Value and Risk Management

[D31VR]

School of the Built Environment

Heriot-Watt University 2004

Address for correspondence:
School of the Built Environment
Heriot-Watt University
Riccarton
Edinburgh
EH14 4AS
UK

Tel: +44 (0) 131 449 5111

Fax: +44 (0) 131 451 3161

Authors:
G Bowles and J R Kelly

Address of course leader:

Dr Graeme Bowles
School of the Built Environment
Heriot-Watt University
Riccarton
Edinburgh
EH14 4AS
UK

Tel: +44 (0) 131 451 4626

Fax: +44 (0) 131 451 3161
e-mail: [email protected]
Contents

1: Clients
1.1 Introduction
1.2 Glossary
1.3 The construction client
1.4 Questions

2: An Introduction to Value Management

2.1 Introduction
2.2 Terminology
2.3 Construction orientated value management theory
2.4 The job plan
2.5 Building function
2.6 Conclusion

3: An Introduction to Risk Management

3.1 Introduction
3.2 Learning outcomes
3.3 Risk Management in Perspective
3.4 What is Risk?
3.5 Risk Something to be Avoided?
3.6 The View of the Professional Bodies
3.7 Risk Upside or Downside
3.8 Risk, Uncertainty and Events
3.9 Risk An Event or a Condition?
3.10 Scope of Uncertainty Relating to the Construction
Project
3.11 Risk and Risk Attitude
3.12 Background to Risk Management (RM)
3.13 Defining Risk Management

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4: RM and the Project Life Cycle
4.1 Introduction
4.2 Learning outcomes
4.3 The project life cycle
4.4 VM, RM and the project life cycle
4.5 Relationship between VM and RM in the project life
cycle
4.6 Strategic Risk
4.7 Tactical risk
4.8 Risk- time, cost and quality

5: Risk and the Nature of the Construction Project

5.1 Introduction
5.2 Learning outcomes
5.3 Why is construction so risky?
5.4 Project Heterogeneity v Homogeneity
5.4.1 Project similarities
5.4.2 Project differences
5.5 Risk and the Project Environment
5.5.1 External Environment
5.5.2 Internal Environment
5.6 Controllable or Uncontrollable?
5.7 A Checklist of Risks
5.8 Risk and the source-event-effect chain

6 : Risk and the Client

6.1 Introduction
6.2 Learning outcomes
6.3 Risk and the client
6.3.1 Risk and the clients investment in a capital
building project
6.4 A Client Approach to Evaluating Project Risk the 3
aspects of risk
6.4.1 Aspect 1: Establishing T, C and Q objectives
6.4.2 Aspect 2: Consequence of failure to meet T, C
and Q objectives
6.4.3 Aspect 3: Risk Profile of a project
6 4.4 Summary of risk aspects

7: The Risk Management Process

7.1 Introduction
7.2 Learning outcomes
7.3 RM terminology
7.4 The Risk Management Framework
7.4.1 Risk management planning

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 7.4.2 Risk identification
7.4.3 Risk Analysis
7.4.4 Risk Response
7.4.5 Risk monitoring and control
7.5 The combined value and risk management workshop

8: Tools and Techniques of Risk Management

8.1 Introduction.
8.2 Learning outcomes
8.3 Techniques for the Risk identification stage
8.4 Techniques for the Risk analysis stage
8.4.1 The risk grid (probability-impact matrix)
8.5 Quantitative or qualitative risk analysis?

9: North American Value Engineering in Construction: A Critical

Review
9.1 Introduction
9.2 The Charette
9.3 The 40-hour value management study
9.4 Advantages and disadvantages of the value
management study
9.5 The value management audit
9.6 The contractors change proposal
9.7 Variations on the formal approaches to value
management
9.8 A North American approach in the UK?
9.9 Conclusion

10: Function Analysis and Function Diagramming

10.1 Introduction
10.2 Examples of element function analysis and
diagramming
10.3 Element function analysis
10.4 Elemental cost planning
10.5 Implementing element function analysis
10.6 Conclusions

11: Common Briefing Structures and Problems in Briefing

11.1 Introduction
11.2 Glossary
11.3 Clients approach to briefing
11.4 Problems encountered in briefing
11.5 Brief documents
11.6 Questions
11.7 References

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12: Strategic Development of Public Private Partnership
Projects
12.1 Introduction
12.2 Glossary
12.3 Key principles of PPP
12.4 Output service specification
12.5 Strategic project procurement and risk pricing
12.6 Key risks in the project life cycle
12.7 Reading
12.8 Questions

Appendix 1 Glossary of Risk Management Terms

Appendix 2 Office of Government Commerce (OGC) Procurement

Guide 04 (2003) Risk and Value Management www.ogc.gov.uk

Appendix 3 Office of Government Commerce (OGC) Procurement

Guide 03 (2003) Project Procurement Lifecycle: The integrated
process www.ogc.gov.uk

Appendix 4: Excerpt from HM Treasury: The Step by Step Guide to

the PFI Procurement Process (Revised November 1999)

iv
Overview of the Course

Value Management (VM) and Risk Management (RM) have been combined
in this course to demonstrate the power of using an informed team under the
direction of a skilled facilitator to recognise and either solve (value
management), or account for (risk management), problems occurring on
construction projects in their various stages. VM and RM are
complimentary disciplines which have been described as being 2 sides of
the same coin. They are complimentary in their objectives, in that improving
value in a project can only be achieved if the risk associated with it is
balanced and manageable. They are also complimentary in methodology, or
process, terms. The implementation of value management and risk
management, in a practical sense, is very similar for each.
Both systems require:

The clear identification of a reference point and the client focused

definition of the relationship between time, cost and quality.

The discovery of relevant information either through research or the

structured questioning of those who have the information.

A team approach to the processing and qualitative and quantitative

assessment of strategic and tactical issues.

An outcome in terms of an implementation strategy (value management)

or a dynamic risk register (risk management).

Construction value management

Construction value management has seen rapid growth in recent years
following studies of North American value management procedures. The
UK method is maturing with its own characteristics and application points
within the life of a construction project. The public sector has embraced its
practice and central government has published risk and value management
guidance as part of its Achieving excellence in construction series (see
appendix 1 and 2 of this pack). Significant agreement has been reached with
a number of European countries on the proper application of value
management in manufacturing, process engineering and construction. In
1998 final agreement was achieved on a European qualification system
leading to the qualification Professional in Value Management (PVM). The

v
course recognises the strengths of the various value systems world-wide but
particularly examines the methodologies of North America and the UK.

Construction risk management

Construction risk management is a subject that has been attracting growing
attention in the industry over the last decade. The increasing complexity and
cost of projects, ever more demanding and sophisticated clients and
increasing competitiveness have all contributed to the recognition of risk,
the need to do something about it and awareness of the financial cost if
ignored. Whilst it is true to say that risk in construction, as in any venture,
has always existed and that good project management practice must deal
with it, the emphasis on formalised and systematic risk management is more
recent. The course gives detailed consideration to the nature of the
construction industry and features of construction projects from a risk
perspective. Some recent RM research is used to give context to the
discussion and help develop the readers understanding of the issues.

Structure of the course

This course is concerned with both the strategic and tactical development of
projects.

Strategic project development

Strategic issues are concerned with the front end of the construction
process and to this end the course examines how a project fits in with a
client organisations overall objectives, questions its scope and audits the
developing brief. At the outset the project can be conceived of as primarily a
business problem in most cases. The front end is typified by the early
steps of any procurement model, usually concept and briefing stages. It is
contended that too little attention is often paid to these stages with a
consequent rush to technical solution to fulfil a perceived need.
Furthermore, the best chance to achieve project VFM will be realised
through a deeper understanding of how a project fits into the organisations
corporate objectives. Value management applied at this stage aims to define
the client value system and express the project in functional terms using a
variety of tools and techniques. Strategic level VM does not presuppose a
built solution as the best way of meeting clients objectives.

Tactical project development

Tactical project development is concerned with built solution form,
structure and asset procurement issues. As such it deals with the harder
end of the construction process, at which stages the business problem or
opportunity has evolved into a construction project, and does not question

vi
the motivation to build or surrounding strategic issues. In this context VM
studies use Function Analysis (FA) and other problem solving tools and a
multidisciplinary design team to suggest alternative elements, materials and
components, as well as making small revisions to the project concept to
improve VFM. RM is a means of improving project performance by
reducing exposure to the many possible risks, threats and hazards that
threaten good project performance. Good project performance is achieved if
the building or other facility is delivered on time, within budget and to the
stipulated quality standards necessary for a happy client and construction
team.

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Aims and Objectives

The aim of the value management aspect of this course is to introduce the
concept of value management and critically appraise its application to the
strategic and tactical decisions taken in construction value management in
USA and UK. With regard to the former the course will promote a better
understanding of project definition and how it supports the objectives of the
client organisation. On the latter, it will promote a good understanding of
construction value management as applied to the design of elements and
components.

The aim of the risk management aspect of the course is to introduce the
student to risk and uncertainty in the context of the construction project and
develop an understanding of some common approaches to managing and
mitigating the risks that its participants are exposed to.

viii
1: Clients

1.1 Introduction
This unit contains information about the construction client, their
characteristic structures and their approach to construction projects. The
questions at the end of this unit are intended to promote further reading and
analysis.

1.2 Glossary

Business case team A team of people with an understanding of the

objectives of the client organisation, who may be
from within the organisation or outside or a
mixture of the two. In small projects one person
can fulfil the role. This team becomes the
decision-making unit. (see investment decision
maker below).

Client The customer for construction.

Client adviser The independent adviser, with a knowledge of

construction, and able to understand the client's
business needs and objectives, including any
special needs of the users. Engaged very early in
the project to give impartial guidance on the best
way to proceed.

Client project manager The individual or organisation supplying the

Technical expertise to assess, procure, monitor
and control the resources needed to complete the
project. The client project manager should act in
the clients interests and report directly to the
project sponsor.

Client representatives Individuals, often heads of department, who

make up a project committee. The project
sponsor or client project manager may chair this
committee.

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1: Clients

Investment decision A term used in Office of Government Commerce

maker documents to describe the business case team.
The investment decision-maker may be one
person or a committee.

Project owner A term used in Office of Government Commerce

documents to describe the named individual who
is accountable to the investment decision maker
for the project and the budget.

Project sponsor A senior executive from the client organisation

who is responsible for developing and delivering
the project to meet the clients needs. The project
sponsor manages the clients input into the
project, co-ordinate the clients functional and
administrative needs, works with stakeholders
and users, resolves conflict on the client side and
acts as the formal point of contact for the project
team.

Stakeholders The key interested parties, such as investors and

end users, whose views must be taken into
account during the development of a project.

1.3 The construction client

The complexity of client organisations forbids modelling of client types on
anything other than a simplistic overview. However, the following do
address the most common characteristics.

1.3.1 Small/private/owner occupier

The simplest case in these terms is the small private organisation that wishes
to build for owner occupation (e.g. a small office, factory or an extension to
an existing facility). Here, the client body is composed of the management
and workforce who will, to some degree, be affected by the new facility.
These two comprise the stakeholders. Even in such a simple case, there will
almost inevitably be some disagreement on priorities between the interest
groups that is between management and workforce and indeed among the
management and the workforce. Resolution of these conflicts and final
decisions are, however, likely to be the responsibility of the business case
team who may be one very senior person who is directly involved in the
briefing process. Hence although the client body may be defined to include

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 Value and Risk Management [D19CV9]

several interest groups, the decision making unit is relatively easy to

identify and probably autocratic in style.

1.3.2 Large/private/owner occupier

In larger, private organisations building for owner occupation, the problems
of identifying and dealing with the client body is that much greater, and in
addition to this so is the problem of identifying the stakeholders and the
decision making unit. It is extremely rare to find one individual who will
have total authority over all decisions during the briefing stage. Instead,
decisions are usually taken jointly by a number of individuals representing
the interest groups and then this information is channelled into the briefing
process by a smaller number of persons designated as client representatives.

It is quite common for some of those interest groups which can be defined
to be part of the client body to have no representation in the decision
making unit, and it is also quite common for the power within the decision
making unit to be unequally shared. The function of the project sponsor is to
overcome these deficiencies by representing the views of those not
represented. The client project manager is often a feature of large
commercial organisations that regularly procure from the construction
industry. In this situation it is less common to have a project sponsor.

In text question

Who should be involved in the business case team from private

owner occupier clients?

1.3.3 Large/small private developer

The unique position of the property developer, large or small, has been
much commented upon. The stakeholders here comprise the developer, the
funding organisation, and the ultimate occupiers of the building. The
occupiers seldom have representation in the decision making unit, and yet it
may be argued that they are the ones who are most affected by the design of
the facility.

1.3.4 Large/small public owner occupier

The public sector presents yet greater difficulties in some respects. Here, the
stakeholders can be defined to include the public sector authority, the people
who will operate the facility and the public whom the facility is designed to
serve. This is an enormously wide definition of the client body with
attendant difficulties in representing all of the interest groups fairly in the

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1: Clients

decision-making unit. To overcome these difficulties HM Treasury has

produced guidance documentation formalising the project team
organisation. This diagram is reproduced below.

Investment Decision
Maker

Project Board
Project Owner (may not be require:
advisory only)

Client Advisor User Panel

(may be required by non
Project Sponsor (including functional &
technical sponsor: generally
operational stakeholders)
external consultant)

Project Manager
(generally external consultant)

Investment Decision
Contractor Suppliers
Maker

Figure 1: Project team organisation

(HM Treasury Procurement Guidance No.1 )

In text question

What are the difficulties associated with clients that are made up of a
large number of stakeholders?

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1.4 Questions
Question 1 Describe a system for categorising construction industry
clients.

Question 2 Consider a construction industry client known to you in the

private sector and produce a diagram of the project team
organisation.

Question 3 Consider a construction industry client known to you in the

public sector and complete the diagram shown in figure 1
by inputting the names and responsibilities of the
appropriate personnel.

Heriot-Watt University Unit 1 - 5

2: An Introduction to Value
Management

2.1 Introduction
The aim of this unit is to review the background to value management and
outline its application to the construction industry.

Simplistically, value management is the name given to an enterprise

concerned with providing the product or service demanded by a customer
at the required quality and at the optimum cost. The philosophy is based
on work undertaken in the manufacturing industry of the USA in the
1940s and defined initially as value analysis:

Value analysis is an organised approach to providing the

necessary functions at the lowest cost.

From the beginning, value analysis was seen to be a cost validation

exercise which did not affect the quality of the product. The straight
omission of an enhancement or finish would not be considered value
analysis. This led to the second definition:

Value analysis is an organised approach to the identification and

elimination of unnecessary cost.

Unnecessary cost is:

Cost which provides neither use, nor life, nor quality, nor
appearance, nor customer features.

In 1954 the US Department of Defences Bureau of Ships became the first

US government organisation to implement a formal programme of value
analysis. It was at this time that the term value engineering came into
being for the administrative reason that engineers were considered the
personnel most appropriate for this programme. The formation of the
Society of American Value Engineers in 1959 established the technique
and the name.

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2: An Introduction to Value Management

2.2 Terminology
The terms most commonly used are value management and value
engineering. In a construction context, value management is generally
considered to relate to the business activity of the client and spans
individual projects. Value engineering relates to studies undertaken on
specific projects between the completion of the sketch design and the
completion of construction work on site. These studies tend to be
technical in nature dealing with elements, components and construction
process. See figure 2.1.

CLIENT'S BUSINESS / CORPORATE STRATEGY IMPACTING THE PROJECT

a b A B C D E F G H J K L M c d e
Project Client Inception Feasibility Outline Scheme Detail Production Bills of Tender Project Site Completion Feedback
1st use nth use demolition
awareness develop- proposals design design information quantities action planning operations
ment

Pre-Brief Briefing Concept Design Detail Design Site Operations Use

VALUE MANAGEMENT / VALUE METHODOLGY OPPORTUNITIES

VALUE ENGINEERING OPPORTUNITIES

Figure 2.1: Terminology

Read: Kelly, Male and Graham Chapter 6

Question: Define Value Management and Value Engineering in

terms of what it is and what it is not.

In text question

Do the terms value management and value engineering mean the

same thing?

2.3 Construction orientated value management

theory
Value analysis/value engineering was initially a service for manufacturing
industries where the aim is to produce a large number of identical
products at the highest quality for the least cost. This high production run
is not a characteristic of construction. However, construction clients also
require the highest quality for the least cost and often within a given time.
In the quest for a single building project a large number of problems will

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 Value and Risk Management [D19CV9]

be addressed and a large number of decisions will be taken. A workable

definition for this situation is therefore:

Value management is a service that maximises the functional

value of a project by managing its development from concept
to occupancy through the audit (examination) of all decisions
against a value system determined by the client.

This service is achieved through the application of the job plan described
below. At the core of a value management service is the identification of a
function which is defined as:

An activity for which a thing is specifically designed, used,

or for which something exists.

And value which is defined as:

A measure expressed in money, effort, exchange or on a

comparative scale which reflects the desire to obtain or retain
an item, service or ideal.

Function and its associated value can only be determined by reference to

the clients value system, a concept discussed later.

2.4 The job plan

All value management studies, in manufacturing and construction, follow
the job plan. The job plan is simply a structured method for the logical,
sequential, analysis of value and is characterised by the following phases:

2.4.1 Phase 1 - information

In this phase all of the available information relating to the project and
relevant to the stage under review is gathered together. The objective of
the information gathering is to identify the functions of the whole or parts
of the project, as seen by the client organisation, in clear unambiguous
terms. The information should not be based upon assumption but be
obtained from the best possible source and corroborated if possible, with
tangible evidence. The reasoning behind this is that the quality of decision
making cannot rise above the quality of the information upon which the
decision is to be made. However, care should be taken not to spend
unjustifiable time and effort in information seeking. There is a dilemma
between the dangerous consequences of acting upon inadequate
information and the possible missed opportunity when waiting for reliable
information to arrive. This dilemma is a critical part of a risk analysis. The
types of information being sought are:

Client needs, which are the fundamental requirements that the project
must possess to serve the clients basic intentions. Needs should not be

Heriot-Watt University Unit 2 - 3

2: An Introduction to Value Management

seen solely in terms of utility as the client may have a need for a
flamboyant statement or a need for a facility or a part of a facility
which heightens the clients esteem.

Client wants are the embellishments which it would be nice to have

but do not satisfy need.

Project constraints are those factors that will impose a discipline upon
the design, for example, the shape of the site, planning requirements,
regulations, etc.

Budgetary limits expressed as the total amount that may be committed

to the project in initial capital and life cycle costing terms.

Time for design and construction as well as the anticipated period for
which the client will have an interest in the building.

Information is the lifeblood of a value management exercise that is

obtained under the direction of a value management facilitator using tools
and techniques specifically designed to extract information appropriate to
the stage of the project. Diagram 1 illustrates the characteristic nature of
information at various stages in the project. At the earliest stage, at the
point at which the client perceives a problem to which a building is only
one solution the information tends to be unstructured. This unstructured
information may exist as supply and demand statistics within the client
organisation, or information relating to a problem identified but not made
explicit by clients employees or consultants, or the strategy of the client
executive for which there is no technical solution. Users of a facility, who
are not a part of the client organisation, may also hold information. For
example, public buildings such as law courts, libraries, museums and
offices offering consultation services are situations where the users do not
belong to the client organisation and yet possess valuable information.

Concept information is largely produced by the client organisation in

terms of a brief and by the design team in terms of initial sketches. Once
the outline proposal stage is complete (final sketch design) the design
exercise becomes a technical task of answering the clients brief. At this
point the clients value system is locked in.

Technical information is the designers solution to the problem described

in the brief in performance specification terms.

2.4.2 Phase 2 - creativity

In the creative phase the value management team put forward suggestions
to answer the functions which have been selected for study. There are a
number of creative techniques, for example: brainstorming, the Gordon
technique, the synectics technique and many more.

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 Value and Risk Management [D19CV9]

Brainstorming is the most popular technique used by value management

facilitators to generate ideas in the creativity phase. The technique
requires a group to consider a function and contribute any suggestion that
will answer that function. Every suggestion, no matter how apparently
stupid, is recorded. So, for example, suggestions for a butchers cold store
for the function maintain internal temperature could be; ice, cold air
curtain, insulation, vary pressure, in fact, any idea that comes to mind.

There are various rules which apply to the management of a brainstorming

session of which the two most important are: firstly, no criticism of any
suggestion by word, tone of voice, shrug of shoulders or any other method
of indicating rejection is allowed. Secondly, the exercise is one of
generating as many suggestions as possible. The good suggestions will be
randomly scattered amongst all suggestions. Research has indicated that in
any sample, the number of good suggestions remains fairly constant as
proportion of wild suggestions, so the more suggestions that there are, the
more good suggestions will be obtained. All suggestions are recorded and
none are rejected on the grounds of apparent irrelevance.

Research has also shown that original suggestions are as likely to come
from those inexpert in a subject as from those who are expert. For
example, the interior design consultant may come up with a good original
suggestion for the solution to a structural function. One reason put
forward for this is that the consultant will not be constrained by
professionally determined technical rules or education.

In text question

Why is the emphasis on maximising the quantity, rather than the

quality, of ideas generated in the Creativity phase?

2.4.3 Phase 3 - evaluation

The value management team evaluates the ideas generated in the
creativity phase using one of a number of techniques, many of which
depend upon some form of weighted vote. This stage forms a crude filter
for reducing the ideas generated to a manageable number for further
study.

2.4.4 Phase 4 - development

The accepted ideas, selected during phase 3, are investigated in
considerable detail for their technical feasibility and economic viability. If
appropriate for the stage of the study, outline specifications or designs will
be worked out and budget costs realised. There is wide scope for the use
of cost models and computer aided calculations at this stage.

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2: An Introduction to Value Management

At the end of the development stage the team will again consider the
worked up ideas and all those which either cost more than the original or
are found to reduce quality are rejected.

2.4.5 Phase 5 - presentation

The refined ideas are presented by the value management team to the
body that commissioned the value engineering exercise, supported by
specifications, drawings, calculations and costs.

2.4.6 Phase 6 - feedback

It is important that the value management facilitator receives some detail
of those ideas that have been put into practice and be given the
opportunity of testing the design and cost predictions of the team.

Read: Kelly and Male, Chapters 2 and 3

Question: Briefly outline the value management job plan stating the
objectives of each stage. Consider the resources that would
be required for a workshop.

2.5 Building function

The function of a building is to provide an environmentally controlled
space suitable for the activity to be carried out within that space. The
design of the building is a technical solution to the functional
requirements of the space. Herein lies one major difference between the
manufacturing industry and the building industry, manufacturing
providing products and building providing environmentally controlled
space. A building has a number of characteristics:

It is comprised of manufactured components and assemblies.

The components and assemblies are constructed to form elements of a

building.

The configuration of the elements of a building form spaces which are

conducive to the activity to be performed within the building.

The building represents a stage in the corporate strategy of the client

organisation and contributes to the capital value of that organisation.

Each of the above represents a level at which a particular value

management technique is appropriate. The levels are incremental but, as
listed above, are in the reverse order of their chronological development.
The levels and the points on the RIBA Plan of Work when they are
generally considered is shown in diagram 2 and discussed below.

