Construction Risks: Identifying, Managing And Mitigating

Construction Risks: Identifying,Managing and MitigatingJon Alvarez, AIAFrances M. GastDavid Pieterse, Esq.“Top 10” Legal Issues in ConstructionContracting

The Construction Contract“Three Legged Stool”1. Scope2. Price3. Time

Construction Issues(Contract Issues) Timing and Bargaining Leverage Unforeseen Conditions – Who Bears the Risk? Force Majeure Events Contractor’s Warranty Contractor’s Review of Plans, Specifications and theProject Site Termination for Convenience

Construction Issues(Contract Issues) Treatment of Damages–Liquidated Damages–“Mutual” Waiver of Consequential Damages–Delay Damages Termination for Convenience Dispute Resolution Long Lead Items and your Contractor’s Request forIndemnification Ownership of the Project Plans and Specifications(Architect)

Construction Risk:Identifying, Managing and MitigatingApril 6, 2009KPMG LLP

IntroductionsIn KPMG’s 2008 Global Major ProjectOwners Survey, we focused the viewsof leading construction owners aroundthe world. 2009 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independentmember firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. Printed in the U.S.A.KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative.1

Top Risks Facing the IndustryOwner PerspectiveContractor Perspective1. Availability of QualifiedContractors1. Shortage of Qualified Resources2. Shortage of Internal Resources3. Transferring Risk3. Managing Risk4. Securing Forward Workload4. Rising Cost of Construction5. Environmental Matters6. Availability of Qualified Vendors7. Delivery on Time and Budget8. Regulatory Matters9. Technology10. Transferring Risk2. Managing Risk5. Entering New Markets6. Gaining Competitive Edge7. Succession Planning8. Bonding Capacity9. Reducing Overhead10. Industrial RelationsSource: KPMG’s 2005 Global Construction Survey11. Entering New MarketsSource: KPMG’s 2007 Global Construction Survey2

Top Risks Facing the IndustryOwner PerspectiveContractor Perspective1. Availability of QualifiedContractors1. Shortage of Qualified Resources2. Shortage of Internal Resources3. Transferring Risk3. Managing Risk4. Securing Forward Workload4. Rising Cost of Construction5. Environmental Matters6. Availability of Qualified Vendors7. Delivery on Time and Budget8. Regulatory Matters9. Technology10. Transferring Risk2. Managing Risk5. Entering New Markets6. Gaining Competitive Edge7. Succession Planning8. Bonding Capacity9. Reducing Overhead10. Industrial RelationsSource: KPMG’s 2005 Global Construction Survey11. Entering New MarketsSource: KPMG’s 2007 Global Construction Survey3

Risk Management: Key ThemesEffective Risk Management practices throughout the project lifecycle?zOwners: 60%zContractors: 80%Use of Advanced Qualitative Risk Management techniques?zOwners: 50%zContractors: 50%4

Construction Risk ManagementInstitutional owners of major construction projects are faced with a seriesof critical issues. For many institutions, capital expenditures are reachingan all time high, and represent a potential substantial risk in nearly allaspects of project delivery.Often complicated, fast-paced and risky endeavors, construction projectsare be prone to cost overruns, fraud, misconduct, waste and abuse, aswell as being carried out in a constrained and demanding environmentsubject to increased scrutiny.The execution of major capital projects presents owners with enormouschallenges. Having an appropriate level of oversight and control in placeis critical, only in doing so can risks be mitigated.5

Construction RiskRisks are uncertainties, liabilities, or vulnerabilities, which may cause aproject to deviate from its defined plan. While risk in a projectenvironment cannot be totally eliminated or transferred, it can bemonitored and minimized or mitigated wherever possible. To succeed,organizations must commit to addressing risk management throughoutthe project lifecycle.zThe objective of a risk management process is to minimize the impact ofunplanned incidents on the project by identifying and addressing potentialrisks before significant negative consequences occurzRisk management incorporates the identification, analysis, andmanagement of project riskszThe purpose of risk analysis is to determine the relative exposure in termsof time and cost. Risk management is concerned not only with identifyingrisks, but also with reducing risks to an acceptable level. It includesmaximizing the probability of positive events and minimizing the probabilityand consequences of adverse events.6

Institutional Risk ManagementInstitutional Risk Management is the establishment of an overall strategy,at the Institutional level, of how risks will be addressed and managed.zInstitutional risk strategies must take into account the organization’s overallappetite for project risk vs. reward.zAt the project level, it is critical to gain an understanding of the risks that willbe managed by the contracted Program or Project ManagerzThe focus of Institutional Risk Management is to ensure that project levelrisks are being effectively managed and escalated to the Institutional Levelas appropriate.zLeading practices include the establishment of a Risk Committee thatincludes both project management and intuitional management.7

Project Risk ManagementProject Risk Management is the processes, policies, and procedures,implemented by the project manager, to identify, analyze, manage, andrespond to potential project risks.zThe focus of Project Risk Management is to ensure that minor, day-to-dayproject level risks are being effectively managed on an ongoing basis.zIt is also the responsibility of the project team to ensure that more significantrisks are quickly escalated to the Institutional Level.zWhile minor risks can be managed and reported as part of the daily projectmanagement process, any major risks should be before a project RiskCommittee.8

