts and Guidance, 2nd ed., ESI International. Pyra, J. and John T. (2002). Risk Management Post Analysis: Gauging the Success of a Simple Strategy in a Complex Project, Project Management Journal, 33:2), pp. 41–48. RAMP (Institute of Civil Engineers and the Faculty and Institute of Actuaries) (1998). Risk Analysis and Management for Projects. Thomas Telford, London. Raz, T. and Erez M. (1999). Benchmarking the Use of Project Risk Management Tools. Proceedings of the Project Management Institute Annual Seminars and Symposium. Smith, C. W., Stulz, R. M. (1985), “The Determinants of Firm's Hedging Policies”, Journal of Finance and Quantitative Analysis, Vol. 20, No. 4, pp. 391-405. Tufano, P. (1996), “Who manages risk? An empirical examination of risk management practices in the gold mining industry”, The Journal of Finance, Vol. 51, No. 4, pp. 1097-1137. Turner J (2008), The Handbook of Project-based Management: Leading Strategic Change in Organizations. Copyright by McGraw-Hill Professional; 3ed edition Williams, T. (1994). Using a Risk Register to Integrate Risk Management in Project Definition, International Journal of Project management Vol 12 No 1 pp17-22 Williamson, O. E. (1998), “The Institutions of Governance”, The AEA Papers and Proceedings, Vol. 88, No. 2, pp. 75-79. Williamson, O.E. (1987), The Economic Institutions of Capitalism: Firms, Markets, Rational Contracting, Free Press, New York, London. Appendix A This figure shows the relationship between the principles for managing risk, the risk management framework and the risk. (ISO/TR 14121-2:2007, Safety of machinery — Risk assessment — Part 2: Practical guidance and 670 examples of methods) Appendix B The figure below describes how risk management should function within a risk management framework which provides the foundations and organizational arrangements that will embed it throughout the organization at all levels. This framework can assist an organization in managing its risks effectively through the application of the risk management process. (ISO/TR 14121-2:2007, Safety of machinery — Risk assessment — Part 2: Practical guidance and 670 examples of methods) Appendix C The figure below shows risk management process which must include five activities as outlined. These activities are; the communication and consultation, establishing the context, risk assessment, risk treatment, monitoring and review as detailed in the table below. (ISO/TR 14121-2:2007, Safety of machinery — Risk assessment — Part 2: Practical guidance and 670 examples of methods) Read More