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 Value and Risk Management [D19CV9]

2.5.1 Task - level 1

Level 1 represents the first stage wherein the client organisation perceives
a problem. This problem may be realised through a study of efficiency,
safety, markets, profitability, etc. Currently, if a client sees a building as a
solution to this problem, a contact with the construction industry is most
likely to be made. The construction industry representative is most likely
to assume that the client has correctly identified that a building is the
solution to the problem and will advise the client on how best to proceed.
The client at this point steps onto the building procurement moving
walkway and is virtually prevented from stepping off until the keys to his
new building are handed over.

As an alternative to this traditional method it is suggested that the first

approach be to a value manager, who, with representatives of the client
organisation will undertake a functional, structured definition of the
project and its objectives. A project is defined here as the investment of
resources for a return where the return may be social or financial.

2.5.2 Spaces - level 2

Having determined that a building is the most promising solution to the
project the value management process moves to level 2 involving the
value manager in an exercise with the client representatives and a design
team. Normally the design team would be that which was to take over the
design of the building, but in situations where the client wished to reserve
the choice of an alternative procurement route e.g. design/build, the design
team would be commissioned for this exercise only.

The exercise would address the definition of the various functional spaces
required by the client and performance specification of the spaces in terms
of area and height, adjacency, IT and other technical requirements, quality
and the heating, ventilation, lighting and sound environment to be
maintained.

2.5.3 Elements - level 3

An element is described by the building cost information service as that
part of construction that always performs the same function irrespective of
the components from which it is made. An element is unusual in that it
has a function but rarely performs or contributes to a process. Also, by
definition, the functional analysis of an element need only be carried out
once. Once all of the functions of an element, e.g. external wall, have been
realised they can be translated into the specific application envisaged by
the project.

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2: An Introduction to Value Management

2.5.4 Components - level 4

Components used in building have been subjected to a process prior to
their arrival on site. All or parts of this process may be analysed to
determine function. Having an understanding of the manufacturing
process and the functional requirements of the component may lead to
alternative design decisions particularly when dealing with components
which are project specific, for example, curtain walling, precast concrete
components, windows and doors. For example, a precast concrete
cladding panel is subjected to a process of manufacture, transport, lifting
and fixing in position, each of which may be viewed as a functional
operation.

In text question

What is meant by the project task?

2.6 Conclusion
This unit has outlined the basic principles of the generic job plan and has
indicated the stages in construction to which this may be applied. Further
units in this course will outline the tools and techniques appropriate to the
use of the job plan at the elements and components stages.

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 Value and Risk Management [D19CV9]

2.7 Self assessment questions

Identify the functions of a university built environment department at the
strategic level. Do you think a building is necessary to accommodate these
functions?

Think about a university department at the spaces level. What are the
different types of functional spaces required by the university and its
users?

Consider a project that you are familiar with. Do you believe the finished
product would have been different if VM had been applied?

Heriot-Watt University Unit 2 - 9

3: An Introduction to Risk
Management

3.1 Introduction
This unit introduces the concepts of risk and risk management. A number
of definitions and perspectives on risk are examined, both generally and
relating specifically to project management. Risk within the context of the
construction project is developed. The distinction between risk and
uncertainty is explained, highlighting that risk on a construction project is
not so much about the possibility of certain events occurring, but more
fundamental is about the very circumstances that surround typical
construction projects throughout their lifecycle- from inception to
completion.

3.2 Learning outcomes

The learning outcomes for the unit are to:

Understand what is meant by risk and uncertainty

Develop awareness of a project management view of risk
Become familiar with the basic components of risk management
Appreciate the distinction between risk events and circumstances.

3.3 Risk Management in Perspective

This section of the unit discusses and defines risk and risk management,
both in a general sense and specific to construction project management.
This will provide a firm base of understanding for the following sections
which look at various aspects of applying risk management to
construction projects.

Although RM has become firmly institutionalised across industry sectors,

it is only comparatively recently that this has extended to include the
construction industry.

The growth in the practice of risk management has been accompanied by

a proliferation of standards and guidance information. There are British
Standards, guidance from professional bodies, public sector guidance,
research published in academic journals and text books dedicated to the
subject matter of RM. A review of some of the more pertinent of these

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3: An Introduction to Risk Management

will help develop our appreciation of the applications and importance of

RM in the context of construction project management. It is useful to
identify common themes emerge from all this material to help our
understanding of the subject area.

3.4 What is Risk?

Risk means different things and has a variety of implications for different
people and organisations in the construction industry. Although this
course makes reference in places to client and contractor specific
perspectives, the overarching perspective is that of the project itself. If risk
is successfully managed and a project is delivered on time, within budget
and to required quality standards, then that should be good for all
participants in the process. In the modern era of integrated project teams
all parties should contribute to the success of, and share in the benefits of,
good project performance. There is no long term benefit from certain
parties to the project gaining at the expense of others.

As a starting point it is worthwhile to begin by firstly defining and being

clear on what we understand risk to mean, both in an everyday sense and
also that specific to the construction professional. It is interesting to see
how views of risk and its management has developed over time.

3.5 Risk Something to be Avoided?

The Concise Oxford Dictionary defines risk as

a hazard, chance of bad consequence, loss, exposure to chance of

injury or loss

Although general, we can clearly relate this to the construction project.

There are obviously many hazards associated with the construction site
itself which can result in injury or loss to the site operatives from
engaging in risky site activities. Indeed, compared to other industries,
the UK construction industry has a particularly poor record in this regard
with an unacceptably high number of site accidents, injuries and fatalities
occurring each year. Whilst the consequences can be clear (damage to the
works, injury or death), the range of sources can be myriad and far less
clear. As well as such direct impact from such risks occurring, there are
likely to be commercial implications from associated insurance claims,
disruption to the programme and consequential effects on other trades and
packages.

Risk, in this sense, is entirely negative and, in a construction project, may

affect one or more parties and will almost certainly involve financial loss.
Indeed, no matter what type of risk we are considering, some financial

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 Value and Risk Management [D19CV9]

impact is almost certain. Such a scenario concurs with Ward and

Chapmans (see supplementary reading) observation that risk is
commonly associated with adversity, implying that risks are potential
adverse effects on the project performance and that sources of risk are
things that might go wrong or threats to the project.

In text question

Identify some common risky site activities in construction.

The BSI Guide 73 (2002) RM Vocabulary Guidelines for use in

Standards defines risk as

the combination of the possibility of an event and its

consequence

In text question

Express each activity identified above in terms of its event and

consequence.

This BSI guide aims to develop a common understanding across different

types of organisation internationally on the terms used in general field of
RM. Contrast this with the dictionary definition above, it is undoubtedly
more precise but also rather abstract. This BSI view is purely concerned
with the possibility of a cause (the event) and related effect
(consequence). Notably though, there is no reference to loss, damage or
any other notion of a negative outcome of risk.

BS6079 -1 (2000) Guide to Project Management, though not containing a

definition, characterises risk from the perspective of a project manager
as.

project risk is primarily the likelihood of negative occurrences

adversely affecting the project so that its objectives become more
difficult or even impossible to achieve

The BS6079 guide is obviously a key publication for a masters

programme in Construction Project Management. It describes risk
management as a process which supports the PM process. Their definition
is more in line with the common view of risk as being overwhelmingly
negative and something to be avoided. It is perhaps unsurprising that this
is one which many project managers may subscribe to the most, given the
many examples of construction projects, both high profile and every day,

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3: An Introduction to Risk Management

that are delivered late and/or over budget for which one or more parties
has suffered. However, the qualifier primarily hints that there are
consequences and effects of risk other than negative ones which is
consistent with the strictly correct definitions of risk.

In text question

What are the 3 criteria that any projects objectives can be

measured in?

3.6 The View of the Professional Bodies

Two of the main international professional bodies governing project

management have developed their own view of risk. The Project
Management Institute (PMI) is a USA based advocate for the project
management profession which exists to promote professional standards
and practices. They identify project management as having nine
knowledge areas, one being Risk Management. The Association for
Project Management (APM) is the largest independent professional body
of its kind in Europe with members throughout the UK and abroad. The
APMs key objectives are to develop and promote project management
across all sectors of industry and beyond.

The PMIs Project Management Book of Knowledge (2000) defines risk

as

an uncertain event or condition that, if it occurs, has a positive or

negative effect on a projects objectives

This view is more explicit about the possibilities of positive, or welcome,

effects of risk i.e. situations or events turning out better than planned or
expected. Since this definition relates to a project, the effects of risk relate
to the effects on the projects time, cost and quality objectives, either for
the project as a whole (the global sense) or some sub-part of the project,
e.g. a particular work package or trade operation etc. a negative impact
will obviously mean late completion, cost over-runs, or not meeting the
required level of quality, either individually or more seriously in
combination.

The APM defines risk as

an uncertain event or set of circumstances that should it occur,

will have an effect on the achievement of the projects objectives

This view is very similar to that above, although in addition to risk being
associated with a specific cause (event) or condition- a set of

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 Value and Risk Management [D19CV9]

circumstances can pose a risk to project outcomes. This is appropriate to

construction projects, particularly large and complex ones, where there
may be many interdependent parties and activities contributing to the
project. In such cases the precise cause (or event) of a cost or schedule
overrun can be far from clear and responsibilities not easily apportioned.
Rather, it has to be untangled from the set of circumstances surrounding
the project.

In text question

What is the difference between an event and a set of

circumstances?

So, although the project management literature recognises, implicitly or

explicitly, that risk stems from uncertainty which can lead to better
outcomes than expected, the more conventional view is that risk is
something to be avoided or minimised where possible, certainly when
discussed in the context of construction projects. This is particularly so at
the site operations stages of the project life cycle where it seems so many
things can (and do) go wrong for projects deemed to be risky.

Discussion and debate on how risk should be perceived has also been
ongoing by practitioners and academics in the field of project
management. Hillson (see supplementary reading) states that risk can have
a range of effects on the achievement of project objectives, from the total
disaster to the unexpected welcome surprise, but is in no doubt that
common usage of the word risk sees only the downside. The negative
connotations are reflected in traditional definitions of the word, both in
standard dictionaries and more technical definitions, but some
professional bodies and standards organisations have gradually developed
their definitions of risk to include both upside and downside. Some
definitions have the nature of the effect as undefined and could therefore
implicitly encompass both positive and negative effects. Others are
explicit in naming both opportunities and threats within its definition of
risk.

In text question

Should all risk be avoided?

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3: An Introduction to Risk Management

3.7 Risk Upside or Downside

To summarise the foregoing, both upside and downside risk is
associated with any uncertain situation. Where there is a possibility that
things may turn out better as well as worse than planned, risk is usually
referred to with negative connotations i.e. downside risk events which are
associated with the concept of loss only. The purpose of risk management
is to minimise loss by reducing the probability of risk events occurring i.e.
making them less likely, or minimising consequences should they occur,
or a combination of both.

Pure risk: normally arises from the possibility of accident or technical

failure.

Speculative risk: possibility of loss or gain, which may be financial,

technical, or physical.

In text question

What loss might be incurred from a downside risk?

3.8 Risk, Uncertainty and Events

Construction projects are all about forecasts of future events. Estimators,
project managers and quantity surveyors all have to make cost and time
related forecasts in what can be a volatile and unpredictable market. The
time span for these forecasts may be months or even years in advance.
However, most future events are uncertain to a degree since perfect
information about the future does not exist. With the application of RM,
consideration is given to the types of events that this uncertainty might
throw up. i.e specific things or occurrences that might affect the project.
With a little thought, the likelihood of occurrence, and magnitude of
possible loss or gain from these events can be assessed. In so doing,
uncertain events can be said to become risk events since some expression
is being made on their probability, whether this be formally (explicit
quantification) or informally (intuitive assessment). It is obviously more
desirable to make decisions under risk than decisions under uncertainty
since more knowledge is gained about a possible event after it has been
considered.

The terms risk and uncertainty are often used together and sometimes
considered to be interchangeable and synonymous. The concepts are very
close and, for the purposes of construction risk management, some writers
tend not to differentiate between them. However there is a distinction to
be made as explained above, and recent research on project risk

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 Value and Risk Management [D19CV9]

management has highlighted a clear difference between discrete risk

events and a more amorphous uncertainty.

In text question

What is the difference between risk and uncertainty?

Risk, uncertainty and events

Uncertainty Risk Certainty

Spectrum of Risk

Unknown Known Known

Unknowns Unknowns Knowns

No information Partial information Complete information

Figure 3.1 The Spectrum of Risk

Traditionally, the distinction between risk and uncertainty has been

woolly or non-existent. Increasingly though, there is a view that a clearer
focus would benefit RM practice. If it is accepted that the term risk
encourages a threat perspective, then it follows that risk management
focuses on the downside and is preoccupied with minimising perceived
threats. Also, risk, having quantifiable attributes (probability and event)
encourages a focus on specified, identifiable events. However, experience
shows that in complex projects which have performed poorly, it is often
difficult to relate the problems to specific events. There are many
interdependent factors that can contribute.

3.9 Risk An Event or a Condition?

A definition of risk at its most fundamental level is the possibility that the
actual outcome for a particular event or activity will deviate from the

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3: An Introduction to Risk Management

forecast outcome. In this sense, an event is some tangible, discrete

happening. At a global level the event may be, for example, the
completion of the building which will have forecast outcomes for cost and
time at completion. The risk to all parties concerned is that actual
outcomes will deviate from those forecast i.e. the building is completed
late and over budget. At a more detailed level, constructing a building
comprises many hundreds or thousands of interrelated events (each design
and construction activity being an event). These events are exposed to
varying degrees of risk that they will not turn out as planned for example,
prolonged bad weather delaying a concrete pour, failure of a supplier to
deliver materials when agreed or the injury of a workman on site from
undertaking a risky activity.

These specific risk events emanate from more general conditions of

uncertainty, and there is, of course, a great deal of uncertainty surrounding
the design and construction of a building.

Ward and Chapman (see supplementary reading) describe uncertainty on

a project as including one or more of the following

Lack of clear specification of what is required

Novelty, lack of experience of a particular project or activity
Complexity in terms of the number of influencing factors and
inter-dependencies between these factors
Limited analysis of the processes involved in the activity
Possible occurrence of particular events or conditions which could
have some (uncertain) effect on the activity

Note that only the last item really relates to specific events or conditions
as referred to in the earlier definitions of a risk. The other sources of
uncertainty arise from a lack of understanding of what is involved and are
less obviously described as threats or opportunities.

In text question

Why does uncertainty lead to risk?

3.10 Scope of Uncertainty Relating to the

Construction Project
It is recognised, then, that risk is not just the consequence of a particular
identifiable event, but also a result of the condition or set of
circumstances that exists in the construction project environment. What
then are these conditions/circumstances surrounding the project that create
risk? Ward and Chapman identify four categories where uncertainty exists
in the project.

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Uncertainty about the basis of estimates

An important area of uncertainty relates to the basis of estimates produced
by members of the project team. Both client and contractor make
numerous estimates and forecasts in a project relating to budgets,
tendering, scheduling and programming. Some will be objective and
based on hard information and historical data, others subjective and
based on gut feel and intuition, judgement and assumptions. More likely
these forecasts will be a mix of the two. The level of uncertainty will
depend on the estimators ability, experience and available resources.
Estimating may be both art and science

Uncertainty about design and logistics

At the earlier concept and briefing stages of the project life cycle, the
technical design and related construction process for the building or
facility are fundamental uncertainties (yet one of the clients earliest
questions will be when will it be ready and how much will it cost?). Over
time the amount of uncertainty in this category will reduce as the design
progresses and these issues are resolved

Uncertainty about objectives and priorities

At the root of good project performance is clarity about project objectives
and their relative priorities, which should be well understood and agreed
throughout the project team. Attempting PM or RM when this clarity is
lacking is like attempting to build a tower on wet sand. Ward and
Chapman recognise the rise of VM in addressing this. As well as being
clear, the project objectives should reflect and reconcile the requirements
of all the project stakeholders.

Uncertainty about the project organisation

This relates to the multiplicity of people, business units and organisations
involved in a project and the fundamental relationships that exist between
these parties (the construction project as a temporary multi-organisation is
discussed elsewhere). These relationships are often complex and may or
may not involve formal contracts. Conditions` of uncertainty arise from
ambiguity in respect of
specification of responsibilities
perception of roles and responsibilities
communication between parties
contractual conditions
mechanisms for coordination and control.

Heriot-Watt University Unit 3 - 9

3: An Introduction to Risk Management

3.11 Risk and Risk Attitude

It is important to appreciate the attitude to risk of clients and contracting
organisations in their decision making. Interpretation of the seriousness of
risks and their response is not a rational and objective exercise. Different
people given the same information on risk exposure for a situation will
respond differently depending on their attitude and whether they are risk
seeking, risk averse or risk neutral. What is an acceptable risk to one
decision-maker will not be acceptable to another.

Therefore it is the combination of risk exposure and attitude that will

dictate responses to and strategies for dealing with risk. Whilst risk
exposure, the extent of maximum possible loss, can be quantified fairly
easily, risk attitude cannot. Utility theory is the branch of decision theory
dealing with measuring risk attitude, though is not the concern of this
course. The figures below are reproduced from Flanagan and Norman and
illustrate the different attitudes of types of people according to their
propensity to take risks and how these relate to disciples in the
construction industry.

HIGH HIGH

+ Challenger + + + Architects
Innovator +
Contractors
Developers
+ Practicaliser
Risk
Modifier
+Synthesiser Risk
+ M&E
taking + taking + Electrical contractors
+ Planner contractors

+ Repeater +
+ Dreamer Quantity
surveyors
+Engineering
consultants
LOW LOW

FEW Creativity MANY

IDEAS IDEAS FEW Creativity MANY
IDEAS IDEAS

Figure 3.2 People and risk Figure 3.3 Construction

people and risk

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3.12 Background to Risk Management (RM)

Now that we have defined and investigated various interpretations of risk,
we can extend this to look at the background to RM. Full consideration of
a RM approach is contained later in the course pack. RM as a recognised
service practiced in a structured way, whether as fee-earning consultancy
or inclusive part of project management services, has been becoming
increasingly popular as the serious consequences of risk become more
evident. Clients are becoming more demanding and buildings more
complex, both in a technical and managerial sense. Of the more recent
influential industry reports, it is Latham who perhaps most effectively
communicated to the industry the need for RM.

In the UK, the public sector has been particularly progressive in

advocating RM and VM, and also incorporating it into their project
management systems. The Office of Government Commerce (OGC)
Project Procurement Lifecycle (see supplementary reading) states that, for
effective construction project management there must always be detailed
knowledge and understanding of the risks relating to a specific project and
reliable plans for risk allocation and proactive management. (note: A
series of OGC procurement guidance has been developed recently, largely
in response to the Egan report). This framework for construction
procurement identifies required risk management activity at key stages
throughout the process, from the business case stage through its design,
construction and operation.

3.13 Defining Risk Management

Just as there are numerous definitions of risk, there are numerous
definitions of RM offered by the various professional institutions and
standards bodies. There is perhaps, though, greater consistency as to what
constitutes risk management. The differences in definition are largely a
matter of semantics and terminology. The key features of a RM
framework are extracted and discussed below.

According to BSI Guide 73 (2002) RM Vocabulary Guidelines for use

in Standards, risk management is

Coordinated activities to direct and control an organisation with

regards to riskand generally includes risk assessment, risk
treatment, risk acceptance and risk communication

The PMIs Project Management Book of Knowledge (2000) describes

RM as..

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3: An Introduction to Risk Management

the systematic process of identifying, analysing and responding to

project risk. It includes maximising the probability and
consequences of positive events, and minimising the probability
and consequences of events adverse to project objectives. It
includes processes of RM planning, risk identification, qualitative
risk analysis, quantitative risk analysis, risk response planning and
risk monitoring and control.

BS6079 -1 (2000) Guide to Project Management, does not offer an

explicit definition of RM as such, but states that

the project manager should take positive steps to identify, assess

and ultimately manage all risk inherent in the project, as an
integral part of the project management process.

Self Assessment questions

1. What is the difference between objective and subjective

probabilities? Which is more commonly found in risk assessment
in construction project management?

2. How do we transform an uncertain situation into a risk situation?

3. Does the Office of Government Commerce view construction risk

as a negative feature of construction projects

Unit 3 - 12 Heriot-Watt University

4: RM and the Project Life Cycle

4.1 Introduction
This unit explains the project life cycle in terms of its two main phases-
the initial strategic phase where the project is being defined, and the
tactical phase which follows and is concerned with delivery. The
application of VM and RM throughout these phases of the project life
cycle is discussed. Good project performance is achieved if the project
which best meets the client needs is correctly and clearly identified in the
former phase, and efficiently delivered in the latter. Whilst both VM and
RM have a role to play throughout these phases, the nature of its practice
and the benefits accrued change as the project evolves.

4.2 Learning outcomes

The learning outcomes for this unit are to:

Appreciate the distinction between strategic and tactical stages of the

project life cycle.
Appreciate the nature of strategic risk and tactical risk
Be aware of when the business project becomes a construction project
in the life cycle
Know the relative importance of VM and RM at stages throughout the
project life cycle.

4.3 The project life cycle

The Project Life Cycle (PLC) is defined by BS6079 Part 1 as the
sequential phases through which a project passes to reach its objectives.
There are numerous interpretations on what these phases comprise of from
the various professional bodies, both in a general project management as
well as construction specific perspective. Within construction the Royal
Institute of British Architects (RIBA) Plan of Work (PoW) is one of the
most widely recognised project life cycle frameworks in the UK. First
published in the 1960s and recently updated in 2000, the RIBA PoW is
most closely associated with traditional procurement- a sequential design
and construction process with lump sum bills of quantities and
competitive tendering. More recently, other forms of procurement have
emerged such as design build, partnering and prime contracting systems
which offer concurrency in design and construction and attempt to
integrate the supply chain in the design process. Since the publication of

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4: RM and the Project Life Cycle

Egans Rethinking Construction in the UK, much emphasis has been

placed on encouraging more collaborative approaches to procurement
which bring together the various design, construction and manufacture
elements of the process into integrated project teams. The OGC Project
Life Cycle framework exemplifies this approach in the UK public sector.

A comparison of the various project life cycle frameworks shows that the
timing and responsibilities for the various design and construction
activities involved may vary, the way the various participants are brought
together may differ, and the number of steps detailed and terminology
used varies. However, fundamentally they all exhibit a number of
common features which see the project go through a strategic definition
phase followed by tactical delivery phase. This distinction is explained in
the next section.

Some Sample Project Life Cycle Frameworks

APM BoK RIBA PoW BS6079 OGC CIRIA

Pre-feasibility Appraisal Conception Strategic Feasibility
assessment
Feasibility Strategic briefing Feasibility Business Briefing
justification

Design Outline proposals Implementation Procurement Scheme design

strategy

Contract Detailed Operation Investment Production

proposals decision information

Implementation Final proposals termination Outline design Tendering

Commissioning Production Detailed design Construction

information
Handover Tender Readiness for Operation
documents service
Operation Tender action Benefits
evaluation
Construction

Completion

Feedback

In text question

What are the 2 main phases that make up any project life cycle?

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 Value and Risk Management [D19CV9]

4.4 VM, RM and the project life cycle

A business project or a construction project?

At the earliest conception, the project is essentially a recognition by the
client of the need to make some investment for a return, usually to satisfy
some perceived business objectives or changing service levels within the
organisation. As such the project can be conceived of as some business
problem or opportunity, rather than a construction project per se. It is only
the point at which the decision to build is made that it becomes a
construction project begins. The procurement of a construction project
then evolves by establishing the functions the built asset will provide and
the form it will take, through to sketch & detail design and construction.
In this way the project moves from a strategic to a tactical phase.

