Protocol to Enhance Profitability by Managing

Risks in Construction Projects

Yoojung Yoon, A.M.ASCE 1; Ziad Tamer 2; and Makarand Hastak, M.ASCE 3

Abstract: To enhance the profitability of a construction company, risks that affect the profit of the company must be controlled as part of
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their long-term business planning. Project risk management is a systematic process used for managing risks. However, it is challenging to
properly analyze the probability and impact of risks because of the inherent uncertainties associated with construction projects. Therefore, a
practical risk management protocol is proposed for construction companies to handle the risks through the analysis of completed construction
projects. The protocol consists of two phases: Phase-1, risk identification and analysis at the project level, and Phase-2, development of risk-
handling strategies to control risks at the company level. The major contribution of the proposed protocol is that any construction company
can practically utilize the protocol to establish risk management strategies by evaluating the effectiveness of the relationships among cost
centers, profit centers, and externals at the company level. As a result, construction companies will be able to: promote efficient organizational
management; make profitable business partnerships with external entities; and provide straightforward risk management guidelines for future
projects. DOI: 10.1061/(ASCE)ME.1943-5479.0000339. © 2014 American Society of Civil Engineers.
Author keywords: Project risk management; Profitability; Construction companies; Construction projects.

Introduction Project risk management is a systematic process that includes:

(1) planning of risk management, (2) identifying potential risks
In the construction business, construction projects are the major that may affect the project performance, (3) performing qualitative
source for making a profit. Each construction project acts like an and quantitative risk analysis, (4) developing risk response strate-
individual business generating a profit. Therefore, a project should gies, and (5) monitoring and controlling risks.
be profitable enough for construction companies to consequently However, it is not easy for risk managers to determine the prob-
be profitable (Pilcher 1994). However, in a competitive bidding ability of risk events for the systematic risk management process.
environment, determining the appropriate mark-up level (i.e., the Furthermore, if the input data for the qualitative and quantitative
percentage difference between the actual cost and the selling price) risk analyses are ambiguous, it leads to improper risk response
is a challenging job because of a tradeoff between maximizing strategies thereby rendering the risk control measures useless
profits and competitive bidding. That is, the mark-up level should (Frame 2003). Construction companies do not recognize systematic
be high enough to cover all overheads required for performing the risk management as valuable for their construction projects because
project as well as to maximize profits for the construction company. of several barriers such as the limited knowledge and practice of
At the same time, the mark-up level should be low enough to raise risk management, lack of qualified professionals, lack of time and
the possibility of winning the bid (Douglas 1987; Drew et al. 2001). resources, cost-effectiveness, and so on (Colquitt et al. 1999; Lyons
Although a company might be successful in bidding for a et al. 2004; Liu et al. 2007). Another problem in managing project
project, the actual profit is often lower than the profit estimated by risks is that there is no common view of risk existing between
the mark-up level (Han et al. 2007). The main reason is that con- project participants (e.g., owner, contractor, designer, investor, and
struction projects are characterized by various risks. A process to so on) as they have different project goals that develop adverse
efficiently control those risks plays an important role for the proj- relationships (Walewski and Gibson 2003). Therefore, project risk
ects to be successful in maintaining gross profit at an acceptable management is an underutilized area of project management.
level for a company. Project risk management brings various ben- This paper proposes a risk management protocol for construc-
efits to the construction companies by maximizing positive risks tion companies to practically handle the risks of new projects
and minimizing adverse risks (Project Management Institute 2008). through the analysis of the risk factors at completed construction
projects. As construction projects are generally exposed to rivalry
1
Assistant Professor, Dept. of Civil and Environmental Engineering, relationships between different project participants (Peña-Mora and
West Virginia Univ., 395 Evansdale Dr., Morgantown, WV 26506 Tamaki 2001), the protocol establishes risk management strategies
(corresponding author). E-mail: [email protected] by evaluating the effectiveness of the relationships among those
2
Former Master’s Student, Construction Engineering and Management, participants at the company level. The relationships provide the
School of Civil Engineering, Purdue Univ., 550 Stadium Mall Dr., West basis of identifying the risk events that increase the project cost
Lafayette, IN 47907. E-mail: [email protected] and risk responsible owners. The risk responsible owner in this
3
Professor and Head, Division of Construction Engineering and paper is defined as the entity that has responsibility for causing
Management, Purdue Univ., 550 Stadium Mall Dr., West Lafayette, IN
profit losses in construction projects by the adverse relationship.
47907. E-mail: [email protected]
Note. This manuscript was submitted on October 11, 2013; approved on
In addition, the proposed protocol utilizes the project breakdown
July 15, 2014; published online on August 18, 2014. Discussion period structures as part of the risk management framework as project
open until January 18, 2015; separate discussions must be submitted for breakdown structures such as work breakdown structure (WBS),
individual papers. This paper is part of the Journal of Management in organizational breakdown structure (OBS), and cost breakdown
Engineering, © ASCE, ISSN 0742-597X/04014090(10)/$25.00. structure (CBS) are commonly used in managing construction

© ASCE 04014090-1 J. Manage. Eng.