Primary Elements of the RiskManagement ProcessThe primary elements of the risk management process, at the projectlevel, is the same as that at the corporate level and would typically includethe following elements:zPlan – deciding how to approach and plan the risk management activitiesfor a project. The overall plan should include delineation of riskmanagementzIdentify – determining which risks might affect the project and documentingtheir characteristics. Risk identification is an iterative process and provides aformal opportunity for project members to identify and capture informationrelated to potential risks and opportunities on the project9

Primary Elements of the RiskManagement ProcesszAnalyze – Performing both a qualitative and a quantitative analysis of risksand conditions inherent to the project and analyzing them in terms of:— Qualitative Analysis – Prioritizing risks in terms of their impact on theproject. Qualitative analysis typically includes prioritizing risks in termsof their critically and potential impact on the project.— Quantitative Analysis – Measuring the probability that the risk willimpact the project and quantifying the degree of impact that it will haveon project cost, schedule, quality, or objectives.10

Primary Elements of the RiskManagement ProcesszRespond – Formulation of an appropriate strategy to respond to theidentified risk, which normally is chosen from among the following options:— Elimination or avoidance of the risk altogether so that its impact is nolonger pertinent to the project.— Transference of risk to a third party (e.g. insurance, hedging,contracting).— Mitigation by identifying actions that will minimize the impact of the riskon project cost, schedule, quality, or objectives.— Acceptance of the risk as inherent to the project. Acceptance isgenerally a viable strategy for high consequence, low likelihood risks,which then must be closely monitored to formulate appropriateresponses if the risk does materialize11

Primary Elements of the RiskManagement ProcesszMonitor – Once risks have been identified, and an appropriate response isformulated, the risk and response must be formally documented, assigned arisk owner, and included in the control functions and documents of theongoing project monitoring process.zReport – Executing risk reduction plans and evaluating their effectivenessthroughout the project life cycle. From an institutional perspective, it iscritical that reporting procedures include guidelines on escalation of risks toappropriate decision makers.12

Between the ideaAnd the realityBetween the motionAnd the actFalls the ShadowBetween the conceptionAnd the creationBetween the emotionAnd the responseFalls the ShadowTockwotton HomeInterior Design PresentationT S Eliot“The Hollow Men”

RISKSTime and CostMissionTockwotton HomeInterior Design Presentation

A FEW THINGS TO KEEP INMIND ITTAKES THE RIGHT ORGANIZATION T’S WHAT YOU DO AT THE BEGINNINGTHAT MATTERS MOST IT’S NOT ALL IN THE RFPTockwotton HomeInterior Design Presentation

HypothesisTHE PROJECT TEAM DOES NOT FOLLOWTHE BUREACRATIC ORGANIZATIONCHART OF THE OWNER OR ANY OF THEOTHER PARTIES INVOLVEDTockwotton HomeInterior Design Presentation

Why A Complex Building Project Is Like (Custom)Manufacturing. Defining the outcomePutting the team igningEngineeringTockwotton HomeInterior Design Presentation Finding and purchasingthe right materialsExecutionTesting/ CommissioningEvaluatingFixing bugs

The Bureaucratic ModelTockwotton HomeInterior Design Presentation

A skunk works is a group of people who, in order toachieve unusual results, work on a project in a waythat is outside the usual rules.Tockwotton HomeInterior Design Presentation

Developer kwotton HomeInterior Design PresentationFrom Rod Rose, “Lessonsfrom the Spider Web”,SCUP42 Chicago.

WHO ARE THE TPURCHPMSTRUCESTIMMEP/FPARCHITECT,LA, /ACTockwotton HomeInterior Design PresentationENV

Role of the ClientTockwotton HomeInterior Design Presentation Set the strategic goals andproject intent -- and insist thatthey are met. Identify program Identify site Set budget and scheduleparameters Manage the project!!!!

Client Role – Myths and ChallengesTockwotton HomeInterior Design Presentation The Client knows everythingthey need to know. The Client doesn’t knowanything. The Client’s point person isinexperienced (or out of the loopor terrified). The Client is disorganized. The Client is a drill sergeant. There are so many peopleinvolved, it’s hard to know whichone is the actual client.

Building Commitment To Project Goals And IntentBuilding a common language and points ofreference Learning about the institution Studying the Master Plan and Strategic Plan Clarifying the RFP To know what to leave out andwhat to put in; just where and justhow, ah, that is to have beeneducated in the knowledge ofsimplicity.Frank Lloyd WrightTockwotton HomeInterior Design Presentation

The Client Culture Importance of understanding the decision-making culture Consultants need to find a Cultural Guide What is unique about a university culture?¾¾¾¾¾Quirky hierarchyWords matter (grammar matters!)Faculty expect to lecture and they are trained to argueSense of time (semester schedule, building for the long-term)Anything else?Tockwotton HomeInterior Design Presentation

Program for TomorrowTockwotton HomeInterior Design Presentation Focus forward Don’t solve yesterday’s problems Appropriate benchmarking Be open minded

Unresolved IssuesTockwotton HomeInterior Design Presentation Define scope: what’s in andwhat’s out Explore the broadest range ofoptions from the beginning Have a clear definition of projectexpectations Be aware of diverse culturalissues Pay close attention Call time-out when necessary