The Project Life Cycle

Business
project Investment/development appraisal

Project brief
Decision to build

Construction project brief

Construction
project Design

Bidding

Construction

time

Figure 4.1 The business and construction project

Breaking the project down into its strategic and tactical phases that
constitute the PLC, both VM and RM have a role to play throughout,
though their relative importance in contributing to good project
performance varies. Generally VM is the dominant discipline in the earlier
stages and RM in the latter as explained in the following section. Figure
4.2 illustrates how the project develops from concept through to
construction. From a VM perspective this is described by Kelly and Male
as Levels 1 to 4; dealing with concept, spaces and elements and
components issues. VE is the part of VM which considers specific aspects
relating to the design and construction of the technical solution, and would
be practiced at the tactical phase of the project. Clearly, with both VM and
RM, the nature of the study, the information being reviewed and the

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4: RM and the Project Life Cycle

people involved will depend when the VM or RM study is carried out in

the PLC. At the business case or briefing stage a study will deal with quite
different issues from that of one held during the detailed design or
construction stage for example.

In text question

At what point does the business project become a construction

project?

Value Management, Risk Management and the Project Life Cycle

VM and RM

VE

Definition Delivery

Strategic issues Tactical issues

(largely client related) (client and contractor related)

Concept Brief Sketch Detail

design design construction

Level 1 Level 2 Levels 3 and 4

concept spaces Elements and components

Broad issues Narrower range of issues

Investment opportunity Procurement
Project type Manufacture
Size and location Co-ordination
Site works

Figure 4.2 Value Management Risk Management and the project

life cycle

4.5 Relationship between VM and RM in the project

life cycle
RM and VM are said to be two sides of the same coin. They are
interrelated activities that should be carried out in parallel on the project.
In practice, VM activities are carried out first to determine what it is that
constitutes value to the business from delivery of the project. As risk is an
inherent byproduct of available project options, it follows that the project
(and VM which helps shape it) must come first. Although risk should be
assessed at the earliest stages of the project, this exercise is more likely

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carried out as part of VM rather than a stand alone risk study. A major risk
at the outset stems from not properly scoping or defining the project
precisely what VM is intended to address. Naturally then, most effort and
attention is given over to VM at the early project stages. It is only as the
project progresses and the design and logistics of its delivery become an
issue that RM as a separate and defined activity comes into its own. The
diagram below illustrates how the boundaries between the disciplines of
VM and RM are blurred at the outset, becoming more distinct and
definable as separate entities as the project progresses. In short VM has its
major role at the earlier stages of a project (particularly the strategic
phase) whilst RMs major role is in the latter delivery stages.

In text question

Why is VM applied before RM at the start of a project?

Definition
(strategic)

VM and RM RM
VM
blurred
(VM dominant)

VM and RM Delivery
VM RM
distinct (tactical)
(RM dominant)

time

Figure 4.3 Relationship between VM and RM in the project life

cycle

In text question

Why is there more emphasis on RM at the tactical (delivery) phase

of the project?

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4: RM and the Project Life Cycle

4.6 Strategic Risk

As stated above the nature and form that the risk management activity will
actually take will be quite different depending on its timing within the
project life cycle. At the earlier strategic phase it has been contended that
there is a lesser role for explicit and structured RM activity of the form
presented later in the course pack. During the strategic phase, when the
brief is being developed, project risk is not characterised by numerous
tangible risk events that threaten project performance, i.e. the type which
abound during the tactical phase where structured risk management has a
valuable role. To reiterate, VRM activity undertaken at the early stage of a
project is more likely to have its emphasis on VM, with the project team
considering, What is this project trying to achieve? Of course risk has to
be accounted for in some way, since solutions of high value to the client
will necessarily involve low, or at least known and acceptable, levels of
risk- but a structured workshop approach focussed on downside risk is not
common.

4.7 Tactical risk

The strategic phase of the project life cycle ends when the clients value
system has been formed. Value management has its major role to play at
this time in the project life cycle in understanding exactly what constitutes
value to the business from the project i.e. what is the project trying to
achieve, what functions does it fulfill and how does it contribute to the
clients corporate objectives. At this point the project becomes more
recognisably a construction project, requiring technical input from the
usual design team consultants to progress. As such the process evolves
from soft problem solving to hard problem solving and risk
management is then largely concerned with efficient and timely project
delivery. Although modern thinking in project risk management formally
emphasises proactively looking for opportunities to exploit (upside risk)
as part of the RM effort, in practice the tactical delivery phase is more
about minimising downside risks and threats to achieving the identified T,
C and Q goals. Whilst risk exposure is partly speculative and commercial
throughout the project life cycle, the tactical risk phase also involves
considerable hazards and threats present in the physical construction
process itself i.e. those threats to safety and welfare of those directly and
indirectly involved.

In text question

At what point in the PLC has the clients value system been
formed?

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 Value and Risk Management [D19CV9]

The tactical phase commences as the design gets underway following the
decision to build. The design teams task is to interpret and transmit the
brief into a technical design solution that meets the clients defined
strategic objectives. Throughout the sketch and detailed design stages of
the various packages the client and design team will work toward
progressing the design and exercising cost control with the aim of
finalising decisions on design, specification and cost for every aspect of
the project. This has to be done timeously to meet the clients programme
and within cost constraints for the project. The numerous activities,
involving many disparate but interrelated activities, have to be effectively
coordinated and controlled for success- typically a major project
management challenge.

A major source of construction project risk - and perhaps the most

obviously risk-prone part of the whole process - is during construction
itself. The unique characteristics of procuring buildings compared to any
other service or product, is what leads many to conclude that construction
is such a risk-prone venture. It is at this stage where much of the risk
management attention in practice has been directed.

The overall objectives are to deliver the project on time, within budget and
to the required quality as defined in contract documentation. This is to the
benefit of all parties concerned, irrespective of how risk is apportioned
under the contractual provisions that bind them together. Contributing to
these objectives is largely a function of effective project management for
the client, design team, contractor, subcontractor and suppliers. Clear lines
of communication, strong leadership, supervision and decision making
will help ensure effective co-ordination and execution of all the works on
site. However this particular phase, unlike the previous, also involves
exposure to hazards. This is the particular class of risks that result in
physical damage, injury or death rather than just commercial loss, should
they occur. The building site and erection of the works is a particularly
hazardous environment and the UK industry has a poor safety record
compared to that of other UK industries and indeed European construction
industries.

In text question

What distinguishes hazards from other types of risks?

4.8 Risk- time, cost and quality

Good project performance is achieved if its time, cost and quality
objectives are met. Whilst the time and cost parameters are clearly readily
measurable and understood, the parameter of quality is not so

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4: RM and the Project Life Cycle

straightforward as the interpretation of quality alters over the project life

cycle. At the earliest stages quality is concerned with how well the project
is scoped, defined and briefed, and how well the expressed functional
objectives actually meet the needs of the client organisation. Quality
measures at this stage are largely subjective, and must be defined in the
clients terms. VM has a key role in improving quality by ensuring its
purpose and functional need are well considered, understood and defined,
as encapsulated in the client value system.

As the project evolves, so to do its measures of quality. Moving into the

tactical phase, the design team must ensure that they accurately interpret
the needs of the project, transmitting the brief into designs and
specifications which the contractor undertakes to build into a product
conforming to prescribed materials and workmanship specifications.
Progressing into the development of a technical solution the definitions of
quality become more tangible, measurable and auditable through objective
technical standards and codes of practice etc.

An important principle to recognise from the foregoing is that, unless the

strategic quality issues are properly considered and addressed - all too
often rushed in practice - then it doesnt matter how successful or efficient
the resulting technical solution is, overall project success will not be
achieved.

In text question

At what stage do quality issues become objective and technical in

nature?

Self Assessment questions

1. The quality of the investment is the clients prime concern at the
investment appraisal phase of the project. What would a private
sector clients main concerns be here and why is it more of a
business than a construction project at this stage?

2. Increasing specialisation in the industry has seen a decline in

traditional general contracting. Why does this create conditions of
risk?

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5: Risk and the Nature of the
Construction Project

5.1 Introduction
It has been said that the construction industry is exposed to more risk and
uncertainty than perhaps any other industry. This unit examines the
features of the process and product of the construction industry that might
justify this status. It will also be shown that the amount of risk and
uncertainty is largely related to the amount of uniqueness inherent in
each project. Risks are either controllable or uncontrollable depending on
where in the project environment they stem from and elements of the
environment are explained. A checklist of typical sources of risk to be
found in many construction projects is presented.

5.2 Learning outcomes

Understand the concepts of project heterogeneity and homogeneity
and how they influence the amount of risk in a project.
Understand the various elements of the project environment.
Know the difference in the nature of controllable and
uncontrollable risks.

5.3 Why is construction so risky?

The construction industry is exposed to more risk and uncertainty than
perhaps any other industry
Professors Flanagan and Norman, 1993

If the above assertion is accepted there can be little argument that RM has
a very important part to play in project success. However, it is worthwhile
reflecting on this statement and the extent to which it is valid. In
particular, why is it that construction is so exposed to risk and what is it
about the industry that makes it so different from any other? The first part
of this unit discusses the characteristics of the construction industry and
its projects to give a greater understanding of the extent of risk and
uncertainty that prevails. Some recent initiatives that have been proposed
for the industry to offset some of the risk and uncertainty are then
discussed.

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5: Risk and the Nature of Construction Management

5.4 Project Heterogeneity v Homogeneity

All construction projects can be considered to have both homogenous and
heterogeneous characteristics. That is to say they exhibit both similarities
and differences from project to project. It is the degree of uniqueness
inherent in any given project that strongly influences the amount of
associated risk and uncertainty.

Project heterogeneity
There is likely to be truly different situations and circumstances that arise
from project to project, no matter how similar the buildings are that are
being compared. In this respect no two projects are the same (even
comparing, say, two identical house types). Where such heterogeneity
exists in the design, construction and management of projects there will
be, by definition, more uncertainty about the outcome of the events or
situations. Members of the project team are working in conditions of
greater uncertainty because of a lack of directly relevant past experience,
information, knowledge and understanding. Correspondingly there is a
higher degree of risk. It is more difficult to accurately forecast outcomes
relating to the time, cost and quality targets. A simple analogy is that if
you are asked to do a task which you have never carried out before, you
will be less confident in predicting the time and effort it takes to do this,
compared with a task you have carried out many times before.
Undoubtedly, any construction projects will have heterogeneous aspects
relating to its technical, managerial and commercial aspects.

In text question

Why does project heterogeneity lead to risk?

Project homogeneity
Contrast the construction project with the product of a high volume
manufacturing process. In the latter case there is little variability to affect
the outcome. Quality control and productivity are much more predictable,
tightly defined and the process can be made to be very efficient. There are
no unknowns and there is little risk involved in the production process
(whether there is a market for the product is another matter- this would be
an example of an external commercial risk). Construction, however, is not
a manufacturing process and cannot achieve the same degree of certainty
and productivity associated with such a scenario.

From the foregoing we can see that the more homogeneity involved in the
process (design and construction activities) and the product (the technical
solution represented by the building or facility and its constituent parts),
the less uncertainty there is about the situation and therefore less risk
involved. Following this line it would be desirable for projects to be

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 Value and Risk Management [D19CV9]

homogenous since there would be less risk to manage and greater

confidence that project objectives could be achieved. (less internal risk i.e.
those situations that the project team have influence and control over).

In text question

What do we mean by the process and product of construction?

Raftery (see supplementary reading) summarised the similarities and

differences between buildings that helps provide a framework for the
discussion. These are expanded and discussed below.

5.4.1 Project similarities

Elements of the building

Every building can be analysed in terms of the standard definition of
elements that are universal across project types. For example, all buildings
no matter how varied will have foundations, internal finishes, services,
walls and partitions and so on. The Standard Form of Cost Analysis
published by the Building Cost Information Service provides a standard
framework of 28 elements into which any building can be analysed and
compared with other buildings, allowing comparisons to be made between
the cost of achieving various building functions in one project with the
equivalent functions in other projects. This is primarily intended for cost
managers and quantity surveyors to allow direct and meaningful
comparison between similar past projects in the cost database, to that
which is being proposed for the purpose of cost forecasting. It makes use
of standard features of projects to reduce risk in cost prediction and
control.

Construction Materials
Many of the materials that buildings are constructed from are practically
universal and in some cases have been used for thousands of years. For
example, we know a great deal about the performance and properties of
materials such as concrete, slate, timber, stone and steel.

Construction Components
As well as many materials being used consistently throughout the
industry, standard designs and components have emerged more recently.
This reduces uncertainty by reducing design variables and simplifying site
and labour processes. The more standardisation that is practiced in
construction, the more the industry takes on the characteristics of a
manufacturing process.

Site Operations
Many site operations and activities of the construction process are also the
same from project to project, using specific types and capacities of plant

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5: Risk and the Nature of Construction Management

and labour operations. Site engineers and project managers use this
knowledge and experience in planning and co-ordinating the works.

Management structure and style

There are a number of standard forms of procurement and contract
conditions which define the roles, responsibilities and communication
links for all parties involved. Such standardisation reduces uncertainty and
should mean more predictable and efficient management.

In text question

Which of the above factors relate to product and which relate to

process?

5.4.2 Project differences

Site and site conditions

An obvious difference- and one which sets construction apart from other
industries- is that every project, no matter how similar is built on a
different site (or plot of land within a site) and will be affected by
surrounding conditions and circumstances. In a technical sense; ground
conditions such as soil bearing capacity, existing services, soft spots, old
mine workings etc. are never fully known until actual work on site begins-
a considerable risk. Site investigation and bore-hole testing will be carried
out beforehand to reduce uncertainty and inform the design of
foundations. In a management and site organisation sense, issues such as
access restrictions, complications from adjacent properties and owners,
availability of site storage space will depend on site location. Contrast two
hypothetical buildings which are identical in every way except location-
one to be built on an out-of-town greenfield site, the other in a compact
city centre location with parking, delivery, loading/unloading and storage
problems. Although identical, they present completely different
construction challenges.

Element specifications
Although buildings can be analysed in terms of a standard set of elements
as discussed above, the actual specification and design for each element is
wide and varied.

Management structure and style

This feature can legitimately appear in both the similarities and
differences categories. As argued above there are of course standard forms
of contract. However they are many in number and in practice are often
adapted with variations and amended clauses as to make the notion of
standard almost unrecognisable.

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 Value and Risk Management [D19CV9]

A construction project is referred to as a temporary multi-organisation.

Any reasonably sized project will involve many people, businesses and
agencies that come together to contribute their resources to the ultimate
end of delivering the project. However, the large and often complex
organisation only exists for the duration of a single project, and the
individual objectives of all the players are not always well aligned. There
is almost an in-built capacity for problems and disputes. The temporary
nature means that all the experience gained by the team from working
together over the course of a project is lost at the end of it. As such,
construction is said to be fragmented

Sources of labour, plant and material

Another distinct feature of the construction industry is the fragmented
nature of labour and materials supply. In fact it has been said that there is
no construction industry as such. Rather, there are a series of local
construction industries and markets throughout the country, with varying
regional features relating to supply and demand. This discontinuous
supply chain makes forecasting and planning difficult. In particular, a
reliable, consistent and trained workforce is a real problem in
construction. The extent of centralisation and supply chain and logistics
management that is evident in other industries is not achieved in
construction.

In text question

What is meant by the term temporary multi-organisation?

In summary, Raftery observed that despite largely common activities and

processes, each construction project is assembled and constructed on its
own site with its own physical characteristics, subject to weather
conditions depending on the season, with different material specifications
and technical solutions to the problem of enclosing space. While a number
of materials and components will be identical, many will not. Each project
usually has a different labour force of operatives and managers. Hence,
there will be differences in the management and interpersonal behaviour
on each project simply because people are different. We can see therefore,
that any construction project has a mixture of heterogeneous and
homogenous characteristics. The balance will depend on the type of
project and client and contracting organisations involved.

The extent to which it is desirable or achievable to encourage greater

homogeneity in construction, which would offset risk and uncertainty, is a
moot point. Quite clearly, the Egan report, representing a lobby of
powerful clients of the industry, firmly advocates that construction can
and must model itself on other industries to standardise and, thus increase
the number of similarities from project to project. The following two
quotes from the report capture this view:

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5: Risk and the Nature of Construction Management

we have repeatedly heard the claim that construction is different

from manufacturing because every product is unique. We do not
agree. Not only are many buildings, such as houses, essentially
repeat products which can be continually improved but, more
importantly, the process of construction is itself repeated in its
essentials from project to project

Moreover, the conventional processes assume that clients benefit

from choosing a new team of designers, constructors and suppliers
competitively for every project they do. We are far from convinced
of this. The repeated selection of new teams in our view inhibits
learning, innovation and the development of skilled and
experienced teams

This view, and related proposals within the report, is not without
controversy though. The supply side of the industry- contractors, sub-
contractors, consultants, suppliers- who had little involvement in the
report, claim that Egan does not really understand construction and
many of the proposals are unrealistic. Undoubtedly though, from a risk
management perspective, more standard repeatable situations whether in
product or process, means less uncertainty about outcomes and therefore
less risk. The degree to which this can happen in practice will continue to
be debated. To conclude this section of the discussion, a quote from
Raftery offers a balanced view:

while it is a clich and an overstatement to say that every project

is unique, it is true that there are large differences between
projects

In text question

Why are standard repeatable situations desirable from a RM point

of view?

The foregoing focussed on the risk and uncertainty that stems from
features of the project itself. The next section looks at the environment
within which the project exists and the influence this has on exposure to
risk and uncertainty. The concept of the project having an internal and
external environment is introduced.

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 Value and Risk Management [D19CV9]

5.5 Risk and the Project Environment

A construction project can be described as an open adaptive system with
an internal environment and an external environment. The project is
open-adaptive system in the sense that it affects, and is affected by, its
external environment. Because the internal and external environment
interacts, the boundaries between the project and the outside world are
said to be porous. The internal and external environments are populated
by stakeholders who will be affected by the project in some way, either
directly or indirectly. This can be either positive or negative i.e. they will
gain or lose something from the existence of the project. The various
categories of stakeholder in the project world are a source of risk which
will warrant examination in any RM exercise.

All risk can be categorised according to whether it emanates from the

internal or external environment.

Commercial opportunity/
social need

Project affects & is affected by its external environment

world at large
Environment markets
interacts with people people
interacts with surroundings communities
construction &operation agencies

External Environment

controllable
Internal Environment

Project constitution/
organisation

uncontrollable

In text question

What makes a construction project an open-adaptive system?

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5: Risk and the Nature of Construction Management

5.5.1 External Environment

No project exists in a vacuum. It is affected by externalities in the way
that the demand for the functions that the building is providing is borne
out of some perceived need by the client. In the case of private sector
clients this is usually some commercial opportunity identified by a
business for which expansion or modification of facilities is required.
(This should be familiar from the discussion in the previous unit on the
strategic issues of a projects development). In the case of public sector
clients it is usually to fulfil some social need or obligation. Whatever the
case, the project is a vehicle for achieving the organisations objectives and
there is considerable speculative commercial risk attached to the
investment.

Risks in the political, social and economic environment stem from

government policy and world economy events that can affect the
construction industry e.g. changing interest, inflation and taxation rates.
This form of environment risk affects the whole of the construction
industry. A common example of an industry specific risk is that of a
national strike by certain trades.

In the physical external environment the weather is an obvious example

which poses risks that can significantly upset planned construction
processes. Prolonged rain, extreme temperatures and high winds are
natural phenomena that can delay certain activities and upset construction
programmes.

In text question

In what way is the project shaped by its external environment?

The project also affects its external environment in the way it changes the
environment and also affects people not directly involved in the project.
The very process of construction itself is a visible, often intrusive process.
Many individuals and groups can be affected in some way, positively or
negatively, by the project. For example, a new building may be perceived
to enhance an area. It may have aesthetic appeal, contribute to the
regeneration of an area, provide some service that is desirable to the
community or increase employment from the staffing and running of the
facility that will be required. In such circumstances it would be considered
an asset to an area and be positively received by the local community and
members of the public, who represent an aspects of the external
environment. Given this scenario, the stakeholders in the projects external
environment would not present a problem or risk to the project.
Conversely, projects may be received negatively by sections of the local
community. Projects which are perceived to be detrimental to an area for
any number of reasons- because they degrade the landscape, cause people

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 Value and Risk Management [D19CV9]

to worry about the effect on the value of their own property, object to the
activities that will be carried out in the building, or object to the nature of
the clients business. Perhaps the noise and disruption from the
construction process itself creates objections. There have been several
high profile examples of projects severely disrupted by individuals and
protest groups for environmental or political reasons. In such
circumstances the external environment and its stakeholders pose a
substantial threat to the project. Stakeholders have to be taken account of
as part of the RM process. Stakeholder mapping is a related aspect of
project management which is dealt with elsewhere in the programme.

In text question

Can you list some projects which have been threatened by external
environment stakeholders?

5.5.2 Internal Environment

The Internal environment largely comprises the project team- both
demand and supply side. The former represented by the various elements
of the client organisation (sponsor, users, employees, design team
consultants, project manager) and the latter the production side of
contractors, sub-contractors and suppliers). The performance of this
project organisation is very important to achieving the project objectives,
as the discussion on the project as a temporary multi-organisation in the
previous unit has introduced.

Somewhere in the interface between the external and internal environment

are agencies such as utility companies, local authorities, planning and
building control. They are not core part of the project or design team, but
nevertheless will directly influence decisions made and affect project
success.

5.6 Controllable or Uncontrollable?

Risks can also be categorised as controllable or uncontrollable. As the
terms suggest a controllable risk is one that can be managed and
controlled, and its likelihood of occurrence is directly related to
competency of management on a construction project and to the
performance of site personnel and operatives. Risks in the internal project
environment would fall into this category.

Conversely an uncontrollable risk is outwith the control of any of the

parties to a project. Environment risks such as adverse weather conditions
and inflationary rises on material costs are examples of uncontrollable

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5: Risk and the Nature of Construction Management

risks. Risks from the external project environment would fall into this
category. Although uncontrollable, such risks can be foreseen and
accommodated for.

In text question

Why are risks in the external environment uncontrollable?

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 Value and Risk Management [D19CV9]

5.7 A Checklist of Risks

The following is a generic checklist of risks that may affect any
construction project. It is not exhaustive, but gives an indication of the
range and sources of risks that can affect construction projects.

3rd Party Risks Contractor risks

Approvals Failure to meet programme

Planning approvals Poor co-ordination of subcontractors
Conservation area consents Inclement weather
Environmental impact assessment Price changes permitted under
Legal Agreements certain contracts
Rights of way Disputes and claims
Rights of light Poor site management
Noise control requirements Accidents or injuries for which client retains
Site of special scientific interest responsibility
Pressure Groups Under contract
Local pressure groups Due to client staff
National pressure groups Latent Defects
Industrial action Liquidation of contractor
Terrorism
Changes in regulation
Client Controlled risks

Site specific risks Inaccurate or insufficient terms of reference

Changes in project scope
Ground conditions Occupancy
Extent of pre-construction Usage
investigations Size
Soil types and variability Delays
Mining works/subsidence Late decision making
Contaminated land Late handing over of site
Climate and weather conditions Delayed programme
Access restrictions/limitations
Existing occupiers/users
Alternative provision Design team risks
working hour restrictions Inaccurate interpretation of terms of reference
maintenance of access roads Errors in design, contract documents,
Maintenance of services drawings
Existing buildings Failure to meet timescale
Need for protection Estimating inadequacies
Need for demolition Escalating labour, plant, material
costs
Security
Taxation changes
Liquidation of design team members
Environment risks

Political change
Government legislation

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5: Risk and the Nature of Construction Management

In text question

Which of these risks are internal and which external to the project
environment?