J. Manage. Eng.
 projects (Hillson 2007). Finally, a comparative case study is pre- structure that do not generate independent profit) and profit centers
sented to validate the process of the proposed protocol. (i.e., construction projects), (2) among cost centers, and (3) among
cost centers, profit centers, and externals (i.e., owners, subcontrac-
tors, suppliers, and so on). The protocol also identifies the changes
Risk Management Combined with the Project in the costs of the work activities (i.e., WBS) from a completed
Breakdown Structures construction project. The cost changes are further analyzed based
on the relationships in order to recognize the causes that finally led
For construction companies as contractors, reducing business to the profit gain or loss. As a result, the protocol allows the
losses caused by risk events is the primary concern to maximize administration of a construction company to take correct actions
their business profitability on construction projects (Akintoye and on the causes so as to enhance the profitability of future construc-
MacLeod 1997). The risk events have a number of attributes such tion projects. Nevertheless, the protocol still has limitations to con-
as impact on project performance (e.g., cost, schedule, quality, and trol the risks for profit gains and losses in construction projects.
safety), probability of occurrence, expenses for controlling risk First, the protocol focuses on the individual construction project
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events, risk responsible owners, and so forth. Therefore, decompos- (project level) analysis to develop the solutions for profitability in-
ing the risk events into the project breakdown structures (e.g., WBS, crease. However, it is known that construction companies would
OBS, and CBS) can benefit construction companies to manage and benefit more from establishing the profitability enhancement strat-
control the risk events (Hillson 2007). In general, the WBS helps a egy through the analysis of the multiple construction projects (net-
contractor organize and define the total work scope of the project work level) completed within a certain period (Federal Highway
(Milosevic 2003). The OBS shows the hierarchical management Administration 2012). Second, the protocol lacks a systematic risk
structure of organizational units and the corresponding functional management process, which requires a series of steps such as risk
responsibilities of work activities (Kerzner 2009). The CBS is the identification and categorization, risk analysis, and risk response
hierarchical structure of cost accounts, which are in line with the strategies.
WBS for a project (Harrison and Lock 2004).
Hillson (2002) first introduced risk breakdown structure (RBS)
that is a hierarchical structure of potential risk sources. Its main use Development of an Enhanced Protocol to Manage
and benefits are (1) risk identification and classification by risk Risks
sources, (2) risk assessment by indicating the most significant risk
sources to the project, (3) risk comparison across projects by pro- This paper proposes an enhanced protocol for construction compa-
viding a common RBS framework, and (4) risk reporting at differ- nies to manage the risks through the analysis or risks at the network
ent levels, for example, a higher level for senior management as level of completed construction projects and a systematic risk man-
agement process. Therefore, the protocol consists of two phases:
well as a detailed level for project team actions. Combining the
(Phase-1) risk identification and analysis at the project level and
RBS and the WBS can help identify which work activities are af-
(Phase-2) development of risk-handling strategies to control risks
fected by which risk events. Wirba et al. (1996) quantified the effect
through the network level analysis for the company. Phase-1 iden-
of the risks on a particular work package. Iranmanesh et al. (2007)
tifies risk events by investigating the work activities that have
and Mojtahedi et al. (2010) used a combination of the WBS and
shown changes in their item costs in completed construction proj-
the RBS to control risks that affect the work activities of a construc-
ects within a specific fiscal year, and then assesses the profit impact
tion project. Grouping the RBS based on the OBS shows which
of the risk events at the project level. This phase also identifies the
units in the organization have responsibilities to handle the risk
risk causes and the risk responsible owners from the risk events
events, whereas linking the RBS and the CBS shows the cost
identified. Based on the result from Phase-1, Phase-2 computes
impacts caused by the risks (Hillson 2007). Wang et al. (2010) used
the annual-based weighted averages of the profit impacts (WAPIs)
CBS-RBS matrix to estimate the risk impact on cost items in the
of the risk events at the company level. Those WAPIs of the risk
bidding phase.
events come to add up for the annual WAPIs of the risk causes and
Although those two-dimensional analyses (i.e., RBS + WBS,
the risk responsible owners. Finally, the solutions are suggested
OBS, or CBS) are useful for identifying the work activities subject
based on the annual WAPIs of the risk causes and the risk respon-
to potential risk events, the risk responsible owners in an organi-
sible owners to enhance profitability for the company. The details
zational structure, and cost impacts that result from risk events, the
are described in the following subsections.
isolated mapping of risks to either WBS, OBS, or CBS, are still not
enough for integrated risk management (Hillson 2007). Higher-
level risk management forming three- or four-dimensions with Phase-1: Risk Identification and Analysis at the Project
WBS, OBS, and CBS is more beneficial for obtaining integrated Level
risk information, so that a construction company can establish
better risk management strategies. Ding et al. (2012) developed Identification of the Risks
an integrated construction management system by linking three- The first step is to identify the work activities, which show changes
dimensional models with WBS, CBS, and RBS so that they can in their item costs, at the project level. The cost changes can be
use the system to efficiently control rail transit construction in detected by comparing the original contract cost and the changed
terms of time, cost, safety, and quality. However, it is still missing cost of each work activity in the WBS at the completion of a proj-
OBS for higher-level risk management. Tamer (2009) developed a ect. All construction projects completed within a specific fiscal year
protocol for profitability analysis for the construction companies are considered for this step, and consequently all work activities
considering the cost changes in work activities on the basis of showing cost changes are listed. The risk events responsible for
the relationships between organizational unit and external entities the cost changes, then, are investigated. The risk events investigated
(e.g., owners, material/equipment vendors, subcontractors, and are grouped based on the risk causes and the risk sources as shown
financial institutions) involved in a construction project. in Table 1, which is developed and refined through an extensive
The protocol proposed by Tamer (2009) describes all the rela- literature review. Each risk cause is not exhaustive but comprehen-
tionships: (1) between cost centers (i.e., units in an organizational sive to represent the similar risk causes in a group. The list of the

