Quantitative Risk Analysis

Quantitative Risk Analysis

This analysis uses numerical values of probability of risk events (or variables and risk factors) and their consequences. This is based on based on a simultaneous evaluation of the impact of all identified and quantified risks.

The first approach of risk analysis process is to determine in which progress level of project the evaluation has to be conducted. In this case, WBS diagrams are very important. Work Breakdown Structures is the hierarchical decomposition structure of a project tasks and can be set at different level of detail (project/ phases/ tasks/ subtasks), each one attached to corresponding actor(s) and resources.

Aleshin, (2001) believes that there is an interconnection between WBS of a project and its Risk Breakdown Structure (RBS) is a useful technique to associate risks. According to (Hillson et al., 2006), RBS can be used as a tool to structure the risk management process.

The quantitative methods rely on probability distribution of risks and may give more objective results than the qualitative methods, if sufficient current data is available. On the other hand, qualitative methods depend on the personal judgment and past experiences of the analyst and the results may vary from person to person. Hence the quantitative methods are preferred by most analysts (Ahmed et al, 2001). When thorough quantitative risk analysis is necessary it can take two alternative approaches (Kuismanen, 2001):

i. risks can be quantified as individual entities while looking at the big picture. This way can include the cumulative effects (to certain accuracy) into each individual risk and thus make more accurate estimations of the net value of the risks.

ii. Alternatively modeling the mathematical properties of the interrelations from the bottom up can be started and then calculate the net impact of each risk including the effects of interrelations”.

 Basic Steps of Quantitative Risk Analysis

When quantitative risk analysis is to be done, it is attempted to describe risk in numerical terms. A typical qualitative risk assessment usually includes the following step :

i. Define the consequence; define the required numerical estimate of risk.

ii. Construct a pathway; consider of all sequential events that must occur for the adverse event to occur.

iii. Build a model – Collect data; consider each step on the pathway and the corresponding variables for those steps.

iv. Estimate the risk; once the model has been constructed and the data collected the risk can be estimated. Included in this estimation will be an analysis of the effects of changing model variables to reflect potential risk management strategies.

v. Undertake a sensitivity and scenario analysis; Undertaking a risk analysis requires more information than for sensitivity analysis”.

Methods of Quantitative Risk Analysis

Any specific risk analysis technique is going to require a strategy which will a good base for analysis.

• Probability Analysis is a tool in investigating problems which do not have a single value solution, Monte Carlo Simulation is the most easily used form of probability analysis.
• Monte Carlo Simulation is presented as the technique of primary interest because it is the tool that is used most often.
• Sensitivity Analysis is a tool that has been used to great extent by most risk analysts at one time to another.
• Breakeven Analysis is an application of a sensitivity analysis. It can be used to measure the key variables which show a project to be attractive or unattractive.
• Scenario Analysis is a rather grand name for another derivative of sensitivity analysis technique which tests alternative scenarios; the aim is to consider various scenarios as options”.

Risk Response Practices

According to PMI, (1996) suggested three ways of responding to risk in projects, these are as follows:

• Avoidance: eliminating a specific threat, usually by eliminating the cause. The project management team can never eliminate all risks, but specific risk events can often be eliminated.
• Mitigation: reducing the expected monetary value at risk events by reducing the probability of occurrence (e.g, using new technology), reducing the risk event value (e.g, buying insurance), or both.
• Acceptance: accepting the consequences. Acceptance can be active by developing a contingency plan to execute should the risk event occur or passive by accepting a lower profit if some activities overrun.
  Abu Rizk, (2003) suggested some actions to be taken in response to residual risks. Actions can include:
• Reduce uncertainty by obtaining more information, this leads to re-evaluation of the likelihood and impact.
• Eliminate or avoid the risk factor through means such as a partial or complete re-design, a different strategy or method etc.
• Transfer the risk element by contracting out affect work.
• Insure against the occurrence of the factor.
• Abort the project if the risk is intolerable and no other means can be undertaken to mitigate its damages.

According to Ahmed et al., (2001), Akintoyne and MacLeod (1997), Enshassi and Mayer (2001), and Education and Learning Whales. (2001) argued that there are four unique ways of responding to risks in a construction project, namely, risk avoidance, risk reduction, risk retention and risk transfer.

1. RISK AVOIDANCE
This is sometimes referred to as risk elimination. Risk avoidance in construction is not generally recognized to be impractical as it may lead to projects not going ahead, because there is no project without a form of risk. A contractor not placing a bid or the owner not proceeding with project funding are two examples of totally eliminating the risks. There are a varioius of ways through which risks can be avoided, e.g. tendering a very high bid; placing conditions on the bid; pre-contract negotiations as to which party takes certain risks; and not biding on the high risk portion of the contract (Flanagan and Norman, 1993).

2. RISK TRANSFER
This is basically trying to transfer the risk to another party. For a construction project, an insurance premium would not relieve all risks, although it gives some benefits as a potential loss is covered by fixed costs (Tummala and Burchett,1999).

The transfer of risk can take two basic form :

• The property or activity responsible for the risk may be transferred, i.e. hire a subcontractor to work on a hazardous process;
•   The property or activity may be retained, but the financial risk transferred, i.e. by methods such as insurance and surety.

3. RISK RETENTION
This is the method of reducing controlling risks by internal management (Zhi, 1995); handling risks by the company who is undertaking the project where risk avoidance is impossible, possible financial loss is small, probability of occurrence is negligible and transfer is uneconomic (Akintoyne and MacLeod,1997). The risks, foreseen or unforeseen, are controlled and financed by the company or contractor. There are two retention methods, active and passive;

A. Active retention (sometimes referred to as self-insurance) is a deliberate management strategy after a conscious evaluation of the possible losses and costs of alternative ways of handling risks.

B. Passive retention (sometimes called non-insurance), however, occurs through negligence, ignorance or absence of decision, e.g. a risk has not been identified and handling the consequences of that risk must be borne by the contractor performing the work.

4. RISK REDUCTION

This is a general term for reducing probability and/or consequences of an adverse risk event. In the extreme case, this can lead to eliminate entirely, as seen in “risk avoidance”. However, in reduction, it is not sufficient to consider only the resultant expected value, because, if potential impact is above certain level, the risk remains unacceptable. In this case, one of the other approaches will have to be adopted (Piney, 2002)”.