5.8 Risk and the source-event-effect chain

To recap, in construction risk management a risk is any event or
occurrence not turning out as planned and affecting some aspect of the
project (usually adversely). In practical terms this usually means an
increase in cost or time being incurred by parties to the project. To
understand this more fully it is useful to analyse risk in terms of its
component parts- the various sources of risk, corresponding events and
the effects they have.

SOURCE EVENT EFFECT

Where does risk How does risk What is impact

come from? manifest itself? T, C, Q?

The source of a risk refers to where in the project environment, internal or

external, the risk emanates from. At the general environment level,
extreme weather conditions such as prolonged rain, frost or high winds are
a source of risk that could potentially affect the project - usually
negatively. At the project level any of its participants, directly or
indirectly involved, are all potential sources of risk.

The risk event is the actual manifestation of a risk on some part of the
project or the project as a whole i.e. how it occurs. For example, if an
unproven supplier is a potential source of risk, the associated event might
be late or wrong delivery of materials to the site. If severe frosts are a
weather risk, the associated event might be delay to concreting operations.
If volatile economic conditions are an example source of risk, the
associated event might be serious increase in the cost of skilled finishing
joiners later in the project. Generic risk checklists contain potential
sources of risk exposure on a project, but the associated risk event is
particular to the project and surrounding circumstances.

The effect of a risk refers to what impact or consequences it will have for a
party or parties to the project. The impact can be measured in time,
monetary or quality terms - though ultimately the impact of risk events
occurring will be monetary for somebody. Therefore, whilst it is true to
say there are many sources of risk on a project, the effects are few.

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 Value and Risk Management [D19CV9]

Self Assessment Questions

1. Consider the aspects of the risk hierarchy as described by
Flanagan and Norman. Which of these are internal and which
external to the project environment?

2. In your view, what type of buildings exhibit most features of

standardisation? Think of specific examples you are familiar with.

Heriot-Watt University Unit 5 - 13

6: Risk and the Client

6.1 Introduction
This unit considers project risk from the perspective of the client. There
are 3 main aspects of risk that should be assessed from the outset, and a
systematic approach to doing this is described. These risk aspects centre
around strategic concerns about how the project relates to the clients
operations, as well as the risks inherent in the project deliverable itself
which are commercial, technical and managerial in nature.

6.2 Learning outcomes

Understand how risk to the clients business from a project can be
assessed.
Understand how the approaches to establishing a projects
objectives contribute to the amount of risk in achieving them.
Become familiar with the technical, commercial and managerial
risk factors of a project

6.3 Risk and the client

The less information there is about a given situation or future event, the
greater the associated uncertainty- and consequently the greater the
amount of risk involved. Uncertainty on any project will be greatest at the
outset when there is little hard information about project requirements or
the nature of the deliverable. If we consider the clients risk exposure at
the outset, some key questions that have to be considered are;

Is there a clearly defined demand for the project?

Will a building meet that demand?
Can it be built within the cost limit, to the required quality, and within
the time constraints required to meet the demand?

6.3.1 Risk and the clients investment in a capital building

project
The client is an all embracing term in construction and can include
anything from a multinational organisation, government department,
speculative developer or private individual. One thing they all have in
common, though, is that they commission, pay for and in most
circumstances use the buildings for a specific commercial purpose. Most

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6: Risk and the Client

buildings are investment goods- that is to say they are only a means to an
end- used as part of the production process but not contributing directly to
the generation of profit for an organisation. Even public sector investment
in building projects must have a sound business case. For commercial
clients the purpose may include furthering the production of goods and
services, through the provision of factories, offices or some industrial
process. Investing in new/adapted buildings or facilities to house some
process or activities will add value to the organisation.

Since risk is inherent in all investment decisions an early question is

whether constructing a new building represents the best use of funds out
of all the investment opportunities open to the client. In commissioning a
building a client is committing a substantial amount of capital that could
be invested in some non-construction venture that may provide a higher or
lower return. Therefore, the risk that is present at this strategic stage is the
possibility that there may be a more attractive investment offering better
returns.

The various investment opportunities will be characterised by varying

degrees of risk and associated return. The greater the risk involved, the
greater return expected. For example treasury bonds are a long term, low
risk financial instrument with predictable rates of return. On the downside
the returns are low. The stock market provides potentially much higher
rates of return through ordinary shares, but as various financial crashes
have shown the value of shares can go down as well as up.

Property as an investment is exposing the client to risk since it does not

provide a guaranteed return unlike some other forms of investment.
Property is also not liquid in that transactions take a long time to
complete. It is a risky proposition because of the unpredictability of
returns. During boom periods the capital growth is very attractive, but
when the market is in recession property prices can drop quite
dramatically in value.

The pre-decision to build stage will include some investment and

development appraisal. At this stage the client is striving to determine
whether the project provides a satisfactory rate of return commensurate
with the level of risk associated with the project.

In text question

What is it that makes most buildings investment goods?

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 Value and Risk Management [D19CV9]

6.4 A Client Approach to Evaluating Project Risk

the 3 aspects of risk
From the perspective of any reasonably sized client organisation in
construction, there are 3 main risk aspects at the strategic project level
that should be thoroughly reviewed when the project commences. This
section of the unit discusses these 3 main aspects with reference to
research carried out by Australian public sector agency (see
supplementary reading) and published in International Journal of Project
Management. The work is of wide reaching interest though as the
principles are largely applicable to any reasonably large client
organisation. It will also deepens understanding of the risk anatomy of
construction projects and their strategic importance to the client business.

The 3 risk aspects to be reviewed relate to

1. How the T, C and Q objectives are established at the outset and the
degree of confidence in them
2. What the impact to the client organisation is in failing to meet
these objectives
3. The riskiness of the project itself- the risk profile of the building.

6.4.1 Aspect 1: Establishing T, C and Q objectives

As discussed in previous units; fundamental issues to be resolved early in
the project are its scope and definition, a timescale for its delivery and the
budget. (i.e. T, C and Q objectives). It is against these objectives that the
success, or otherwise, of the project will largely be judged. If the basis for
establishing these objectives is not sound or realistic, then conditions of
risk and uncertainty are present from the outset. Remember that a
definition of risk is the possibility that actual outcomes deviate from those
predicted. If the predicted outcomes are not sensible or achievable, then it
follows that actual outcomes are likely to deviate from predicted.

The table below shows how risky a project is according to how these
objectives are established. As the means of establishing T. C and Q
objectives become increasingly unsound and unclear, the risk rating for
the project increases. Notice how, for all criteria, it is the level of
information available which determines the level of risk involved. Projects
which have inbuilt contingencies (a form of RM) are the least risky, and
those with a higher risk rating indicate more unknown unknowns

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6: Risk and the Client

Establishing T, C and Q objectives

Objective
Risk Time Cost Quality
Rating known knowns
1 Benchmarks were used to Benchmarks were used to Quality requirements have
establish schedule and establish budget and adequate been agreed and
adequate contingencies exist contingencies exist documented - Good PM & cost control
- More info across criteria
- Explicit contingencies
- Less uncertainty
2 Benchmarks were used to Benchmarks were used to Quality requirements have
establish schedule establish budget been agreed and are being
documented
known unknowns

3 The basis for the schedule is The basis for the budget is Quality requirements have
clear, but indications are that clear, but indications are that been agreed but not yet
overruns are possible overruns are possible documented

4 The basis for the schedule is The basis for the current Some initial discussions
unclear or the budget is likely budget is unclear or the budget with the client on quality
to be inadequate is likely to be inadequate requirements
- Absence of good PM
- Less information
- Increasing uncertainty
5 There is no clear schedule or There is no clear budget or the Quality requirements are
the schedule is clearly budget is clearly insufficient not known
insufficient unknown unknowns

In text question

What characterises a project with a high risk rating, and a project

with a low risk rating in relation to this aspect?

6.4.2 Aspect 2: Consequence of failure to meet T, C and Q

objectives
The second main aspect to be assessed is the risk to the client from not
meeting the project objectives. i.e. what are the consequences to the
clients business or operations should the project be delivered late and/or
over budget. The T, C and Q objectives for any project are always in
tension as they are competing for finite resources, and have to be
prioritised according to their importance to the client. An early purpose of
VM is to help determine these high level objectives and their level of
priority. Some objectives, and the consequences of not meeting them, will
be more critical than others. As you would expect, as the project value
increases, the risk rating of the project increases since the project will
represent a larger proportion of the clients overall business.

Again, it can be seen from the table that the risk rating of the project for
this aspect increases as the consequences of failure to meet the objectives
become more critical. These range from nuisance value at the lowest level
(risk rating of 1), through to complete failure of the business at the highest
level (risk rating of 5).

Unit 6 - 4 Heriot-Watt University

 Value and Risk Management [D19CV9]

Meeting T, C and Q objectives

Objective
Risk Time Cost Quality
Rating
1 Completion date not important Additional funds available No noticeable effect on
(project period <6 months) (project cost <25000) clients business

2 Alternative arrangements Some scope for additional funds Tolerable effect on clients
available (project cost 25000 - 250000) business
(project period 6 12 months)

3 Delays undesirable but could be Request for additional funds clients business
managed would be difficult moderately affected
(project period 12 18 months) (project cost 25000 - 1M)

4 Severe disruption to clients No additional funds available and clients business severely
business scope reduced disrupted
(project period 18-24 months) (project cost 1M - 2M)

5 Clients business ceases altogether No additional funds available and clients business ceases
(project period >24 months) project will not proceed altogether
(project cost >2M)

In text question

What is the riskiest scenario for a client in not meeting the projects
objectives?

6.4.3 Aspect 3: Risk Profile of a project

The first 2 aspects of risk described above consider project risk at a
global, or strategic level, i.e. considers the project and how it relates to the
clients business or operations in overall terms. The 3rd aspect of risk is
concerned with the detail of the deliverable itself i.e. assessing the risk
characteristics of the project. Understanding all the elements of the risk
anatomy of a project helps to heighten awareness of and sensitise the team
to risk. Again, although this table relates in particular to a public sector
client, it will be recognised that nearly all of the factors described are
relevant to any client organisation. Such a checklist of factors can be used
to assess the overall riskiness of a construction project.

The table below shows a range of technical, commercial and managerial

factors against which risks can be assessed. Riskier projects will
obviously have a greater number of drivers assessed at a higher risk rating.
Notice how there are a mixture of strategic (project definition), tactical
(project delivery) and organisation & relationship issues.

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6: Risk and the Client

Risk profile of a project

High Risk Rating Low
Factor 5 4 3 2 1
Uniqueness of Prototype Unusual project Conventional Modifications to One of a series of
project incorporating new project an existing design repetitions
techniques

Complexity of Outcome based Coordination of Design and Supply and Supply only
deliverable contract (e.g. PFI) services (e.g FM) construct installation

Financing Private sector Capital works not Capital works in Capital works Recurrent funds
funding or joint yet approved or forward estimates already allocated in current year
venture requested

Adequacy of Very likely to be Likely to be Tight budget, Adequate with Adequate with
funds inadequate adequate achievable with some contingency generous
control contingency
Project location Remote, Remote, Regional but Regional Metropolitan
inaccessible accessible distant

Project Activities in Staging within Additions to Well clear of Greenfield site

surroundings occupied areas occupied areas occupied areas occupied areas

Hazardous Working with Possibly involves Hazardous Unlikely to No known

materials hazardous hazardous materials exist, encounter hazardous
materials materials but not part of hazardous materials
works materials
Definition of No project Brief project Generic project Feasibility study Detailed project
project information description brief available completed brief available
available

Site availability Site not identified Several sites Site identified but New site Existing site
identified not yet purchased purchased

Project Need has not Justification is Needs justified Need justified Need fully
justification been justified questionable but may change based on justified through
through project historical recognized
information process
Project Unidentified Potential Required Few approvals No approval
approvals approvals approval delays approvals are required or most required or
required have been known and obtained already obtained
identified documentd

Clients Inexperienced Mixed Inexperienced Experienced Experienced

experience multiple clients experience single client multiple clients single client
amongst clients
Client Multiple reluctant Mixed Reluctant client Good working Good working
relationships clients or relationship with or relationship relationship relationship
relationship not clients not established (multiple clients)
established

Assessment of Unknown Limited number Limited number Adequate number Abundance of

contractors contractors of unproven of competent of competent competent
contractors contractors contractors contractors

Procurement No tendering and Negotiated Tendered outside Public open Selected

method involving tender agency tender tenderers
sponsorship

Consultant Selection without Design Full EOI and RFP Period panel Consultant
selection approved competition consultant selected using
processes approved process
Stakeholder High level of High profile Stakeholder Project may Project unlikely
interest political, client or project groups involved attract to attract
community or stakeholder or stakeholder or
media sensitivity media interest media interest

In text question

From your own experience, list projects that you know of which
would fit into either end of the risk profile spectrum

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 Value and Risk Management [D19CV9]

These factors can be grouped according to whether they are strategic or

tactical- concepts which should now be familiar from discussion in earlier
units

Grouping of Risk Factors

7 funds/financing
8 definition of project
9 project justification (Strategic level)
10 stakeholder interest
11 site availability

Project
related

12 project location
13 project surroundings
14 hazardous materials (Tactical level)
15 availability of contractors
16 uniqueness of product

17 clients experience
Project 18 client relationships
Management 19 consultant selection
related

6.4.4 Summary of risk aspects

Taking these 3 main risk factors together- the means of establishing T, C and Q
objectives and the confidence we have in them, the consequences of not meeting
them, and the risk characteristics of the project itself- we can build up a complete
picture to rate the overall riskiness of a project.

At one extreme scenario of low risk we would have a technically simple project
of modest cost, where sound information underpins the estimates and forecasts,
and with an impact to the clients business which is minimal anyway should they
not be met. At the other extreme of high risk we would have a difficult and novel
project, where forecasts are based on poor/incomplete information, and it forms a
critical part of the clients business. Of course these scenarios are an
oversimplification and, realistically, any project will have a mixture of risk
ratings across all three of the aspects as described.

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6: Risk and the Client

Self Assessment questions

1. Clients can be categorised broadly as public sector or private
sector- how might they be further categorised according to their
demand for buildings?

2. There are many sources of risk, but ultimately few impacts. What
are the impacts of risk on any project?

Unit 6 - 8 Heriot-Watt University

7: The Risk Management Process

7.1 Introduction
Previous units discussed the nature of risk and uncertainty and the ways in
which it can affect the construction project. The strategic and tactical
viewpoint of risk, according to where in the PLC it is being assessed has
also been examined. Hopefully, the importance of ongoing RM to project
success is now firmly established in the readers mind. This (and the next)
unit now turns attention to more specific matters of applying risk
management itself. i.e. how it is actually carried out in practice. The RM
framework, which sets the agenda for the team based study, is explained.
A number of these studies, applied at targeted stages throughout the PLC,
would constitute a comprehensive approach to project RM. A study
structure for combining both VM and RM together is also presented. The
unit which follows explains some of the actual tools and techniques that
can be employed by a team within a study.

7.2 Learning outcomes

Be aware of the RM framework
Understand risk identification activities
Understand risk assessment activities
Understand risk response activities and outcomes
Understand how a combined VM and RM framework might be
implemented.

7.3 RM terminology
As for the definition of what RM actually is, the description of what
constitutes the RM process differs slightly from author to author. Again,
though, there are a number of key steps recognisable in all which are
discussed. It is mainly a difference in terminology and emphases which
separates the various explanation of RM, rather than any matters of real
substance. The following is an overview of the generic RM process which
would fit any application, adapted from the PMI PMBoK

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7: The Risk Management Process

7.4 The Risk Management Framework

Define the process to be followed

-Agree process for the project
Risk management planning -Identify roles and responsibilities
-Decide frequency of reviews and reports

A number of techniques available

Risk identification - brainstorming
- checklists
- interviews
- questionnaires

The Quantitative or qualitative

study
Risk analysis - quantitative: simulation, scenario analysis
- qualitative: nominal group techniques

What to do about priority risk areas?

Risk Response Action taken to mitigate threats/exploit opportunities

Ongoing evaluation of risk throughout

Risk monitoring and control Project life cycle.
Updating of the Risk Register

Figure 7.1 The Risk Management framework

7.4.1 Risk management planning

The first stage of RM is for the project team to actually define and agree
the process to be followed at the outset as part of the overall project
management plan. This may already be reasonably well defined where an
established PLC framework is being followed. An example would be
where the public sector OGC procurement framework is being adopted.
This has clearly identified RM application points throughout the PLC,
each having a particular purpose. Alternatively, in the case of
organisations with no recognised approach, this would have to be defined
from scratch. This is likely to depend on the level of experience and
maturity of the organisation as far as its risk management practice is
concerned. In addition to identifying the points at which RM is to be
applied in the project, it is necessary to identify roles and responsibilities
of the participants involved, agree the methods and approaches to be used
and review and reporting frequency. In short, the RM plan defines how
RM will be undertaken and implemented throughout the project.

For each risk study the appropriate members of the team will come
together and work through steps 2] to 4] as described below, within a
facilitated and highly structured workshop type setting. It is likely that
either the project manager or someone else with specific RM
responsibility will facilitate the risk study sessions. An external consultant

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 Value and Risk Management [D19CV9]

is often engaged to facilitate the study and effectively manage the work of
the group.

In text question

What do we mean by RM planning?

7.4.2 Risk identification

This is the first step to be carried out within each risk study undertaken on
the project. There are a number of possible creativity techniques that can
be used for risk identification, but by far the most common is the
technique of brainstorming. There is no single best technique to be
used; only the most appropriate to fit the circumstances. Part of the
facilitators skill is in selecting the techniques most appropriate to the
nature of the study and the team members involved.

The purpose of the risk identification stage is to capture all possible range
of risks that might affect the project at that stage of its development. The
emphasis is to maximise the quantity of possible risks rather than their
quality. i.e. no assessment is intended at this stage as this may stifle the
creativity process. By generating a large quantity of imaginative risk
scenarios, it is more likely that all possible scenarios will be covered.

At the conclusion of the risk identification stage the team will have a list
of risks that threaten the project (or opportunities to be exploited)

In text question

How many risks should be recorded at the identification stage?

7.4.3 Risk Analysis

In this step an assessment of the likelihood of each risk is made for its
likelihood of occurrence (probability) and effect on the project objectives
(impact) if it were to occur This assessment may be a simple descriptive
(or qualitative) statement of their perceived likelihood of occurrence, or in
a more detailed exercise a numerical probability will be attached to each.
A two stage approach may be adopted, with the first stage used to quickly
screen out those risks not worth further deliberation (either because their
likelihood is so small, their impact insignificant, or a combination of
both). The approach to be used will be influenced by the quality of
information available and also upon the type of analysis to be carried out
by the team. Again, there is no correct or best approach and the level
of sophistication is not necessarily an indicator of the quality of the
exercise. There is not normally any detailed analysis as such. i.e. there is

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7: The Risk Management Process

no sophisticated number crunching involved. Such a quantitative approach

would not normally be appropriate for use with a workshop setting,
though may be carried out separate to the study. An techniques applied
within the workshop setting should be simple to understand and easy to
apply, so that the team can concentrate on the real issues at hand, rather
than being bogged down and distracted with complicated analysis
techniques. The amount of effort expended should be commensurate with
the needs of the project. At the end of this step the team will have a clear
view of and consensus of the risk profile of the project at that point in
time, based on the knowledge, expertise, experience and judgement of all
those involved. A consensus should emerge on what the priority areas are
where attention and resources should be focussed on dealing with the
risks.

In text question

What features does a good workshop technique have?

7.4.4 Risk Response

In this step, planned responses to the most pertinent of the identified risks
are developed. Obviously it is not possible, affordable or appropriate to
develop responses to all identified risks. The team will focus only on the
higher priority areas. Whatever the approach to dealing with each of the
identified risks is agreed, it will lead to one of the following effects, and
this should be clearly identified as part of the exercise. The following all
relate to negative risk, where the objective is always to minimise.

Elimination
This is obviously the most desirable outcome to completely eliminate the
risk. Possible areas may be to eliminate a safety risk by not undertaking a
certain type of welding inside a building, but perhaps prefabricating.

Reducing probability of occurrence

This involves reducing the probability of a risk event materialising. For
example, if theft of materials from the site is considered a major risk, the
contractor may respond by employing 24-hour security on the site.
Introducing education and training programmes in the use of certain
equipment for staff will reduce the probability of occurrence.

Reducing impact of occurrence

Acknowledging that a risk event may still materialise no matter how much
effort has been invested in avoiding it, strategies may be put in place to
minimising their consequences. Such strategies may include providing a
standby generator in the event the main one fails, preparing an emergency
evacuation plan in the event of terrorism, fire drills etc and installing a
sprinkler system in the building to reduce effects of fire damage.

Unit 7 - 4 Heriot-Watt University

 Value and Risk Management [D19CV9]

Transfer risk
Contractual transfer of a risk perhaps to another party or insurance
company is a method of dealing with risks that cannot be wholly or
partially eliminated. Of course, transferring a risk does not reduce the
effect it would have, or the likelihood of its occurrence- it only passes the
responsibility for it to another party.

In text question

Will the team develop responses to all the identified risks?

Threats Opportunities

Eliminate Exploit

Transfer Share

Reduce probability Enhance probability

Reduce impact Enhance impact

Absorb (accept) Ignore

Insurance as a risk transfer strategy

A common means of risk transfer is through insurance. The effect of
obtaining insurance cover is to convert an uncertain exposure to some risk
to a known cost, that is to say, the premium to be paid for obtaining cover.
It has the advantage of smoothing out unpredictable peaks in losses, in
favour of a regular annual liability to the insurance company. Insurance is
an easy sleep soundly option to risk management, suitable for
organisations who could not cope with financial exposure to such losses
from time to time. However, it is also perceived as an unsophisticated
approach to risk management and should only be used as a last resort or
when strictly necessary, such as when required by the contract or for
statutory reasons.

Insurance often does not represent value for money for an organisation,
since the premium will be based on general claims experience of other
organisations that may not reflect the firms own experience. Also there is
a high mark-up to cover the overheads and profit of the insurance
company, and also the possibility of disputed claims and delayed
payments if the service offered is poor.

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 7: The Risk Management Process

The growing cost of insurance services has been a contributory factor in

the development of the risk management profession. Recently insurance
cover has proved to be too expensive for some organisations or
unobtainable for some risks. This has led to the necessity for more
improved management of the risks an organisation carries. Organisations
that are more sophisticated in their risk management techniques are less
likely to need widespread insurance cover, instead using it tactically
where strictly necessary rather than for blanket coverage. A consequence
of this is that the insurance market is made up of cover for organisations
that are poorly managed, or for risks that are unpredictable and high
impact, leading to ever-spiralling premiums.

The risk register

The results of a risk management exercise should be recorded in a single
document, known as the risk register. The risk register is simply a single
source of reference for all the risks and their current status for a project. It
should be emphasised that the risk register is a dynamic document and
will need updating over time as the risk profile changes.

Probability --- EFFECT ---

of occurrence
Source Owner Consequence Response Eliminate Transfer Reduce

A typical risk register

In text question

What makes the risk register a dynamic document?