© ASCE 04014090-2 J. Manage. Eng.

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 Table 1. Risk Sources and Causes
Risk category Risk source Risk cause
Internal risk External Owner • Requirement change and variation due to unclear requirements
relationship • Financial incapability (for payment, and so on)
• Management incapability (for decision making, site acquisition, and so on)
Design consultant • Incomplete design scope
• Errors and omissions in design
• Inadequate standards and specifications
• Conflicting site conditions
Subcontractor • Shortage of skilled workers and construction techniques
• Delay of project schedule
• Lack of logistic control
• Usage of inadequate quality of materials
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• Financial default
Material/equipment supplier • Delays in material and rental equipment supply
Internal process • Incompleteness of design review/ Cost underestimation
• Shortage of resources (e.g., labor, material, equipment, and so on)
• Lack of skilled labor and techniques
• Poor site/project management skills
• Poor equipment management
• Delay in material procurement
• Delay in appointing subcontractor
• Inappropriate project organizational structure
• Lack of interdisciplinary communication
Project characteristic • Different site conditions
• Bad accessibility to the site
• Poor geotechnical condition
• Poor availability of basic infrastructure
• Demands of new materials and new construction methods
• Technology complexity
• Inadequate project duration/ labor dispute and strike
External risk Political • Changes in laws, regulations, and policies
• Delay in planning permission approval
• Inefficient administration system
• War and civil disorder
• Restriction on profit transfer
• Political interference
Economic and financial • Exchange rate fluctuation
• Inflation rate fluctuation
• High market competition
• Tax rate increase
• Interest rate fluctuation
Social • Opposition of neighboring community
• Language barrier
• Different social, culture, and religion
• Insecurity and crime
• Pestilence
• Bribes and corruption
Environmental • Weather conditions (wind, temperature, rain, and so forth)
• Natural disaster (flood, earthquake, landslide, fire, and so on)

risk causes should evolve to create a more deliverable checklist

when new causes become known or the existing risks require
changes.
The risk sources for the risk causes are refined in the consid-
eration of the relationships between two entities, where one is
called the risk responsible owner and the other the counter-partner.
In this paper, risk responsible owner (henceforth risk owner) is
defined as the entity with responsibility for the occurrence of the
risk events, whereas counter-partner is the entity affected by the
risk events because of their relationship with the risk owner.
The entities in the relationships come from any of the cost centers,
profit centers, or externals as shown in Fig. 1. The externals are
Fig. 1. Relationships among cost centers, profit centers, and externals
entities from outside the project circumstances that affect both cost
for a construction project
and profit centers. The owners in the category of the externals

© ASCE 04014090-3 J. Manage. Eng.

