Risk Management - Definition, Importance and Benefits

Risk Management – Definition, Importance and Benefits

What Is Risk Management?

Risk management is can be defined “as a set of principles and practices aimed at identifying , analyzing and handling risk factors to improve the chances of achieving a successful project outcome and/or avoid project failure (Boehm, 1989, 1991; Charette, 1989; Kerzner, 2003).

Risk management ensures that an organization identifies and understands the risks to which it is exposed. Risk management also guarantees that the organization creates and implements an effective plan to prevent losses or reduce the impact if a loss occurs.

Risk management is probably the most difficult aspect of project management. A project manager must be able to recognise and identify the root causes of risks and to trace these causes through the project to their consequences. Furthermore, risk management in the construction project management context is a comprehensive and systematic way of identifying, analyzing and responding to risks to achieve the project objectives. The use of risk management from the early stages of a project, where major decisions such as choice of alignment and selection of construction methods can be influenced, is essential. The benefits of the risk management process include identifying and analyzing risks, and improvement of construction project management processes and effective use of resources.

The construction industry is heterogeneous and enormously complex. There are several major classifications of construction that differ markedly from one another: housing, non-residential building, heavy, highway, utility, and industrial. Construction projects include new construction, renovation, and demolition for both residential and non-residential projects, as well as public works projects, such as streets, roads, highways, utility plants, bridges, tunnels, and overpasses. The success parameters for any project are in time completion, within specific budget and requisite performance (technical requirement).

The main barriers for their achievement are the change in the project environment. The problem multiplies with the size of the project as uncertainties in project outcome increase with size. Large construction projects are expose d to uncertain environment because of such factors as planning, design and construction complexity, presence of various interest groups (owner, consultants, contractors, suppliers, etc.), resources (manpower, materials, equipment, and funds) availability, environmental factors, the economic and political environment and statutory regulations”.

A risk management plan includes strategies and techniques for recognizing and confronting these threats. Good risk management doesn’t have to be expensive or time consuming; it may be as uncomplicated as answering these three questions:

1. What can go wrong?

2. What will we do, both to prevent the harm from occurring and in response to the harm or loss?

3. If something happens, how will we pay for it?

Risk management is a process for identifying, assessing, and prioritizing risks of different kinds. (Risk, 2013) Once the risks are identified, the risk manager will create a plan to minimize or eliminate the impact of negative events. A variety of strategies is available, depending on the type of risk and the type of construction. “According to a scientific literature review on project, risk management led to findings of variety of “Risk” (PMI, 2008; Baloi and prince. 2003; Barber, 2005; Chapman and Ward, 2002; Flanagan and Norman, 1993; IEC, 2001; Jaafari, 2001; Smith et al., 2006). Several of these definitions have a common feature: they define risk in terms of uncertain events and their impact on project objectives. The international standard “Project risk management–Application guidelines” uses the terms probability and consequence and defines risk as a combination of the occurrence probability of an event and its consequences on project objectives (IEC, 2001). According to PMI (2008), risk is defined as “an uncertain event or condition that, if it occurs, has a positive or negative effect on one of project objectives”. Ward and Chapman (2003) discuss the concept of risk in greater detail and suggest using a more general concept of uncertainty.

They argue that the term “risk” is often associated with adversity and focus on threats, not opportunities. The questionnaire survey conducted by Akintoye and MacLeod, (1997) strengthens the argument, showing that the majority of respondents perceive risk as a negative event”.

There are various contradictory and different meanings attached to “risk” which lead to widespread confusion and also brings different approaches to risk management which are taken in different fields. An example, in a research by Zhi (1995), the major risk factors of the overseas construction projects have been identified and the risks are classified in terms of their initial sources which include the external and internal aspects of an overseas construction project. Some of the identified risks are: defective physical works, schedule delay, cost overrun, social environment, market fluctuation, etc. The problem is that, all the items are ambiguously called RISK, while schedule delay and cost overrun are the “consequence” on the project objectives and the other items are the “source” of difficulties.

The objectives of risk management are to ensure the rapid identification of risks within the business and to establish a clear process of assessment, action planning and reporting of the risks identified. In addition, it is important that concentration is given to the identification of opportunities as this will enable effective decision making to ensure that:

1. Business opportunities can be quickly assessed at an appropriate level in order to decide whether and how it might proceed with such opportunities.

2. Threats to the project or other parts of the company’s operations can be eliminated or at least reduced to an acceptable level.

3. All decisions take account of contributing to sustainable shareholder value.

The basic principle is that key risks and the appropriate control measures are kept under regular review and reported to project team, project sponsors and key client representatives”.

Why is Risk and Risk Management Important?

A risk which is being controlled leads to reward that provides independent risk management consultancy, which offers technical support service and for internal audit and provides solutions for construction firm (Risk Reward Limited, 2010).

The primary objective of any company is to maximise profit, so therefore the firm appoint agents (managers) who takes various investing and financing decisions to achieve the firm’s objectives. The main criteria are to maximise returns and minimise risks related to any decision.

Risk management is probably the most difficult aspect of project management. A project manager must be able to recognise and identify the root causes of risks and to trace these causes through the project to their consequences. Furthermore, risk management in the construction project management context is a comprehensive and systematic way of identifying, analyzing and responding to risks to achieve the project objectives.

Basically, “from the organizational perspective, risk arises when organizations pursue opportunities in the face of uncertainty, constrained by capability and cost. The challenge is to find a position on each of these dimensions that, in combination, represents a risk profile that is appropriate to the initiative and acceptable to internal and external stakeholders. Consequently, risk and risk management are strategic and governance issues that usually involve a compromise: a risk adverse strategy can limit distinctive achievement; however, a risk-embracing strategy can increase project losses. Explicitly managing this balance is often under-played or overlooked in the pursuit of desired goals (Charette, 2005).

Benefits of Managing Risk

Risk management provides a clear and structured approach to identifying risks. Having a clear understanding of all risks allows an organization to measure and prioritize them and take the appropriate actions to reduce losses. Risk management has other benefits for an organization, including:

• Saving resources: Time, assets, income, property and people are all valuable resources that can be saved if fewer claims occur.
• Protecting the reputation and public image of the organization.
• Preventing or reducing legal liability and increasing the stability of operations.
• Protecting people from harm.
•  Protecting the environment.
•  Enhancing the ability to prepare for various circumstances.
• Reducing liabilities.
• Assisting in clearly defining insurance needs.

An effective risk management practice does not eliminate risks. However, having an effective and operational risk management practice shows an insurer that your organization is committed to loss reduction or prevention. It makes your organization a better risk to insure.