7.4.5 Risk monitoring and control

The final step of the risk management process aims to monitor the status
of identified risks, identify new risks, ensure the proper implementation of
agreed responses and review their effectiveness, as well as monitoring
changes in overall project risk exposure as the project progresses. Risk
review meetings maybe held to assess the current status of risks to the
project, and project review meetings should include status reports from the
project team on key risks and agreed responses.

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 Value and Risk Management [D19CV9]

7.5 The combined value and risk management

workshop
Value management and risk management are closely related, both in their
objectives and process of workshop implementation. However, the value
management and risk management methodologies have been presented as
two discrete entities with separate value management job plan and three-
step risk management framework.

Traditionally the literature and practice of both value management and

risk management has dealt with them separately, but more recently there
has been interest in combined value and risk management approaches. A
combined service is achieved essentially by integrating the two
methodologies. The value management job plan provides the overall
framework with a number of intervention points for risk management
activity. There are benefits and limitations of a combined value and risk
management approach as opposed to separate value management (VM)
and risk management (RM) activities.

Although there is no definitive methodology for value and risk

management, the intervention points where risk management stages may
be logically carried out within the job plan are shown in the diagram
below.

VM Job Plan RM Intervention points

1. Information
Select topics for Function and risk
brainstorming from FAST diagram
2. Creativity
Identification
Brainstorm risks associated with function
solutions. Brainstorm global risks
3. Evaluation
Analysis
Evaluate risks, select those requiring consideration

4. Development
Analysis
Consider remaining risks, weight them
and develop a response Response
5. Presentation

Develop risk register for presentation

Figure 6.5 The VM job plan

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7: The Risk Management Process

Value and risk management workshop structure

Stage Main Activities Discipline Output

Information Function Analysis VM Identify Solutions &

Construct FAST
Creativity Positive VM Alternative solutions
Brainstorming to functions
RM
Negative Risks associated with
Brainstorming solutions
Global risks
Evaluation Crude sort
Discard infeasible VM Solutions for
solutions consideration
RM
Prioritise Risks for
brainstormed risks consideration
VM (Function and
Refined sort Global)
Pairs RM
comparison/criteria
weighting Ideas for
development
Risk weighting (prob.
& impact) Prioritise risks
requiring response
strategy
Development Develop solutions VM Worked up proposals
into proposals
RM Risk response
Develop response strategy
strategy for priority
risks
Presentation Present solutions and VM/RM Client report
risks to client

Self-assessment question
What are the practical benefits and limitations of combining value and risk
management into a single service?

Who would you expect to be involved in a construction RM workshop at

the briefing stage?

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 Value and Risk Management [D19CV9]

Who would you expect to be involved in a construction RM workshop

during the construction phase?

Think of a project, construction or otherwise, that you have been involved

with. Would the application of a RM workshop have improved the
outcome?

Heriot-Watt University Unit 7 - 9

8: Tools and Techniques of Risk
Management

8.1 Introduction.
This unit introduces some of the more common tools and techniques
applied within a RM workshop study. These help the team lend structure
to the study for effectively identifying and assessing risks that affect the
project. Tools and techniques that are appropriate for a workshop study
will be easy to understand and straightforward to apply.

8.2 Learning outcomes

Become familiar with some of the more common RM tools and
techniques
Be able to apply these in practice

8.3 Techniques for the Risk identification stage

The objective of this stage is to compile a list of possible risks that might
affect the project. A number of information sources or certain techniques
may be used, and some of the more common are described below.

Historical data
Probably the best means of assessing what the risky aspects of a project
are is to draw from direct experience of similar past projects, since most
projects contain a number of reasonably standard and recognisable risk
situations. Useful historical data for risk identification in the construction
project may come from a number of sources. An obvious example of
historical data is that of the Meteorological Office for weather forecasting,
where prediction of future events is based on many years of recorded past
events of rainfall, temperature, wind speed and direction etc. Although
this is from outside the construction industry it obviously has its uses in
construction management and planning, such is the influence the weather
has on many operations.

Insurance companies, by the very nature of their business, are

sophisticated in risk management and also rely heavily on historical
records of the occurrence and impact of past events for risk analysis.
Within the construction industry, bodies such as the Building Cost
Information Service observe past trends on tender price levels and the

Heriot-Watt University Unit 8 - 1

8: Tools and Techniques of Risk Management

effect that inflation has on the labour and materials markets. Based on this
data, predictions for the future are made.

Although actual experience, documented in historical records, is the most

reliable and desirable source of information for use in risk management, it
has to be said that it is also the most wanting in construction management.
The types of databases of information simply do not exist in any usable
form yet for widespread use. The extent and usefulness of records kept
within the organisation itself will depend partly on how sophisticated its
risk management operations are. If a register, or log, of the risk profile of
previous projects has been built up, this will provide a useful source of
information. It may be that these will develop over time as the discipline
and the industry matures. On the other hand, much has been made of the
uniqueness of construction projects [Raftery et al] and the problem may
be too intractable to develop any meaningful industry wide databases.

In-text question

Why is there a general lack of useful historical data for risk

identification?

Checklists
Generic checklists are a useful source of information when compiling a
list of possible risks associated with a project. A checklist is simply a
comprehensive list of risks that could affect any project. Although
necessarily general in nature checklists can be used as prompts in
determining what the potential risks are for the project under study.
Published risk checklists in texts and journal papers can be consulted as
part of the risk identification process. Separate ones exist for client,
contractor and consultant perspectives. Whilst checklists are undoubtedly
a convenient and relatively simple approach to risk identification it is
important not to be over reliant on them. There is a danger that they can
act as a straitjacket and actually inhibit detailed thought on specific project
risks that may not be recorded on a generic checklist.

Brainstorming
This is one of the most powerful, and most widely used, techniques for
risk identification. Brainstorming is a creativity technique extensively
used in value management and much can be found written about it in
value management literature. Essentially a brainstorming session is a
short-term intensive group exercise, where a team of individuals will
generate as many ideas as possible for risk events that may adversely
affect the project. In a sense, this may be termed negative brainstorming
as the team of individuals is trying to determine all the things that may go
wrong with the project i.e. the downside risks, as compared with more

Unit 8 - 2 Heriot-Watt University

 Value and Risk Management [D19CV9]

conventional value management brainstorming where the team is trying to

generate ideas for fulfilling functions.

8.4 Techniques for the Risk analysis stage

The second phase of the risk management process is risk analysis. The
objective of risk analysis is to determine what the impact or consequences
would be of a risk event occurring. The impact may not be restricted to the
project itself, but could have an effect on the whole organisation
depending on how serious a risk, or combination of risks, are. Not all of
the risks identified at the risk identification stage will be given the same
consideration since there are simply too many to consider. There are an
almost inexhaustible number of risks that could affect any project and it
would simply be too time consuming to deal with them all. The point is to
limit the analysis of project risks to those that are most serious, namely
those that have a high impact on the project in terms of time, cost and
quality. It is also worth considering risks which may have lesser, but still
significant impact, if they are highly likely to occur since the cumulative
effect of a number of low impact risks materialising may have serious
impact. Ultimately, the effect of all risks directly or otherwise is in
increased costs for one or more parties to a project, whether client,
contractor, subcontractor or consultant.

The assessment of likelihood of occurrence i.e. the probability, may be a

simple qualitative exercise where probability of each event is assessed
against some descriptive scale. This may be as basic as a three point scale
of low, medium or high probability, or it can be refined up to any
number of descriptions. The two tables below are examples of probability
gradings. Although this may appear to be a subjective or unscientific
approach to assessing probability of risk occurrence, the use of a common
scale gives a measure of objectivity to the exercise. Such intuitive
assessment, formalised in this way, is a powerful technique when
employed by experienced individuals.

It can be seen from the second column of the tables below that an
informal, qualitative grading can be quantified and expressed in more
formal, numerical terms. This provides a format suitable for any
subsequent quantitative risk analysis.

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8: Tools and Techniques of Risk Management

Assessed likelihood Equivalent probability

No chance of occurring 0%
Unlikely to occur 5 - 45%
As likely as not 45 - 55%
Likely 55 - 95%
Almost certain 95 - 99%
Certain to occur 100%

Assessed likelihood Equivalent probability

Loss is not possible 0
Very remote possibility 0.1
Remote possibility 0.2
Slight chance of occurrence 0.3
Slightly less than equal chance 0.4
Equal chance of occurring 0.5
Fairly possible 0.6
More than likely to occur 0.7
Predictable 0.8
Very likely to occur 0.9
Loss is certain 1.0

Figure 8.1: From Qualitative to Quantitative, two examples

(adapted from Edwards)

8.4.1 The risk grid (probability-impact matrix)

In the initial stages, a qualitative risk analysis study will always be carried
out. Any further and more detailed consideration of the most serious risks
highlighted may then be the subject of more sophisticated quantitative
analysis.

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 Value and Risk Management [D19CV9]

PROB.
RISK MATRIX

MEDIUM HIGH PROB

PRIORITY PRIORITY
H

LOW MEDIUM
PRIORITY PRIORITY M

IMPACT L

L M H IMPACT

Arrow of Attention

VHI VHI

HI HI
Probability

Probability
MED MED

LO LO

VLO VLO

VLO LO MED HI VHI VHI HI MED LO VLO

Negative impact Positive impact

Figure 8.2 The risk grid (probability-impact matrix)

After a risk list is compiled using brainstorming and any other appropriate
techniques each identified risk area is gone through and a quick
assessment made of its impact and probability of occurrence. This is a
group activity and the assessments should be based on consensus.
Depending on which box on the grid each risk is placed in, based on
probability and impact, it can be prioritised as having low, medium or
high priority for further investigation and consideration. The advantage of
the risk grid approach is that it is quick and easy to apply, and can be
readily understood by everyone involved in the risk workshop. Its
limitations are that it is a rough technique, and further analysis will almost
certainly be required for those risks having a higher priority. However it is
always useful as a first pass through the list to streamline it and quickly

Heriot-Watt University Unit 8 - 5

8: Tools and Techniques of Risk Management

focus on the most important areas. Hillson (IJPM 20, 2002) developed a
risk grid which separately identifies upside risk from downside risk, and
termed the high priority area as the arrow of attention.

The impact of risks can be further qualitatively assessed by some

classification of their impact as in the table below. Some subjective
estimate may also be made as to the financial loss associated with risk
occurring.

Grading Assessment of impact Estimated cost

1 Little impact, nuisance only
2 Medium loss
3 Manageable loss
4 In range of largest previous loss
5 Serious loss
6 Catastrophic

Figure 8.3 Risk analysis: severity grading

8.5 Quantitative or qualitative risk analysis?

Although the term risk analysis suggests some detailed numerical or
statistical work, it is often the case that there is no actual number
crunching to be done in a risk analysis exercise. Where some technique
has been applied which requires input of numerical data and the carrying
out of some calculation work, this is known as quantitative risk analysis.
There are a number of standard techniques used in construction risk
analysis that you may have come across before. Most are techniques
developed in the operational research discipline (also known as
quantitative management science) that have been appropriated for use in
construction. A quantitative risk analysis study provides some numerical
results that allow more informed decision-making by the team.

Qualitative risk analysis does not involve any mathematical manipulation

or application of numerical techniques. Instead, a subjective assessment
based on the experience and intuition of the team may be used to
determine risk impact. Although there is no hard analysis, a qualitative
exercise still requires to be carried out using some structured system or
rules in order that that the project risks are made transparent and presented
in a consistent manner. Reasons for adopting a qualitative approach as
opposed to quantitative may include a lack of resources (in terms of staff
expertise and software for carrying out a numerical technique), lack of
demand for a more detailed approach, absence of numerical data relating
to identified risk e.g. probability of occurrence and its financial
implications. On the other hand qualitative and quantitative exercises can
be complimentary in the risk analysis phase.

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 Value and Risk Management [D19CV9]

At this stage it may be felt that a qualitative exercise is in some way

inferior or less professional than the application of some numerical
analysis in a quantitative exercise. However, this is an oversimplification
since the type of analysis carried out will depend on such considerations
as the data available, amount of time available, resources of the
organisation carrying out the study and the attitude of management who
will be making decisions on the basis of the outcome of the risk analysis.
In short, there is no overall best technique: those used will depend on
what is appropriate for the circumstances prevailing.

Heriot-Watt University Unit 8 - 7

8: Tools and Techniques of Risk Management

APPENDIX 1 Glossary of Terms

Risk Possibility that an actual outcome will deviate from

that forecast.

Risk Event Actual occurrence of a risk with positive or negative

consequences for a project.

Hazard Risk of physical damage, injury or death.

Upside Possibility that actual outcome of risk is positive.

Downside Possibility that actual outcome of risk is negative.

Exposure Extent of possible loss associated with a risk, usually

measured in financial terms.

Risk Attitude Willingness of an individual, team or organisation to

take a risk.

Uncontrollable Risk whose possibility cannot be influenced by the

Risk actions of associated parties.

Controllable Risk whose possibility can be influenced by the

Risk actions of associated parties.

Pure Risk Hazards that result in loss only. Usually covered by

appropriate insurance in the contract.

Speculative Risk Risks which may result in loss or gain and will be
apportioned amongst parties to a project.
Strategic phase Initial stages of a project concerned with defining its
scope and developing the brief.

Tactical phase Latter stages of a project concerned with its design

and delivery.
Source Origin of the risk in the project environment.

Event The actual occurrence, or manifestation, of the risk

on the project.

Effect The consequence of the risk occurring for a party or

parties to the project.

Hierarchy Means of classifying sources of risk according to

where in the project environment they originate from.
Qualitative Non-numerical assessment of risk based on
analysis judgement and experience of individuals.

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 Value and Risk Management [D19CV9]

Quantitative Numerical measurement of risk exposure using RA

analysis techniques and processing of hard data.

Risk grid Graphical technique for qualitative analysis of risk.

Risk register Document recording the risk status of a project at a

particular point in time. Requires frequent updating.

Self Assessment question

1. What qualities does a good workshop technique exhibit?

Heriot-Watt University Unit 8 - 9

9: North American Value
Engineering in Construction: A
Critical Review

9.1 Introduction
This unit is a synopsis of the review of value engineering practice in the
USA in Value Management in Design and Construction (1993). A follow
up visit in 1997 confirmed that the practices reported here remain largely
unaltered. In the USA a significant proportion of value engineering is
undertaken for public sector organisations. Value engineering consultants
obtain this work through competitive fee bidding against a specification
drawn up by the public sector authority. This results in a prescribed and
relatively standardised value engineering service.

Described here in some detail are the Charette or 10% stage study, the
40-hour value engineering study at 35% stage, the audit and the
contractors change proposal.

9.2 The Charette

This method seeks to rationalise the clients brief through the identification
of the function of the spaces specified. This analysis through function at a
meeting involving the clients staff and the design team should ensure that
the latter understand fully the requirements of the former. During the
research into this subject interviews were held with a client who had
commissioned a value management study following a tender in which the
lowest bid was 18% higher than the permitted budget. The client stated that
a value management study at briefing would be useful:

Just to focus on what are the objectives, what are the

primary functions of any given activity. The design team and
the client team should meet in a VM study. When we got
around the table for the VM study it was clear that what the
client team thought were the primary functions differed from
what the design team thought and this was after the design
was done.

There is a theory which states that the brief given by the client to the design
team is an amalgam of the wish lists of all of the parties who contribute to
the brief. This is particularly so for buildings that are to house organisations
comprised of diverse departments such as hospitals, universities, prisons,

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9: North American Value Engineering in Construction: A Critical Review

owner-occupied offices for complex organisations and manufacturing plants.

Even where a project manager is employed, there is a high probability that
the brief will reflect data gathered from departmental heads who will seek to
maximise their requirements. In a hospital for instance two departments may
each have a requirement for a laboratory and the two laboratories may be
identical, but this is not likely to be realised unless a study is made of the
function of each space.

The charette is organised along the traditional job plan lines with the first
stage being to gather as much information as is available regarding the
function of the spaces defined in the brief. The function of all of the spaces
are defined along with performance criteria e.g. this space must be held at a
constant 20C 5 where the activity within the space generates heat.

The next stage in the process is to be creative in terms of arrangement,

adjacency, timetabling, etc. It may be found for example that by siting two
particular hospital departments together that they may use the same
laboratory with immense savings in capital and running costs (including
laboratory staff).

The ideas generated are recorded and analysed and the final decisions are
incorporated into the brief.

The charette has five major advantages. First, it is considered by many

clients to be inexpensive. There is of course staff time to consider and the
time of the design team. However, if the design team were informed at the
time of their selection that this meeting was to happen, the chances are that it
would not affect the fee bid greatly. The only real expenditure is the fee of
the value manager himself. One client interviewed during this research also
stated that it was beneficial to have a cost consultant at this meeting. There is
finally the secretary to the team who will either be provided by the client or
by the value manager.

Secondly, the exercise was considered by some clients to be the best way of
briefing the whole team. One industrial client with a large and expanding
building stock stated that even if the exercise did not realise any great
rationalisation the very fact that all members of the team, the architect,
structural engineer, mechanical and electrical engineers, etc, were present
meant that all understood fully his requirements.

Third, the exercise occurs early in the process, stated by many to be the most
cost consequent stage. Fourthly, the exercise can be carried out in a short
period of time, only the most complex projects will involve more than two
days work.

Finally, the exercise cuts across organisational, political and professional

boundaries. One central government organisation client stated that a meeting
of this kind would not normally be possible since departmental heads would
be reluctant to give up the time, the meeting would be politically structured

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 Value and Risk Management [D19CV9]

and the design team themselves would not normally organise such a
meeting. The fact that it was a value engineering exercise under the
chairmanship of an outsider made it happen.

The charette is therefore an inexpensive means of examining the clients

requirements by the use of functional analysis and allowing rationalisation
and full design team briefing.

9.3 The 40-hour value management study

The 40 hour study is the most widely accepted formal approach to value
engineering, indeed the initial training of value managers as laid down by
the Society of American Value Engineers (SAVE) is based on a 40 hour
training workshop. The study involves the review of the sketch design of
project by a second design team under the chairmanship of a value manager.
It applies all of the stages of the job plan within a working week and is seen
as being quick and effective. The procedure for the study is as follows.

The client should inform the members of the design team at the time of their
fee bid that the project will be the subject of a value management exercise.
This is important both from a human relations aspect and also from the point
of view of establishing how the design team are to cover the cost of any
redesign work arising out of the exercise. Some clients require the members
to cover this cost within their fee bid. Others state at the time of the fee bid
that the design team members will be reimbursed for any necessary redesign
work on an hourly basis.

The client appoints the value engineer, the value manager and in discussion
with the design team establishes the date for the study. Normally the value
engineer will submit a fee bid that covers the cost of the complete value
management exercise described under.

The value engineer will appoint a value management team, normally six to
eight professionals in a mix that reflects the characteristics of the project
under review. So for example, a project with a large amount of mechanical
and electrical servicing may attract a team including four members with
these professional backgrounds. These team members will be drawn from
professional practice and may or may not have any previous value
management experience. The team members are paid by the value engineer.

The study is normally held near the site of the proposed project, either in a
hotel or in a room provided by the client within the clients office.

The date of the study is a key date for the design team and the value
management team. The design team must be complete to sketch design stage
one week before the date of the study. This includes the architectural design
and also the structural, mechanical and electrical engineering designs. The
completed drawings are sent to the value engineer for distribution to the
team during the week preceding the study.

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9: North American Value Engineering in Construction: A Critical Review

During the week of the study the team will follow strictly the stages of the
job plan. It is the logical step by step approach to the generation of
alternative technical solutions that makes value management unique.

Monday - phase 1 (information)

The team have each had the project sketch drawings, initial cost estimate
together with calculations and outline proposals for the structure and
services for two days and will have gleaned some information from these.
At the beginning of the study the architect and the client are present. The
value engineer gives an introduction and states the objectives for the
week. Often the value engineer will have prepared a timetable and may
also have prepared an elemental breakdown of the initial estimate.

Following the introduction the client and the design architect present the
project, answer questions and the client reaffirms which areas of the project
are within the scope of the exercise. This latter point is important since, for
example, if the client has already reached an agreement with a trade union
that a specific number of men will be employed within a plant, then any
ingenuity on the part of the value management team to reduce manning
levels will be in vain.

After the presentation the client and architect leave.

The team now concentrates its efforts on identifying the functions of the
various parts of the building. In the study emphasis is given to those
functions which are not important, or are secondary, but attract a high
cost. Attention will also be paid to those functions that are primary and
important but attract a low cost.

In one study for the modernisation of a boiler house on a large military site
in North America, with an estimated project cost of $71,500,948, the team
identified 17 functions of which 7 were selected for study.

Tuesday morning - phase 2 (creativity)

During this phase the group brainstorm ideas to satisfy the identified
functions. In the boiler house example above over 200 ideas were generated
during this session. Creativity is a rapid but exhausting process, 200 ideas
could easily be produced in one hour.

Tuesday afternoon - phase 3 (judgement)

At this stage the team decides which of the ideas generated are worthy of
further development. For example, of the 200 plus ideas generated above
only 42 were thought good enough for development.

Before moving on to the development phase some value managers prefer to

invite the design architect back to the study at this point to discuss the

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 Value and Risk Management [D19CV9]

acceptability of the ideas in principle. This can reduce abortive work if, for
instance, the design team had already thought of the idea and rejected it or if
the architect would not agree to such an idea under any circumstances.

Wednesday and Thursday - phase 4 (development)

During this phase the team may split into individual or small groups to work
on the ideas in detail. The aim is to develop the ideas into a worked and
costed solution.

Friday - phase 5 (recommendation)

In the morning of the final day the group reconvene to discuss the worked
solutions. At this stage those solutions that cost more than the original,
reduce quality or are not technically feasible are rejected. In the boiler house
case above 15 worked solutions were rejected at this stage leaving 27 viable
solutions for presentation to the client and design architect.

In the afternoon those worked solutions accepted by the team are presented
to the design architect and the client.

The formal study is now at an end. The members of the study return to their
practice leaving the value engineer to take away the weeks work and write
the report.

The following week - action and feedback

In the early part of the following week the completed report is sent by the
value engineer to the client and design architect. At this stage, one North
American government department takes all of the ideas, sets them out on a
sheet horizontally with vertical columns for each member of the design team
who receive a copy. The team members are requested to enter either
accepted, rejected, or further discussion required against the
suggestions. A meeting is called where all members of the design team
gather to discuss the suggestions. All those that have been unanimously
accepted are required to be incorporated into the design. In respect of the
others discussion takes place to determine which may be acceptable. The
client will wish to be convinced of the need for rejection.

In the boiler house example above, 11 of the 27 suggestions were

incorporated into the final design, leading to $32,868,302 savings on the
original estimate of $71,500,948. This remarkable saving of 45% of
estimated cost was achieved by demolishing two perfectly satisfactory
buildings adjacent to the site and rebuilding them elsewhere. Within the
original scheme the design team had used considerable ingenuity to design
an expansion in the boiler house facility around the constraint of the existing
buildings.

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9: North American Value Engineering in Construction: A Critical Review

In-text question

How many people should be involved in a VM team?

9.4 Advantages and disadvantages of the value

management study
A value management study is seen as being effective in that it generates
alternative technical solutions to a problem which have been costed in initial
and life cycle cost terms.

It also ensures the fixing of a date for the completion of a sketch design.
Although not a function of the study it has been stated that the setting of a
date for the study, forces the design team to complete to a more advanced
stage than would otherwise be achieved particularly by the engineering
designers.

In the majority of cases the costs of the study are a small proportion of the
savings achieved. Value managers state that on any project at least 10% of
the estimated contract value is within the area of unnecessary cost. They also
state that the value manager will achieve a 10:1 return on the investment
made by the client and therefore in the majority of cases the study fee,
usually quoted as a lump sum, would work out to be not less than 10% of the
savings realised.

In responding to questions on How often do studies fail? value managers

stated nil, but one major client stated about 2%.

The problems associated with the study relate to conflict, time and
resourcing. These centre on:

The fact that the client may consider that the design team should arrive
at the optimal solution without the need for a further exercise at
additional expense. This criticism may be countered in two ways, firstly
that it is the function of the design team to arrive at a workable solution
given the information in the client's requirements. Secondly, that a value
management study is an analysis of the ideas which have been
generated. A value management study cannot be carried out until there is
an idea to analyse and it is therefore truly a second phase of the design
exercise. Currently, designers are not expected to carry out nor paid for
such an exercise.

The interpretation of the exercise by the design team as a critique of their

design judgement. This is a difficult problem that is hard to counter
unless the original designer plays a part in the activity. The reason given
by some value managers for not including members of the original
design team is the danger that old ideas are defended and their presence

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 Value and Risk Management [D19CV9]

may stifle frank comments on the design. This potential area of conflict
can be alleviated through the education of the designers in value
management techniques, informing the members of the design team at
the time of their appointment that the exercise is to take place and
payment of an additional fee for implementing design changes.

The time of the value management study. It is beyond dispute that the
value management study will effectively take three to four weeks from
the design programme. That is one week prior to the study for the
distribution of drawings and information, the study week and the period
of time following the study for the submission of the report, discussion
and design changes. In some projects this period of time, during which
the design will be at a standstill, will be unacceptable. However, in the
majority of cases it is capable of being accommodated particularly in
view of the fact that the study itself is a watershed between sketch design
and working drawings and provides an immovable date for the
completion of the sketch design.

The resourcing of a study can pose problems associated with the

withdrawal of professionals from their home office for a one-week
period. It is a condition precedent to a successful study that members of
the value management team are isolated from their home environment
for the study period.

The study therefore is not without its problems, but has consistently proved
to be a very effective means for the application of value management.

9.5 The value management audit

The value management audit is a service offered by value managers to large
corporate companies or government departments to review expenditure
proposals put forward by subsidiary companies or regional authorities. The
procedures employed follow exactly those of the job plan. Following a
proposal the value manager will visit the subsidiary company or regional
authority and undertake a study of the proposal from the point of view of
providing the primary functions. The study may be carried out using
personnel from the subsidiary company or regional authority or from another
company within the group or another regional authority. The study is a
global review and normally takes one or two days, so is therefore fast and
relatively inexpensive.

Following the review the value manager will submit a report detailing the
primary objective and the most cost-effective method for its realisation.

The audit may be criticised on the grounds that it is potentially conflict

oriented and that depth is sacrificed for breadth. However, the projects
director of one subsidiary company stated that a value management audit on
one proposal revealed a number of shortcomings with the statement of

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9: North American Value Engineering in Construction: A Critical Review

requirements to the extent that the company now adopts a policy of holding
a charette before a proposal is submitted to the parent company.

9.6 The contractors change proposal

The contractors change proposal (or value management change proposal) is
a post tender change inspired by the contractor. The United States
government includes a clause in their conditions of contract, which states
that contractors are encouraged to submit ideas for reducing costs. If the
design team accepts the change, then the contractor shares in the saving at
the rate of 55% of the saving for fixed price contracts and 25% for cost
reimbursement contracts. For example, if a contractor, on a contract of
250,000 makes a suggestion that the contractor estimates will save 10,000,
then following verification and acceptance by the design team, the contractor
will receive 5,500. The payment is made by reducing the contract sum by
4,500.

The benefit of the clause is that it allows the contractor to be pro-active and
use construction/engineering knowledge to improve a facility at on-site
stage.

The disadvantage of the clause is that the contract may be delayed while the
design team investigate the viability of the change. For this reason changes
tend to be relatively superficial.

9.7 Variations on the formal approaches to value

management
Although the four approaches detailed above are most often described they
are not suitable in every case. The following are applications of the job plan
which have been used in practice but do not fall within the standard
approaches.

9.7.1 The orientation meeting

Similar to the charette, this meeting is a part of the value management
procedure operated by New York City, Office of Management and Budget.
The meeting of client representatives, design team and independent
estimator is held when either the brief or the brief and schematic have been
developed. The objectives of the meeting include; an opportunity for all
taking part to understand project issues and constraints, to give and receive
information, to determine whether all information for a 40 hour study is
likely to be available by the date set for the study. A full report of the
orientation meeting is given in The Practice of Value Management:
Enhancing Value or Cutting Cost? Kelly and Male, RICS, 1991.

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 Value and Risk Management [D19CV9]

9.7.2 The shortened study

In many cases the estimated project value is lower than the 2-3 million
considered the lower limit for a full 40-hour study involving a team of six. In
this case the 10% rule of thumb is used to determine how much can be spent
on the study. For example, for a project of 500,000 the target savings are
50,000 and the fee for the study 5,000. It is now a question of determining
how much professional time can be bought for 5,000. If a rate of 600 per
person per day is assumed, including expenses, then 8 person days can be
afforded. This could be three people for two days with two extra days for the
value manager.

9.7.3 The concurrent study

This approach involves the design team themselves coming together on a
regular basis under the chairmanship of the value manager to review design
decisions taken. The method has much to commend it in that it answers
much of the criticism levelled at the standard 40-hour study. The extent of
involvement of the value manager needs to be determined in advance so that
the fee can be established. The fee bid from members of the design team will
also have to account for their extra involvement.

The concurrent study is also suitable for construction management contracts

in which the design is carried out in stages along with the construction,
(fast-tracking). In a study of a $100 million office project in Canada, on
which a value management design meeting was held on site each
Wednesday, the reference point for the comparison of costs was the
elemental cost plan. At initial meetings, the functions of the spaces were
analysed and, five adjacency diagrams generated.

These were reduced to three for presentation to the client. For the selected
plan a number of structural solutions were generated and analysed on a
matrix along with solutions for the electrical and mechanical installations.
Once the building form was established construction work began. Meetings
continued with the construction manager in attendance through to the end of
the project. The final cost of the project was $9 million less than the budget.

A disadvantage of the concurrent study is the difficulty of proving the value

of the time expended, it is easy to say that the budget was too high.

9.8 A North American approach in the UK?

The review of North American value engineering methodologies above
demonstrates characteristic approaches, which may be applied in the UK.
However, in comparison to North America the presence of a quantity
surveying profession in the UK construction industry is one major aspect
that should be taken into account in the formalisation of an equivalent
service.

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9: North American Value Engineering in Construction: A Critical Review

In 1997 it was confirmed that the prime method used by the public sector
was the 40-hour value engineering study with an independent team. Heavy
public sector patronage of value engineering studies in construction
suggests a close linkage with public accountability. In respect of the 40-
hour value engineering study the authors (refs 1987, 1991 & 1993) and
Palmer (1992) noted that much of what was purported to be value
engineering was equivalent to the traditional specification reduction and
component substitution cost reduction exercises undertaken by quantity
surveyors in the course of their normal cost planning function. The major
difference was in the use of a team approach to problem identification and
problem solving.

It was quickly concluded by the UK construction industry that where a

professional cost consultant was a member of the design team then cost
control on the project would be undertaken from sketch design onwards.
Therefore, an equivalent 40-hour value engineering study with an
independent team would not add benefits equivalent to its costs.

However, the Charette, with its emphasis on application early in the

design process (not later than outline sketch design) and its emphasis on
bringing together key members of the client team and the design team did
find favour in the UK. In 1998, at a conference in London, it was stated
that the majority of value management studies carried out in the UK were
of the Charette type.

There are no known examples of the value engineering audit being applied
in a UK context. Similarly, it is also concluded that while agreements to
share value engineering change proposals at the post contract stage have
been made in the UK, the application appears to be informal or based
upon an exchange of letters, rather than being incorporated into a standard
form of contract.

In-text question

Why might a 40 hour study be considered excessively long in a UK

context?

9.9 Conclusion
This unit has described in outline the method of value engineering used in
the construction industry in the USA. Its use is typified by public sector
patronage where it can only be assumed that the use of the technique is for
public accountability purposes. In the UK, the professional quantity
surveyor is the member of the team who is liable for the correct budgetary
control of the project from post sketch design to its completion. This has
an impact on the type of study used in the UK. The UK construction

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 Value and Risk Management [D19CV9]

industry has learnt much from the Charette form of value engineering and
continues to develop this approach.

Self assessment question

Consider an area of work where you could have successfully applied VM.
Prepare an agenda for the workshop that you would have run that
identifies who would be involved and what the issues needing resolved
are.

Heriot-Watt University Unit 9 - 11

10: Function Analysis and
Function Diagramming

10.1 Introduction
This unit begins by introducing techniques that may be used in the
briefing process to describe the customer or clients requirements. The
concept of Function Analysis (FA) is introduced and its essential
principles are described. These principles are developed with the Function
Logic diagram and examples are presented to illustrate its application in
practice. The unit develops by considering technical orientated FA and its
application at the level of a buildings elements. The relationship with
traditional elemental cost planning as practised by the quantity surveyor is
then discussed.

10.2 Value and strategic briefing

Consider the following definitions of value and reach a conclusion as to
which are correct.

1. Value to me is getting exactly what I want at the lowest price.

2. Value is obtaining a defined level of quality at the lowest cost,

the highest level of quality at a given cost or an optimum
compromise between the two.

3. The worth of an item is represented by the lowest cost to provide

the necessary functions irrespective of quality. For example, the
worth of a solid core mahogany door is the cost of a hollow core,
hardboard faced flush door of the type obtainable from any DIY
store.

4. You cannot measure value in terms of currency as esteem and

aesthetic come into play.

5. The worth of an item is represented by the lowest cost to provide

my functional requirements that may include aesthetic and
quality aspects.

6. Quality cannot be measured, it is a personal view of a product or

service and therefore the scaling applied to quality is personal.

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10: Function Analysis and Function Diagramming

7. Quality has no antonym.

8. Value and worth are the same.

9. A team can decide on the criteria for value, worth and quality by
consensus. In this respect a team acts as an individual.

10. While value is difficult to define, the value system used by an

individual or a team is capable of being extrapolated.

11. Value is directly related to the ability of a product or service to

satisfy our needs and is inversely related to cost.

12. In a value of management team, the team will develop a concept

and a set of values which they will use to control the
development of a project.

10.3 Examples of element function analysis and

diagramming
Function analysis can be performed at various levels of the project life
cycle. The procedure for establishing the necessary functions is outlined
below.

In-text question

What are the main benefits gained by the VM team from

constructing a FAST diagram?

10.3.1 Function Analysis (FA)

Verb/noun definition
Most texts recommend that the function of an item or a system be
expressed as a concise phrase, ideally one comprising just an active
verb followed by a noun.

Primary and Secondary functions

Primary functions are defined as those without which the project
would fail or the task would not be accomplished. Secondary
functions, on the other hand, are those that are a characteristic of the
technical solution chosen.

When conducting a FA exercise it is useful for the VM team to first

question what the project, process, activity, element or components i.e.
whatever the object under study is- will do. Following this a list of

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 Value and Risk Management [D19CV9]

verb/noun functions can be generated for the object under study. Further
consideration should see the team distinguish between needs and wants
functions. Client needs are those functions the project must possess to
serve its basic intentions. Client wants are those embellishments to the
project which are nice to have, but not critical to the survival or basic
integrity of the project. From the finalised and agreed list of functions, a
function logic - also known as FAST (Function Analysis System
Technique) - diagram can then be constructed.

10.3.2 Function Logic Diagram

As an aid to information gathering and synthesis it is recommended that
the workshop team should construct a function logic diagram. This will
act as a knowledge leveller and is useful to establish consensus before
progressing further. The function logic diagram is used to determine the
project task and its justification for existing. It is a very good deepening
and focussing technique that describes a project concisely in a visual
form. It brings together the value criteria of a project, highlighting the
strategic issues that represent the clients value system.

The usual process for preparing a function logic diagram in a workshop is

for the team to brainstorm functions, then group and structure them into a
hierarchy. Once the hierarchy has been established it is useful to pose the
question, What if we go one level higher? and then establish the
resulting function or objective. This will force the participants to step back
from the project and place it in a wider context i.e. linking it into
corporate and business strategies. The examples below are used to
illustrate the principles of the function logic diagram.

Example 1
Consider the construction of function logic diagrams for the following
simple project. The project came into being when a local authority
decided to extend an existing country park to incorporate land on the far
side of a river. The project involved the investment of resources to
transport pedestrians, including disabled and children in prams/buggies,
safely across the river.

Generation of functions
The functions were generated by the team in a random fashion on post-it
notes and placed on a large sheet of paper.

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10: Function Analysis and Function Diagramming

Maintain
Facility Position
Meet People
Minimise Demand
Wear

Reduce
Establish
Downtime
Non slip Rules (of
(due to
Surface passage)
flooding)

Minimise
Labour
Support Protect Cater for
Peopler People children
Control
People

Cater for Facilitate

disabled Passage
Educate
people

Direct
Routes Prevent Focal
Falling (into point
Span
river) River

Figure 10.1 Generation of Functions

Sorting of functions
Following the generation of functions, undertaken as a brainstorming
process, the team are invited to order the functions by putting the highest
order need at the top left hand corner of the paper and the lowest order
want at the bottom right. This is illustrated in Figure 8.2 below.

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 Value and Risk Management [D19CV9]

Facilitate Span
Passage River

Prevent
Support Protect Focal
Falling (into
Peopler People point
river)

Educate Cater for Cater for

people children disabled

Establish
Meet Control Position
Rules (of
Demand People People
passage)

Reduce
Downtime Direct Maintain
(due to Routes Facility
flooding)

Minimise Non slip

Wear Surface

Minimise
Labour

Figure 10.2 Initial sorting prior to diagramming

Diagramming
A diagram is constructed from the ordered post-it notes. The type of
diagram will depend upon the focus of the study being undertaken. To
gain a technical appreciation of the problem a function diagram with a
technical bias will be constructed. If the focus of the study is of a strategic
nature, such as a strategic briefing, a client orientated function diagram
will be constructed. The figures below illustrate the two types of
diagramming technique for the problems outlined above.

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 10: Function Analysis and Function Diagramming

Minimise
Wear
Design Objectives Cater for Meet
Desired Objectives children Demand

Reduce
Downtime Cater for Maintain
(due to disabled Facility
flooding)

Educate Minimise
people Labour
Non slip

es
Surface e

tiv
tiv

ec
ec

bj
bj

O
O

ry
e

da
im

on
Pr

c
Se
Facilitate
Establish
Passage Support Position Protect Control
Rules (of
across Peopler People People People
passage)
River

Span Prevent
River Direct
Falling (into
Routes
river)
Pa
rra
lel
lO
bj
ec
tiv
e

Figure 10.3 - Technical FAST

It should be noted from the above diagram that the prime objective is a
technical objective and the brainstorming of ideas following the
construction of the diagram will therefore lead to the exploration of
technical solutions. The brainstormed solutions, for example, a suspension
bridge, a simply supported span bridge, stepping stones, etc, will be
audited back against the diagram to determine the extent to which the
ideas meet the functions.

The diagram is structured such that the prime objective of the project is
situated on the left-hand side of the scope line. The prime objective "
support people" is situated immediately to the right of the project
objective. Parallel objectives are below the prime objective in this case
"span river". Secondary objectives appear to the right of the prime
objective and design objectives are situated immediately above. Desired
objectives are located on the top right of the diagram above the secondary
objectives.

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It is the structuring of the diagram that prepares the team for

brainstorming. For a client or customer orientated situation the same post-
it notes will be ordered in a slightly different manner. The diagram
overleaf illustrates a client-orientated diagram that takes the form of a tree
laid horizontal. In a very general sense the logic of the diagram answers
the question "how?" when working from left to right and "why?" when
working from right to left. Highest order needs are placed at the top of the
diagram and the lowest order wants at the bottom of the diagram. A scope
line divides the primary function of the project from the functions that
may form the basis of brainstorming. It should be noted that there is a
high correlation in terms of the post-it notes used but the emphasis, as
judged by the team, has been altered somewhat. In the case of this
particular project the final solution might not a bridge but an old fashioned
cable stayed ferrying boat which used the power of the river acting on the
rudder to move the ferry across the river. A full-time ferryman working
between two covered shelters one of which might be an exhibition centre
could operate the ferry.

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 10: Function Analysis and Function Diagramming

HOW WHY
Support
People

Span
Prevent NEEDS
Falling (into
River
river)
Protect
People
Establish
Rules (of
passage)
Control
People
Position
People

Direct
Routes

Cater for
children
Create a focal Meet
point for the Demand
park which
educates and
Cater for
facilitates the
disabled
crossing of the
river
Reduce
Downtime
(due to
flooding)

Minimise
Wear

WANTS
Maintain
Facility
Minimise
Labour

Figure 10.4 Client or Customer orientated FAST

Value and Tactical Project Development

10.4 Element function analysis

This section will outline the principles of cost planning using cost data
organised in the form of elemental cost analyses. This will be followed by
a debate on element function and put forward the idea that elements may
be defined by a list of characteristic functions which are not project
specific. A method of element function analysis is described.

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10.5 Elemental cost planning

In 1969 the Building Cost Information Service (BCIS) of the Royal
Institution of Chartered Surveyors defined an element as follows:

An element for cost analysis purposes is defined as a

component that fulfils a specific function or functions
irrespective of its design, specification or construction.

The introduction to the BCIS document, The Standard Form of Cost

Analysis goes on to state that the list of elements, however, is a
compromise between this definition and what is considered practical.
However, apart from the elements within the subsection building services
the definition works well. This is fortuitous for all those involved in value
management exercises that have a cost plan in elemental format as, by
definition, the building costs are distributed according to element
function.

Elemental cost planning is one of a family of techniques based upon

parametric modelling. The technique relies upon an extensive database of
building costs broken-down into elemental costs. In the UK it is normal
practice for lump sum fixed price contracts to be tendered based upon
detailed bills of quantities. The bills of quantities are normally arranged in
elemental format such that following the selection of the lowest tender, an
elemental cost analysis of the project is prepared. The elemental cost
analyses are submitted by quantity surveyors to the building cost
information service. In this way, quantity surveyors share tender data for a
wide range of construction projects.

The cost planning methodology is comprised of:

A frame of reference.
A means of checking.
A method for remedial action.

The frame of reference comprises an elemental cost plan for the project
under review. For example, assume that a quantity surveyor is required to
compile a cost plan for an office building of 2000 square metres floor
area. The surveyor will select from the database of cost analyses an
analysis that bears the closest resemblance to the project. For example, the
surveyor may find a cost analyses for a 2500 square metre office building
with similar characteristics to the proposed project.

The cost analysis is presented as a list of element costs expressed as

element costs per square metre of gross floor area. The surveyor
multiplies the element costs per square metre of the analysis by 2000
square metres to arrive that the first elemental cost plan for the proposed
building. Obviously, the surveyor will need to make a large number of
adjustments, for example:

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Inflation in prices between the date of tender of the analysis and the
date of tender of the proposed project.
Difference in prices between the location of the project represented by
the analysis and the proposed project.
Any major differences between the likely specification of the proposed
project and the analysis, for example, the type and extent of air-
conditioning, inclusion of car parking and access roads, etc.
Differences in the market prices due to demand for construction work.
Differences in risk costs brought about by choice of a particular
procurement method.

After these and a large number of other adjustments are made the surveyor
will have an elemental costs plan which displays a high degree of cost
certainty. This is the point when the cost plan becomes the frame of
reference. The cost plan figure is given to the client for the building and
therefore, generally, may not be exceeded. It should be noted that the cost
plan compiled in this way could precede sketch design but rarely does.

With the sketch design the surveyor will measure the elements and revise
the costs plan figures based upon priced measurement. In the event, and it
should be emphasised that generally only in the event of an increase in
costs the surveyor will ask for a design team meeting to address the
overspend. This highlights the use of the frame of reference, and the
method of checking.

The overspend is generally rectified by examining each element in turn to

determine whether a less expensive solution is available for one or more
elements based upon a change in specification. This can result in a
lowering of quality. This is the remedial action.

The method of elemental costs planning and cost control described above
is appropriate to design where a high level of certainty has been
established, i.e., at the completion of the final sketch design. The
advantage of a value management exercise prior to the final sketch design
is that it ensures that sketch design fulfils the performance specification of
the brief and in accordance with the clients value system.

The important point to note here is that while value management will
address the functions of all elements, cost planning only triggers action in
the event of an overspend.

10.6 Implementing element function analysis

While the concept of elemental analysis was derived for the cost planning
function described above two ingredients are essential to the undertaking
of elemental function analysis. These ingredients are:

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A database of costs which may be used for benchmarking projects.

A common understanding of the costs which are contained within a
particular element. For example, the BCIS definitions will include
the costs of forming the opening for a window in with the cost of the
window element.

Element function analysis comprises the stages listed below:

10.6.1 Stage 1 - List all the functions of the element

As elements are defined as being components of construction that
fulfil a specific function or functions irrespective of its design,
specification or construction it is logical to deduce that a definitive
list of functions can be derived for each element in the BCIS list.

For example, an internal wall will have one or more of the following
functions irrespective of the project context.

Support load.
Divide space.
Separate environments.
Dampen noise.
Transmit light.
Secure space.
Support fittings.
Facilitate finishing.
Restrict fire-spread.
Demonstrate hierarchy.
Minimise distraction.

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Debate

The above is not intended to be a definitive list, but one that

indicates the functions a team may brainstorm as being
functions of an internal wall. There is an argument that the list
of element functions need only be generated once. However,
there is a more convincing counter-argument that the list is
better generated as a team event during a workshop. Although
this is time-consuming it results in a list of functions owned by
the team. Some facilitators keep a definitive list in order to
prompt the team.

10.6.2 Stage 2 - Select functions for project context

In this next stage of element function analysis the list is reviewed and
functions deleted which are not relevant to the project situation.

An internal partition is a particular case of an element that may have a

number of different functions within the same building. Therefore it
would be necessary for the team to undertake a study of internal partition
type before proceeding further. For example, such a study of a university
department building may reveal the following partition types:

Division between lecture rooms.

Division between laboratories.
Division between storerooms.
Division between a lecture rooms and a corridor.
Division between offices.
Surround to lift shaft.
Division surrounding the computer room.

The above illustrates a number of partitions which display differing

functional characteristics. For example, a division between two lecture
rooms is required to dampen noise transmission to an absolute
minimum. A division between stores needs only to divide space and
perhaps support fittings. In many situations designers will choose a
single technical solution to meet all partition situation which, as shown
above may be inadequate and/or wasteful.

To take the functions of a partition between lecture rooms as an example

of function selection, the process would be to first delete those functions
that do not apply in this situation.

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Support load Framed building

Divide space Required function
Separate environments Heat, vent etc same requirement either
side
Dampen noise A primary requirement
Transmit light Not required
Secure space Lecture room contains IT equipment
Support fittings Boards, screen, display panels etc
Facilitate finishing Hard surface finish, easy to clean
Restrict fire-spread Required function
Demonstrate hierarchy Not required
Minimise distraction No visual or other sensory transmission is
permitted between lecture rooms

On completion of the above it may, in some circumstances, be necessary

to undertake a weighting and scoring exercise to heighten the teams
awareness of those aspects which are of primary importance.

10.6.3 Stage 3 - Brainstorming solutions

The brainstorming exercise will be undertaken following the analysis
complete analysis of the elements. The reason for undertaking
brainstorming as single exercise on the 34 elements lies in the dynamics
of the brainstorming process. Once the brainstorming has commenced it is
relatively easy with the 34 element functions defined to undertaken a
satisfactory and fulfilling session.

The rules relating to brainstorming are described earlier.

10.6.4 Stage 4 - Evaluation and development

The evaluation and development stage will be undertaken in exactly the

same way as described earlier. Element function analysis is normally
undertaken by a team that is capable of completing the majority of the
development exercise during the workshop. This has an advantage in
terms of simplifying the implementation stage.

10.7 Conclusion
The understanding of the functionality of projects, whether at concept,
physical spaces, construction elements or components level, in a value
management context, is critical to the strategic and tactical stages of a
projects evolution. The unit has considered FA and function logic (or
FAST) diagrams at the strategic and tactical project levels. At this point in
time relatively little academic work has been undertaken in the
development of procedures, tools and processes to properly understand

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10: Function Analysis and Function Diagramming

and evaluate elements and components. In manufacturing considerable

resources are expended on the accurate functional definition of
components. The prime manufacturer then feeds these definitions evolved
from benchmarking and market research activities to the suppliers. The
suppliers are requested not to supply a given piece of kit at the lowest
price but to innovate ways of satisfying the primary function which adds
value to the product as a whole. This is rarely done in construction.

Further analysis is required in relating element functions to the primary

functions of the building. For example:

The frame, floors and substructure exist to support and transfer load.
Lifts and escalators exist to minimise walking.
Heating and air conditioning exist to maintain comfort.
The external walls, roof, windows and external doors protect the space
and express aesthetic.

Only the internal walls, internal doors, floor wall and ceiling finishes, and
fittings and furnishings overtly serve the client function. In traditional
cost planning it is likely that these elements will be targeted for cost
reduction. In other words the very elements that the client requires service
from in order to achieve the strategic objective are often those that, from a
value perspective, are mismanaged.

Self assessment questions

Think about the value of a motor car to you personally. Prepare a FAST
diagram that captures all the functions it fulfils. What is the prime
function? Is there any other solution that meets the require functions?

At which stage of the project life cycle might a customer oriented FAST
diagram be prepared in a VM workshop?

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11: Common Briefing Structures
and Problems in Briefing

11.1 Introduction
This unit investigates identifiable briefing structures and the commonly
identified problems in briefing. The questions at the end of this unit are
intended to promote further reading and analysis.

The text is taken from Kelly J, MacPherson S and Male S, The Briefing
Process; A Review and Critique RICS, 1992, ISBN 0 85406 541 5.

11.2 Glossary
Project brief The full statement of the clients functional and
operational requirements for the completed
project.

Project execution plan The statement of policies and procedures

designed to ensure that every aspect of the
design and construction of the project is properly
undertaken within the clients constraints, and to
achieve the stated objectives.

Statement of need A document which defines the objectives and

needs of the client organisation.

Strategic brief The statement of the broad scope and purpose of

the project and its key parameters including
overall budget and programme, agreed at an
early stage of the project.

11.3 The clients approach to briefing

For owner occupation, the decision to build follows the identification of a
need. In large projects, this need is usually revealed as a result of long
term studies and forms an integral part of the client's long term strategic
plans, however small projects are frequently a response to unanticipated
changes in the client organisation or in the environment which rendered
existing facilities inadequate. Public sector clients reported that their long
term building strategy was closely linked to the means of securing

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11: Common Briefing Structures and Problems in Briefing

finance, however private sector clients did not report the same concern
over funding, and there appears to be an assumption that money could be
found if it were needed. For developers, on the other hand, the decision to
build is opportunistic and based on the availability of desirable sites.

Following the identification of the need or the opportunity, the way in

which the client proceeds depends upon the size of the client.

11.3.1 Large clients

Large clients frequently proceed to develop a brief prior to approaching
the industry. They perceive the architect (and the rest of the design team)
as technicians who will translate their stated requirements into a built
solution. Most large and regular clients of the building industry now
employ in-house project managers (although the precise meaning of this
term varies from client to client). Alternatively they may call upon the
services of outside consultants to act as project managers to provide the
interface between them and the design team (Franks, 1990a). It should be
recognised that the appointment of a project manager results in a
gatekeeper situation arising in that those wishing to influence the client
must pass there information first to the project manager. The converse is
also true for client representatives wishing to influence the design team.
Therefore, the influence that the actual design team has on the brief under
these circumstances is limited.

Highly sophisticated clients often retain their own design consultants who
participate in the briefing process and so provide some design advice at
the early stages. They may also take the advice of letting agents about the
design of commercial buildings so that their 'purpose built' properties are
not designed so specifically to their particular requirements as to
compromise their asset value and be difficult to dispose of should this be
necessary at some future time. Such clients will often have developed
model briefs for certain generic types of building such as an office, a
school or a leisure centre. A rather dated example of this is the system
described by IBM (AJ, 1987a). The brief for a project is developed by an
in-house project manager who consults with a facilities manager and
representatives of the user groups, with advice on the design and cost
implications of decisions coming from in-house design consultants. The
extremely rigid brief is then passed to the design team who will work on
the project. The project design team must then liaise exclusively with the
project manager. They never meet the users of the building, and if they
wish to deviate from the brief they must present an extremely good case
for doing so.

11.3.2 Small clients

The approach taken by smaller clients reflects the limited expertise
available to them in-house. They tend to rely more heavily on the design
advice of a consultant architect at the briefing stage. The way in which
these clients present their requirements to the architect can vary

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considerably. Some clients have highly detailed preconceptions of the

project, while others have only the vaguest notion of what they want, and
consider it to be the architect's task to develop the brief. The architect's
involvement in the early stages can sometimes extend to locating sites
(AJ, 1986a).

11.4 Problems encountered in briefing

Architects have long complained that many clients do not appreciate the
importance of the brief. This problem is particularly serious among
smaller, less sophisticated clients, but is by no means restricted to them
(O'Reilly, 1973). The identifiable problem areas are:

Client experience with the building industry.

Representation of client interest groups.

Identification of client needs.

Solution focused thinking.

Buildability.

Provision of sufficient time for briefing.

Incomplete briefs.

11.4.1 Experience with the building industry

Smaller, inexperienced clients often do not understand the structure of the
building industry, nor do they have an appreciation of the technicalities of
buildings. This lack of understanding frequently leads to the inappropriate
selection of sites given the type of building project envisaged, an
unrealistically low expectation of project costs, and a failure to appreciate
the roles of the various parties in the design and construction process. These
difficulties can be made worse if the design team find themselves dealing
with a forceful client business case team who are unwilling to compromise
on their preconceived ideas (Goodacre et al, 1982).

For unsophisticated clients, the initial approach to the industry can present a
problem. Most initially contact an architect and subsequently rely on his
advice for the selection of other design team members and contractors. It
has been observed, however, that this approach results in the client being
steered down the traditional procurement route without the option of
considering alternative methods (Newman et al, 1981).

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11: Common Briefing Structures and Problems in Briefing

11.4.2 Representation of client interest groups

Identification of the client body is extremely difficult as has been pointed out
already. Even assuming that all of the interest groups can be identified, the
problem then is deciding if and how they should be represented in the
business case team.

For owner occupiers, the usual way of doing this in all but the smallest of
organisations is to appoint representatives for each of the user groups (e.g.
departments affected by the building project) and form a committee to draft
the brief. There is little information available on how clients select these
representatives, but there is some evidence to suggest that many client
organisations, in underestimating the importance of the briefing process,
appoint representatives of relatively low status (O'Reilly, 1986).
Consequently, their ability to access information quickly and to make
decisions is limited, and this can slow down the briefing process. It can also
be frustrating for the design team, because they are effectively denied access
to the business case team. These representatives do however have the power
to influence the briefing process by their interpretation of information
between the client interest groups and the design team, and between the
design team and the other more powerful members of the business case
team. If this interpretation is not faithful, the brief can become distorted in
relation to the real client needs and decisions.

The use of facilities managers and project managers by larger client

organisations is an attempt to address this problem, however some
architects are sceptical about the effectiveness of these new professionals.

The facilities manager is much more aware of the technical implications of

client needs, and in that respect is certainly better qualified to translate the
needs as expressed by the user groups into terms which are meaningful to
the architect (Duffy, 1986a; Duffy 1986b). However, fears have been
expressed that the increasing professionalisation and technical orientation of
facilities managers might lead to the situation where they take decisions
based on their own judgement in the name of the users. Consequently, the
architect could never be sure that the user needs were not being distorted in
the interests of smoother technical facilities management (Cave, 1987).

The project manager is likewise held to be a more effective interpreter of

user needs, and in addition to this, a more effective person to manage the
project, freeing the architect of his management role and allowing him to
concentrate on design. Some architects have pointed out, however, that on
all but the very largest projects, the project manager often limits his role to
handling the legal issues of site acquisition, project funding, procurement
method etc. They claim, therefore, that in these circumstances the
architects role in managing the briefing and design process is in fact
undiminished (AJ, 1986b).

Design teams commissioned by property developers have the unique

problem of designing a building for users who are usually unknown at the

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 Value and Risk Management [D19CV9]

time. Moreover, the interests of the members of the client body can be quite
diverse.

Traditionally, the developers objective has been to make a profit by selling

the building once complete (or even before that). The funding institutions
objective has been to have a building which cost as little as possible to
construct but could command a relatively high rent. The users objective has
been to find a suitable building, with economical running costs, in which to
carry on his business. Although similar conflicts of interest still exist, recent
changes in the property markets and in the way in which property
development is being carried out are tending to modify the attitudes of the
developers and funders, making them more sympathetic to the needs of the
users. Nevertheless, in general the users cannot be directly represented in
the business case team, and designers remain extremely uncomfortable with
this position.

11.4.3 Identification of client needs

Even assuming that there is fair representation of the various client interest
groups, identification of the true needs of these groups can be problematical.
There is a tendency to assume that in approaching the building industry, the
client has at least correctly identified that a building project of some kind is
the correct solution to the problem which gave rise to the needs in the first
place. Larger and more sophisticated clients are generally assumed to have
investigated the need to build quite thoroughly, however there is a consensus
among writers in this field that the same cannot be said of smaller, less
sophisticated clients.

The statement of a need will tend to be influenced by the envisaged nature of

the solution, and so brief writers can find themselves attempting to solve the
wrong problem. Allen (1984) gives three examples of client groups who
had wrongly defined their needs. In these examples, more detailed
questioning of the stated requirements by the design team lead to
fundamental re-thinking of the project by the client. The result in all cases
was a more appropriate building and, in two of the cases, a lower cost
solution for the client.

Another difficulty facing the brief writer is the competition for resources
within the client organisation. When asked to state their requirements, it has
been found that user groups tend to maximise their 'wish list' in anticipation
of being bargained down from this (Kelly and Male, 1988). The problem
confronting the brief writer is then to understand the priorities of the user
groups such that high priority needs are not sacrificed for lower priority
wants.

A third difficulty facing brief writers is the changes that can occur in the
client organisation and the environment during the briefing and design
process. A brief can only reflect the needs (and anticipated future needs) of
the client at a particular point in time, however these needs can change
during the course of the project. These changes can be sudden and

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11: Common Briefing Structures and Problems in Briefing

unpredictable, however Morris and Hough (1987) demonstrated that in

larger projects, history shows that the greater danger is the failure to
recognise gradual changes which subtly alter the needs of the client
organisation and render the project, as initially conceived, inappropriate.
Duffy (1987) and Cave (1987) both comment on the tendency for clients to
'change their minds' which frustrates design teams, but point out that change
in the client organisation is a fact of life, and as such efforts must be made to
accommodate it.

Dealing with the above problems is an exceptionally difficult task for the
brief writer, and it is all the more difficult for him if he is unfamiliar with the
client organisation. This is one of the reasons behind IBMs briefing. They
maintain that it would be impossible for a consultant architect to reach an
understanding of IBMs corporate culture in the short time available at the
briefing stage.

Finally, there is the position of the architect who is designing a building for a
developer and is unable to consult the ultimate users regarding their needs.
Indeed the users will normally be a number of different groups who will
change during the life of the building. Here, assumptions must be made
about the user requirements, and the building designed to be flexible enough
to satisfy most of the requirements for most of the time.

Until recently, the needs of the users have been largely ignored in
development. It has been suggested that where demand has outstripped
supply, as in the London office market during certain periods in its
history, users placing exceptionally high priority on location have been
forced to accept what buildings were available. In the absence of any
consumer pressure therefore, bad design has gone unchecked during these
periods. When there is a relaxation in demand, however, design becomes
more important and users can be seen to exercise their judgement by
renting those buildings which they consider better designed (McIntosh,
1984).

Agents are now arguing that this brings the longer term requirements of
the funders and the users closer together. They believe that although the
users are not part of the business case team, commercial pressures will
force the funders to take user requirements more seriously in future,
placing pressure in turn on the developers to build better buildings (Ellis,
1984). Of course, funders have always had criteria for office building
design, but as Duffy (1986a) points out, the basis for these criteria laid
down by the anonymous, far seeing gnomes within the funding
institutions was never clear, and has since proved disastrously wrong as
witnessed by the growing number of obsolete office buildings constructed
in the boom of the 1960s. Consumer research is therefore on the increase
among funders and developers, as they make an effort to understand the
requirements of their customers more clearly (Evans, 1989).

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 Value and Risk Management [D19CV9]

11.4.4 Techniques for ascertaining client needs

Specific techniques used in eliciting and evaluating client (or more
specifically user) needs are rarely ever referred to in the literature on current
briefing practice. It would appear that the most commonly used method is to
hold a series of meetings with the representatives of the client body during
which they are questioned on their requirements, and then produce the brief
document based on notes from the meetings (Goodacre et al, 1982). It has
been argued that this approach is not sufficiently rigorous, as the client
representatives themselves may not have a sound enough basis for stating
their requirements. More formal procedures for appraising existing
buildings and accounting for the value judgements made by individuals is
advocated by researchers, and a discussion on these is presented in chapter 4.

11.4.5 Solution-focused thinking

As pointed out above, a clients expression of needs can be influenced by the
envisaged building solution. However, it is also common for the expression
of needs to be modified as possible design solutions are developed, i.e. after
the briefing stage has supposedly passed. This can be another reason for
client (or more precisely user) representatives changing their minds during
the design process - because it is only by seeing designs that they come to a
fuller understanding of what is possible in construction (Lawson, 1980;
Canter, 1984). This is the same process of understanding design problems
by attempting solutions which designers go through (see chapter 2). Some
user representatives are also unable to conceptualise well enough to imagine
the effects of design decisions on their organisational function or the
aesthetics of the building (Carrington, 1979; Goodacre et al, 1982), and so
mismatches between their needs and the design can slip through until quite
advanced stages in the design, or perhaps never be noticed at all until they
occupy the building.

11.4.6 Buildability
The issue of buildability in relation to early design decisions is also much
written about. Ever since the Tavistock report of 1966 there have been calls
for contractors to be involved at the earliest opportunity to provide advice on
the practical construction implications of design decisions. The traditional
separation of the design and construction processes has been described as a
division of responsibility not meant for this world(Quantity Surveyor,
1982). The design and build procurement method is supposed to allow
greater integration in this respect, although to what extent design practice is
truly influenced by procurement method is not clear. However, the design
and build procurement method (although the fastest growing method) only
accounts for about 10%-15% by value of all work in the UK (Franks,
1990b), furthermore there is no universal agreement that it is an appropriate
procurement route in all cases, and so the debate over how to introduce
buildability advice into early design continues. Gray (1985) suggests that
the only way to accomplish this is to involve a contractor at the early stages
or to employ a buildability consultant. However, there are actually very
few people within a contractors organisation who have the skills to analyse

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11: Common Briefing Structures and Problems in Briefing

design decisions and give advice of this kind. The same skill shortage
applies to buildability consultants, and as a result, states Gray, there are very
few good ones.

11.4.7 Provision of sufficient time for briefing

By the time most projects get as far as the briefing stage, the client group is
anxious to proceed as quickly as possible. As a result, there is usually not
enough time allocated to the briefing stage (Lera, 1984; Carrington, 1979).
The research action referred to in section 2.4.1 requires investment of time
and money, and when resources are limited, the client business case team
and the designers may be forced to act without proper consultation simply in
the interests of making some tangible progress (Duffy, 1987).

11.4.8 Incomplete briefs

In a case study analysis (Mackinder and Marvin, 1982) evidence was
produced to support the conclusion that incomplete briefing and lack of
information at an early stage of the design process tended to complicate
the design process and in some cases was the cause of abortive work. One
conclusion drawn from the study was that clients, especially those
inexperienced at commissioning buildings, required more assistance in the
delivery of proper briefing information and in being decisive.

11.5 Brief documents

As indicated above, smaller, less sophisticated clients often do not have a
formal approach to briefing. Under these circumstances, there is unlikely to
be any brief document per se, and any documentation produced will
originate from the architect recording information in meetings with the client
representatives (Goodacre et al, 1982; Mackinder and Marvin, 1982).

Newman et al (1981) found that in larger client organisations the brief

document tends to develop in two stages. The first stage (strategic brief) is
often the result of high level, informal discussions within the client body,
stemming from the identification of a need, where general agreement is
arrived at on the form of building project required. This document generally
comprises a functional description of the building, its scale etc, with a rough
adjacency diagram to illustrate the building concept.

In the second stage (project brief), the general statement above is developed
further, usually in a series of committee meetings of some kind and a more
detailed document produced in the form of room data sheets with a budget
cost for the project and a target completion date.

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 Value and Risk Management [D19CV9]

Questions
Question 1 Outline the differences in the processes used by large and
small clients in briefing.

Question 2 Tabulate the problems encountered in briefing.

Question 3 How many stages are there to a typical briefing process?

Draw a diagram representing these stages and enter the point
where the decision to build is made.

Question 4 What is solution-focused thinking and how can it be

avoided?

Question 5 Who should be involved in drafting the project brief?

References
AJ (1986a) Development economics series No 2: Sites Architects' Journal,
23 April 1986, pp 49 - 50

AJ (1986a) Development economics series No 5: The architect's role

Architects'Journal, 30 April, 1986, pp 55 - 56

AJ (1987a) Management by design Architects' Journal, 19 & 26 August

1987, pp 68 - 71

Allen, D. Towards the client's objective Quality, and Profit in Building

Design,
P S Brandon and J A Powell (Eds), Spon, 1984

Canter, D. Beyond building utilisation Designing for Building Utilisation,

J A Powell, I Cooper and S Lera (Eds), Spon, 1984

Carrington, D. Briefing Encounters Architects'Journal, 23 May 1979, pp

1058 - 1063

Cave, C. Not least the users Architects' Journal, 19 & 26 August 1987, pp
80 - 81

Duffy, F. (1986a) A case for more collaboration Estates Gazette, 18

October 1986, pp 276 - 278

Duffy, F. (1986b) Development economics series No 1: Form or

substance Architects' Journal, 23 April, 1986 pp 45 - 46

Duffy, F. (1 987) Change is importunate Architects' Journal, 19 & 26

August 1987, pp 34 - 37

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11: Common Briefing Structures and Problems in Briefing

Ellis, P. The impact of changing office production processes on office

quality for the user Quality and Profit in Building Design, P S Brandon
and J A Powell (Eds), Spon,1984

Evans, P. Developers must try harder to please tenants Estates Times

Supplement, September 1989, pp 45 - 48

Franks, J. (1990a) Building Procurement Systems Second Edition, CIOB,

1990

Franks, J. (1990b) Procurement in the 1990s Chartered Quantity

Surveyor, February 1990, pp 11 - 12

Goodacre, P., Pain, J., Murray, J. and Noble, M. Research in Building

Design
Occasional Paper No 7, University of Reading, 1982

Gray, C. Achieving American levels of productivity in the UK Estates

Gazette, 4 May 1985, pp 459 - 464

Kelly, J. and Male,S. A Study of Value Management and Quantity

Surveying Practice RICS Occasional Paper, Surveyors Publications, 1988

Kelly, J. and Male, S. Value Management: Enhancing value or cutting

costs? RICS Occasional Paper, Surveyors Publications, 1991

Lawson, B. How Designers Think Architectural Press, London, 1980

Lera, S. Architects design strategies: some justifications for current

practice Designing for Building Utilisation, J A Powell, I Cooper and S
Lera (Eds), Spon,1984

Mackinder, M. and Marvin, H. Design Decision Making in Architectural

Practice Research Paper No 19, Institute for Advanced Architectural
Studies, University of York, 1982

McIntosh, A. J. P. The influence of the property market on building design

Quality and Profit in Building Design, P S Brandon and J A Powell (Eds),
Spon,1984

Newman, R., Jenks, M., Dawson, S. and Bacon, V. Brief Formulation and
the Design of Buildings Oxford Polytechnic, 1981

Unit 11 - 10 Heriot-Watt University

 Value and Risk Management [D19CV9]

12: Strategic Development of

Public Private Partnership
Projects

12.1 Introduction
This unit is intended to provide the framework for the undernoted topics,
but reference to further reading and consideration of the questions is
required for a fuller understanding of the units subject matter. It should
be noted that, prior to 1997, Public Private Partnership (PPP) was
formerly known as Private Finance Initiative (PFI) under the Conservative
government administration and is often still referred to as PFI. This
includes official policy and good practice documentation produced by the
Treasury. Therefore the terms PFI and PPP may be thought of as
being synonymous. PPP projects provide a particularly good means of
introducing project risk issues at the strategic stage and, although PPP is
particular to the UK, its generic form of BOOT (Build Own Operate
Transfer) procurement exists throughout the world.

This unit relates to the following topic areas:

Essential principles of the Public Private Partnerships (PPP), formerly

known as PFI.
PPP project procurement during strategic development.
The principle of Output Service Specifications and payment
mechanisms.
The key risk areas associated with PPP projects.
Questions for the reader.

The learning outcomes for the unit are:

Understand PPP philosophy and how it differs from traditional capital

procurement.
Know the steps in the strategic development of a project through the
PPP process.
Appreciate and interpret a projects requirements in terms of its output
specification.
Know the risks associated with major projects over their whole life
cycle.
Understand approaches to payment mechanisms for service delivery.

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12: Strategic Development of Public Private Partnership Projects

12.2 Glossary
PFI Private Finance Initiative. The procurement policy introduced in
1992.

PPP Public Private Partnership. Labour governments preferred title.

Public Sector The government department client body procuring a PPP project.

Private Sector Commercial organisations in the private sector responsible for

providing services under PPP.

Consortium The body of financiers, contractors, facilities managers, operators

and any other private sector organisations formed for the purpose of
a PPP project.

Concession The long term contract between public & private sector for
providing services.

Concessionaire The private sector operator responsible for providing the services as
contracted.

Purchaser The public sector client who wishes to purchase specific services
from the operator.

Operator As Concessionaire.

Output Specification A statement of the services to be provided that define the PPP
project.

Reference Project A costed notional project used by the public sector as a benchmark
in assessing PPP bids.

Treasury Taskforce The Treasury body formed to co-ordinate and develop central PPP
policy.

Base Estimate Estimated cost of the project excluding any allowance for risk.

Investment Appraisal Financial model of a PPP projects cost and revenue stream over its
life to assess viability of project.

VFM Value For Money.

Service Charge Operators remuneration for delivering the agreed service.

Payment Mechanism Contractual basis linking payment with the service delivered.

Note: Technically the term Public Private Partnership (PPP) replaced PFI
in 1997. However, PFI has become so established that it remains the most
commonly used term to date. Indeed, emerging Treasury publications
refer to PFI rather than PPP. In practice the terms are interchangeable.

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 Value and Risk Management [D19CV9]

The relevance of PPP to this course is laid out below.

A key principle of PPP is that of risk transfer. The transfer of risk over the
lifetime of projects from the public sector client body to private sector
provider is one of the main motivations for the clients decision to procure
through the PPP. It has also proved to be one of the most controversial
feature of PPP to date. Risk transfer necessarily involves identifying key
risks at the earliest phases of the project, and allocating them to public or
private sector.

PPP projects are based on output specifications, rather than technical

solutions, which are developed through the briefing process. This is
closely aligned with the principles of VM, which is based on explicit
analysis and articulation of project functions before development of
solutions that meet them.

The PPP has had a major impact on the UK construction industry since its
launch in 1992 through the wide ranging changes it makes to a large
sector of the industry and the value of work it will affect. The scale of PPP
means that the construction professions, consultancy and contracting
organisations and government departments are all having to develop
awareness of and expertise in dealing with PPP procurement. In the future
most government funded projects are likely to be procured through the
PPP as the industry and the government gets to grips with the policy.
Major infrastructure projects and projects requiring substantial capital
investment typically associated with the public sector including transport,
schools, health, water and sewerage treatment works are already being
delivered through PPP. In addition, major client organisations in the
private sector who invest heavily in the construction industry are
becoming interested in PPP style procurement for their own property and
facilities needs.

12.3 Key principles of the PPP

The PPP is a policy for procurement of services which the government,
through its sponsoring departments, are responsible for providing to the
nation. The aim of PPP is to increase the flow of capital projects and
government services in the face of restraint in public sector capital
expenditure. It involves the private sector in the provision of these
services in a way far more reaching than mere privatisation. Typically,
the PPP makes the private sector responsible for providing the services
and infrastructure e.g. health, transport, sewerage treatment works schools
etc. that would normally be regarded as public. Whilst PPP is about
involving the private sector in provision of services, this invariably
requires substantial investment in the construction industry in designing,
constructing and operating the buildings and facilities involved in
providing the services.

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12: Strategic Development of Public Private Partnership Projects

It is important to stress that the PPP is not a form of contract or

procurement for the construction industry, it is a policy initiative and there
is no fixed or rigid definition of a project. Although the government
intends it to be deal driven rather than rule driven it is likely that
standard contractual conditions and clauses will emerge and become
common as experience in the PPP grows. Indeed much of the teething
problems and criticism of the PPP is that the lack of guidance and
contractual blueprints leaves all the parties to a PPP project unsure of their
positions and unwilling to enter into contracts in the face of so much
uncertainty. This has resulted in protracted negotiation periods and huge
tendering costs for private sector bidders. The uncertainty surrounding
PPP increases the risk associated with projects and the allocation of this
risk has been a major stumbling block in the progression of PPP deals.

12.4 Parties to a PPP project

Essentially there are only two parties to a PPP project:

1. The public sector client.

2. The private sector provider.

12.4.1 The public sector client

This is the purchaser of services in the form of the government
department responsible for providing the services e.g. Highways Agency,
NHS Trust, Scottish Office, East of Scotland Water. The public sector
identifies the need for the services and develops the project for providing
them in the form of output specifications.

12.4.2 The private sector provider

This is the operator, a consortium of companies who will bid to provide
the services over a long period (typically 25 years) in return for annual
remuneration. The operator must raise the finance, develop and design
solutions for providing the service, and then operate the contract over its
lifetime.

12.5 The output service specification

PPP procurement involves the public sector identifying services for which
the government is responsible, and purchasing them from the private
sector who contracts to provide them. The public sector largely transfers
responsibility for providing services, and with this, whatever built assets
and facilities are required as a vehicle for their provision. This changes the
whole nature of project specification from inputs, basically prescriptive
specification typical of traditional procurement, to outputs, which are akin
to performance specification. The rationale for this is to give the private
sector maximum flexibility to innovate in meeting the service
specification by whatever means they choose.

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 Value and Risk Management [D19CV9]

The relevance of value management is clear here, in that functional

analysis seeks to identify functions the project has to fulfil without
reference to technical solutions. Arguably the most important phase of
VM is to clearly and unambiguously define the project in functional
terms, before attempting to develop and assess the most efficient
alternative solutions that meet these functions. Similarly, the public sector
prepare an output service specification in the briefing of a project without
presupposing the built solution that might meet the needs. This is left up
to the private sector during negotiations. i.e. what is required rather than
how it is to be provided.

Technical solution Output

School gymnasium Regular access to sports facilities
Heating plant Reliable supply of heat/ occupant comfort
Aircraft simulator Pilot training service
Office building Serviced accommodation
Computer system information service

12.6 Strategic project procurement and risk pricing

One of the most important and detailed guidance notes issued by the
Treasury is the step by step guide to the PFI procurement process
(Revised April 1999) which is essentially a project delivery framework.
As the title suggests, this guidance describes the stages, and required
activities, for developing a project from earliest establishment of need
through to contract award stage. Although, PPP procurement specific, the
process described has much in common with any project delivery
guidance, with the familiar identification of need, development of the
brief and technical design stage. Contrasting this document with the VFM
guide will confirm this. Indeed Stage 3-Options to Meet User Needs of the
VFM guidance, dealing with strategic options, requires the consideration
of PPP as a form of procurement.

Identification, allocation and costing of project risk is carried out with the
development of a Reference Project by the client which will be used to
guide their negotiations with the private sector in ascertaining VFM. Stage
3 deals with this and risk management activity is defined below.

12.7 Business case and reference project

The business case for the project is the first step in determining whether a
PFI solution is the best way forward and provides the best value means of
investing for providing the service. The steps prior to this involve
establishing that the perceived service requirements actually do contribute
to the objectives of the client, and that substantial investment is required
to achieve this (rather than a reorganisation of the existing business). A
necessary part of preparing the business case involves the development of

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12: Strategic Development of Public Private Partnership Projects

a reference project, basically a costed notional project which serves as a

benchmark for comparison with bidders solutions in subsequent
negotiations. The costed reference project is used to determine whether
the service is affordable on a year on year basis. Although the reference
project is in essence a possible technical solution to the service
requirements the Treasury stress that it should not be used as an input
specification for the project, only as a comparitor for assessing bidders
solutions

Costing of the reference project has to be in whole life terms and includes
capital investment, operation, maintenance and FM costs of the project
over its life i.e. all the costs that a bidders PPP solution would include.
These would constitute the base estimate. Significantly, the reference
project also has to include costing of the risks so that a true comparison
can be made with private sector bids which will include a pricing of the
risks that they absorb. This is comparable to the VFM guide which
requires explicit pricing of risks from the outset, and no sanctioning of
funds for general contingencies. All risks transferred under the PPP
option, but which would not be transferred under traditional procurement
have to be costed.

Further on in the process, when a shortlist of bidders is being drawn up,

the selection of preferred bidders involves ascertaining the willingness and
appetite for taking on the risks the client has allocated to the private
sector. Furthermore the guidance stresses the need for the client to seek
evidence that the risk allocation agreed upon within bidders offers is
acceptable to their funders, underlining the importance of financiers to the
whole process.

In-text question

What is meant by the Reference Project?

12.8 Key risk areas in the project life cycle

12.8.1 Risk transfer

A fundamental objective of the PPP for the Treasury is to transfer risks in
service delivery to the private sector, particularly those connected with
constructing, owning and maintaining any built assets associated with the
service. At the outset, when the public sector sponsor is determining
whether a project should be procured through the PPP route as opposed to
the traditional the project should be tested as to whether transfer of most
or all of the risks associated with it will be borne by the private sector.
Risk transfer test clearly involves the explicit assessment of project risk
and establishment of where it should be allocated- either public sector
client or private sector procurer. This will involve, at the early stages of

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 Value and Risk Management [D19CV9]

the PPP procurement process, drawing up a matrix of project risks and

stakeholders which will form a basis for negotiation on where final
allocation will lie. The second main test to determine PPP suitability of
projects is the Value for Money test, although the two are inextricably
linked- the VFM case is strengthened if risk is substantially transferred,
and undermined if it is not (see Unit 8).

There are a number of key risk areas to be considered from the earliest
stages:

12.8.2 Bidding risk

Bidding involves the consortia proposing solutions for meeting the public
sectors service requirements, for a specified period of time (typically 20 or
25 years) in return for an annual remuneration (the service charge). PPP is
an attractive investment opportunity for investors as it involves tapping
into a long term revenue- and profit- stream provided the risks have been
adequately assessed and provided for in the bid. Profit is generated from
what is left over after subtracting debt servicing and operating costs from
service charge remuneration.

The pure performance nature of the output specification puts all the
responsibility on bidders for developing solutions for meeting those
service specifications. This is part of the philosophy of PPP, that the
private sector should have the flexibility to innovate in designs and
proposals for the project, and not be constrained by prescriptive
specification. The thinking behind this is that the private sector driven by
commercial considerations can provide the service more efficiently than
the public sector, thus providing greater value for money than the
traditional approach. Risk inherent in bidding has been a major
contentious issue in the evolution of PPP as many industry reports and
journals will testify. Risk lies in investing time, money and effort
researching solutions and preparing bids and negotiating with the client
with no guarantee of success. The process is lengthier and investment is
greater than for traditional tendering, which essentially involves pricing a
ready defined solution by the client. As the private sector have a long term
interest (the duration of the concession) and responsibility for the project,
there is far greater uncertainty and therefore risk associated in trying to
account for future variables that must be assessed as part of the investment
appraisal. In general terms variables include design and construction risks,
cost of finance and operational and management costs.

12.8.3 Design, construction and operating risks

These are the responsibility of the private sector. The concessionaire does
not earn any return on their investment until the facility has been
commissioned and is delivering the service. Design and construction is
solely the responsibility of the concessionaire who will have to absorb any
cost overruns in meeting the agreed service. As many of the solutions are
expected to depart from design norms of traditional facilities, in order to

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12: Strategic Development of Public Private Partnership Projects

achieve VFM and operating efficiency, there is greater uncertainty and

risk associated with the built facilities.

There are cases where responsibility for, and therefore operation risk
associated with, certain core services will be retained by the public sector
for policy reasons. In prisons, prison officers will always be employed by
HM Prison Services, the public sector department. Likewise, core clinical
services in hospitals will be the responsibility of doctors and nurses
employed by NHS health trusts, not the private sector operator of the
hospital. As a PPP principle, though, as little operating risk as possible
should be retained by the public sector

12.8.4 Volume risk

This relates to the long term availability and demand for the service which
the operator is providing. Volume risk is an area which has caused a
number of difficulties in negotiations relating to who absorbs the risk,
namely, what happens if actual demand in the future turns out to be less
than that forecast, with resulting overcapacity and unrecovered
expenditure. The question is, who pays? Although there are no hard or fast
rules governing volume risk for all projects, some principles are emerging
as a result of precedents set in deals which have been structured.

The volume risk held by the private sector relates to availability of the
service i.e. ensuring that a minimum capacity of service can be delivered
throughout the concession. For example, this could be ensuring a certain
number of hospital beds, or prison cells are available at all times, or that a
sewerage treatment works guarantee that a certain volume of sewerage
can be processed at all times.

The availability of a service is distinct though from that of actual usage.

The public sector retain the risk of demand falling below a certain level
yet still having to pay the concessionaire for having the service available.
Clearly, this leaves considerable risk with the public sector and is not
really true to the principles of risk transfer. However, experience to date
has shown that the private sector have robustly refused to absorb demand
risk since the PPP does not provide an attractive investment opportunity
under this condition. The risk is simply too great to bear as there are so
many uncertain variables which could affect projections. For example,
with school buildings, a distinct PPP sector, demographics, educational
performance and local population movements could all affect future
demand for places. These are factors over which the private sector has no
control.

In-text question

Who is the concessionaire in a PPP project?

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 Value and Risk Management [D19CV9]

12.8.5 Quality risk

In addition to quantity, quality of the service to be provided has to be
considered. The risk here is that the quality of service will fall below the
standards set out in the brief and payment penalties will be incurred. The
operator has to ensure the quality and consistency of core and non-core
services provided are maintained throughout the length of the concession.

12.8.6 Residual value risk

At the end of the concession period there is the question of what happens
to the built facility used to deliver the service. It is likely that the service
being provided will still be required and the project will be put out to
tender and a new deal negotiated, either with the existing operator or a
new bidding consortium. The residual value (positive or negative) of the
asset will have to be included in subsequent concessions.

1. If the asset has significant residual value at the end of the concession,
future bidders will want to take ownership of it and its value will be
reflected in a lower bid to for the next concession.

2. If the asset has no residual value, the successful bidder for a

succeeding concession may dispose of the asset and provide the
service by another means.

3. If the asset has substantial liabilities then clearly no future bidder

would be interested in taking them on, the current service provider
would have to meet these.

12.8.7 Finance risk

The successful PPP consortium has to raise the finance required for the
substantial capital investment in asset procurement. The Funding will
come from a combination of debt and equity raised by the bidders. Most
of the funding will be debt finance, secured against future revenue
generated by the project or secured against bidding consortium members
assets. Only around 5-15% of the project finance will typically come from
equity although there have been cases where has been zero equity from
the bidding company. Lending institutions are traditional risk averse
organisations and finance has been difficult to attract for a number of the
riskiest PPP projects (It has been said that there are more projects than
there are consortia). The risk here is that future revenue stream will not be
enough to service dept repayment. It is

12.8.8 Regulatory risk

Regulatory, or legislation, risk should lie with the party best able to
manage it. Logically, this would suggest the public sector retain all
regulatory risk. However, an argument against this is that commercial
markets are subject to regulatory risk and function without assurances

Heriot-Watt University Unit 12 - 9

12: Strategic Development of Public Private Partnership Projects

from the government about the effects of regulatory change- so why

should PPP be different?

There are some exceptions to this:

Certain specific legislative changes which could affect the procured

service by changing the service requirements of the public sector. The
private sector has been unwilling to accept these risks in PPP deals.

The need for specific legislation or planning permission for the asset
which would be a prerequisite to enable the PPP contract to take
effect. For example, if outline planning permission is required for
buildings or facilities then it is unlikely the private sector will take on
the risk for securing this. In the experience of PPP procurement of
prisons, the public sector obtains outline planning permission, leaving
the private sector to obtain detailed planning permission for their
design solutions.

12.8.9 Obsolescence risk

Developing technology means there is a risk that newer and more efficient
solutions will become available in the future, yet the public sector is
signing a contract which commits them for decades based on the
technology of todays solutions. If it is likely that obsolescence will make
a project redundant at some stage during its life, then it is in the public
sectors interests to be able to terminate the contract if it feels more able to
secure better value service elsewhere, although this would obviously
involve a payment to the operator for termination. Another option is to
include incentivisation clauses in service contracts to improve efficiency,
i.e. upgrade in the light of new technology or better solutions emerging.
This could involve sharing in any benefits of improved efficiency.
Obsolescence risk will obviously apply to some projects more than others
e.g. compare hospitals with roads and consider which is prone to greatest
risk in this area.

12.9 The payment mechanism

The terms of the payment mechanisms agreed that dictate the service
charge are fixed from the outset. Therefore if the operating costs turn out
to be greater than expected in the future, the responsibility lies with the
concessionaire who must absorb these costs. The bidders investment
appraisal will involve forecasting what they expect the cost of the service
being supplied to be, and using this as a basis for its service charge. When
dealing with such long planning horizons there are obvious difficulties
involved in forecasting cost of service delivery many years in advance.
The operator bears the risk of future income not meeting the costs of
providing the service due to inadequate planning, or unforeseen
circumstances impacting on the financial forecasts. Although payment of
the service will generally be index linked to general price rises (RPI),

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 Value and Risk Management [D19CV9]

there are still risks posed by the long term movement of prices. For
example, sector specific wage rises or an underestimation of the effects of
general inflation would not be correspondingly compensated for in the
payment mechanism.

Reading
PPP is a fast evolving area with new policy and procurement procedures
emerging regularly as the industry tries to improve its performance, and
address the many problems (not least risk transfer) that exist. As such,
there is no definitive text book on the matter. Instead journals and web
based sources are the best means of keeping up to date. The following are
good examples.

HM Treasury web site (www.hm-treasury.gov.uk)

As the centralised public sector client (or more accurately, sponsor), the
Treasury publishes briefing notes and policy information on its web site.
These are aimed at improving the procurement and project management
processes to deliver VFM.

Papers published in construction journals

Peer reviewed journal papers are regularly published which provide
critical analysis and research into many aspects of PPP. Recent relevant
papers have also included an overview of PPP and key stages in its
development. See;

Bing Li, A. Akintoye, P. J and Edwards, et al. (2005) Critical success

factors for PPP/PFI projects in the UK construction industry.
Construction Management & Economics, Volume 23, Number 5/June
2005

Ahadzi, M and Bowles, G (2004) Public-private partnerships and

contract negotiations: an empirical study. Construction Management
& Economics, Volume 22, Number 9/November 2004

Akintoye, A, Hardcastle, C, Beck, M et al. (2003) Achieving best

value in private finance initiative project procurement Construction
Management & Economics Volume 21, Number 5/July-August 2003

Note: These (and other) papers are available for download as PDF files
through the University library web site. See the electronic journals
section for details.

Heriot-Watt University Unit 12 - 11

12: Strategic Development of Public Private Partnership Projects

Questions
1. Consider the range of PPP type projects being procured. In view of
the risks discussed, what would you consider to be the least and most
risky type of projects on a whole life basis and why?

2. What quantitative and qualitative aspects could be included in the

payment mechanisms for schools, roads, hospitals etc?

3. In your view, has the PPP been a success to date and will it succeed in
the future?

4. With reference to articles in recent industry journals, what are the

private sectors main concerns with PPP based on their experience to
date?

5. Examine the Step by Step Guide to PFI Procurement Process. How

does the clients approach to risk assessment differ from that of
traditional procurement?

6. What variables have to be considered in the Reference Project and

how is the RP priced to allow objective comparison with alternative
solutions?

Unit 12 - 12 Heriot-Watt University

 Value and Risk Management [D19CV9]

Case Study: Prisons

The procurement of prisons under the PPP is a sector where experience
has been gained and at least two major projects completed and within their
first few years of operation. The (now defunct) Private Finance Panel
published a report on two prisons procured through PPP, and summaries
of further case studies are emerging on the Treasury Taskforce website.

Some of the more important points and principles of PPP are discussed
below in relating to procurement of two prisons at Bridgend and
Fazakerley.

Prison A
800 category B places at Fazakerley on Merseyside. Securicor, Siefert and
W S Atkins consortium with construction partners Costain and Skanska.

Prison B
600 Category B places at Bridgend, awarded to Tarmac and Group 4
consortium.

The PPP tests

Risk transfer
The public sector were satisfied that design, planning, construction and
operation risks were substantially transferred through the terms of the
contract, payment mechanisms agreed and the output specification
developed for the project. Some risks were retained as outlined below.

Value for money

The projects were compared to reference projects of a traditionally
procured prison with both public and private sector operator. The greater
transfer of risk through PPP was assessed as supporting the VFM
principle. In comparing their costs, the NPV of PPP procurement was
assessed as providing savings in excess of 10% compared to that of
tradition risk-adjusted public sector procurement.

Features of deals
The concession periods are for 25 years, after which ownership of the
prisons is passed to the public sector. This is NOT the usual structure of
PPP deals, where there is no reversion of ownership to the public sector. It
was an unusual feature of these deals due to substantial difficulties in
obtaining outline planning permission for new prisons. The public sector
client (HM Prison Service) do not recommend this for future deals if
possible, as an asset designed today may not be suitable for service
provision in 25 years and may simply become a liability. The normal
route is for the service contract to be re-bid, with the facility offered to the

Heriot-Watt University Unit 12 - 13

12: Strategic Development of Public Private Partnership Projects

successor service provider if it is of any value (which bidders will have to

take into account at the time).

The payment mechanism is based on availability of prisoner places. The

operator is paid an index linked daily rate for places available. A place is
not simply a cell or prison bed, rather it is a number of functions that
constitute a place such as the provision of healthcare services, food and
adequate staffing levels. The operator must ensure a minimum number of
places are always available. Although this does not transfer demand risk
to the private sector, pressure on prison places and expected growth of
inmates means there is no real risk of falling demand and overcapacity.
The public sector may therefore be fairly relaxed about not transferring
this. However, demand risk was an early goal of the public sector to pass,
but this proved wholly unacceptable to the private sector due to the way
prisoners are allocated and the way policy is made dictating their
numbers. Clearly the operator has no control over this.

Quality of service risk is also absorbed by the operator who must

undertake effective prison management. In practice, this means there are a
number of measurable performance indicators covering this, including
number of escapes and provision of out of cell activities.

Contract termination
Should the operator become insolvent or be in serious breach of
obligations the Prison Service can terminate the contract. Alternatively,
the consortiums lenders can provide an alternative operator if there is
outstanding debt.

Other risks transferred to private sector:

Responsibility for obtaining detailed planning consents.

Construction cost and time overruns. No payment was made until the
projects were actually operating.

Maintenance and upkeep of the facility, monitored through regular

dilapidation surveys.

Changes in general legislation, but not legislation specific to custodial

services.

Unit 12 - 14 Heriot-Watt University

 Value and Risk Management [D19CV9]

APPENDIX 1 Glossary of Risk Management Terms

Risk Possibility that an actual outcome will deviate from

that forecast.

Risk Event Actual occurrence of a risk with positive or negative

consequences for a project.

Hazard Risk of physical damage, injury or death.

Upside Possibility that actual outcome of risk is positive.

Downside Possibility that actual outcome of risk is negative.

Exposure Extent of possible loss associated with a risk, usually

measured in financial terms.

Risk Attitude Willingness of an individual, team or organisation to

take a risk.

Uncontrollable Risk whose possibility cannot be influenced by the

Risk actions of associated parties.

Controllable Risk whose possibility can be influenced by the

Risk actions of associated parties.

Pure Risk Hazards that result in loss only. Usually covered by

appropriate insurance in the contract.

Speculative Risk Risks which may result in loss or gain and will be
apportioned amongst parties to a project.
Strategic phase Initial stages of a project concerned with defining its
scope and developing the brief.

Tactical phase Latter stages of a project concerned with its design

and delivery.
Source Origin of the risk in the project environment.

Event The actual occurrence, or manifestation, of the risk

on the project.

Effect The consequence of the risk occurring for a party or

parties to the project.

Hierarchy Means of classifying sources of risk according to

where in the project environment they originate from.
Qualitative Non-numerical assessment of risk based on
analysis judgement and experience of individuals.

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12: Strategic Development of Public Private Partnership Projects

Quantitative Numerical measurement of risk exposure using RA

analysis techniques and processing of hard data.

Risk grid Graphical technique for qualitative analysis of risk.

Risk register Document recording the risk status of a project at a

particular point in time. Requires frequent updating.

Unit 12 - 16 Heriot-Watt University