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 could be owners, design consultants, subcontractors, financial based on the risk causes and the risk owners from the OBS and the
institutions, suppliers as well as countries, communities, public externals, (3) suggestion of risk-handling method(s) for the risk
agencies, private developers, and individuals according to the causes, and (4) the risk owners considering their annual WAPIs
project characteristics. The cost centers consist of the organiza- and the business constraints of a construction company.
tional departments within a construction company that provide es-
sential services for the profit centers. The profit centers are those Annual WAPIs
entities that create billable work such as projects, the equipment The profit impacts of the risk events from Phase-1 are averaged
yard, the real estate division, and others. based on the risk causes and the risk owners, generating annual
In addition to the described relationships in Fig. 1, there are average of the profit impacts for both. However, as the projects
two more possible relationships that might affect the project profit. completed within a specific annual period have a different amount
One is the relationship between two entities in the cost centers. of bid profits, the calculation of the annual average profit impacts
In the organizational structure of a construction company, the de- should consider the relevance of each bid profit out of a total annual
partments as the cost centers have their own tasks and create the bid profit. Eq. (3) represents the calculation of the weighted value
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relationships with other departments. For example, the main role of for the project j where wj and BPj are the weighted value and the
the human resources is to supply skilled and qualified labor to all bid profit of the project, respectively.
other departments in the organization. The constructability review
BPj
of designs and specifications by the design and construction depart- wj ¼ ðj ¼ 1; 2; 3; : : : ; mÞ ð3Þ
ments is the essential task for the site teams to productively manage BP1 þ BP2 þ · · · þBPm
the projects. Another example is the relationship between two en-
tities in the profit centers. That is, if a construction company oper- Therefore, the profit impact for any risk event i from the proj-
ates multiple profit centers, one profit center can have relationships ect j should be adjusted using the weighted value of the project.
with other profit centers by sharing some resources such as labor, The annual WAPI for any risk event i can be expressed mathemati-
equipment, and materials. cally as
X
Profit Impacts of the Risk Events at the Project Level WAPIi ¼ ½wj × ðPIi Þj
ð4Þ
In risk management, the qualitative risk analysis is the process to j
prioritize the risks by assessing their probability of occurrence and
impact on the project performance in terms of cost, time, scope, Once the annual WAPIs of risk events are estimated, the annual
and quality (Project Management Institute 2008). The qualitative WAPIs of the risk causes and the risk owners can be obtained by
risk analysis enables construction companies to focus on the risks adding all the WAPIs of the risk events in terms of the risk causes
in the high priorities, thereby efficiently allocating their limited and the risk owners. In particular, the annual WAPIs of risk owners
resources to improve the project performance. For the prioritiza- can be categorized into five levels of severity as shown in Table 2.
tion process, this paper develops the profit impact due to a risk The severity levels of profit impacts are derived from the cost im-
event where the profit impact is represented as the percentage of pact scales, which are used for evaluating risk impacts on project
profit loss over the bid profit of a construction project. Eqs. (1) costs in the PMBOK guide (Project Management Institute 2008).
and (2) show the calculation of total costs incurred and the asso- The severity levels of the risk owners become an essential measure
ciated profit impact (PI) for each risk event, i, respectively. It to suggest the risk handling methods for the risk causes. For exam-
should be noted that the bid profit is gross profit that includes ple, the construction company is likely to avoid bidding on a con-
operating profit and overhead. Therefore, the profit loss because struction project solicited by an owner who is rated at high severity.
of a risk event should consider both costs increased in a work On the other hand, if the owner’s severity level is lower than mod-
activity and overhead erate, the construction company would like to bid on the project but
X increase the estimated profit of the project as much as the owner’s
ΔCi ¼ ðCCai − OCa Þ ða ¼ 1; 2; 3; : : : ; nÞ ð1Þ annual WAPI.
a
Risk-Handling Method
ΔCi × ð1 þ rOH Þ In general, there are four risk response strategies as follows: risk
PIi ¼ × 100ð%Þ ði ¼ 1; 2; 3; : : : ; mÞ ð2Þ avoidance, risk transfer, risk mitigation, and risk retention. Each
BP
risk response strategy is described with the practical methods
In the equations above, ΔCi = total increase in the cost of below.
work activities by the risk event, i; CCai = changed cost of work • Risk avoidance: Risk avoidance (also called risk elimination)
activity, a, due to the risk event i; OCa = original cost of is a strategy to remove some potential risk by eliminating
work activity, a; PIi = profit impact (%) of the risk event, i; the risk cause in construction projects or avoiding projects
rOH = predetermined overhead rate for the project cost; and (Project Management Institute 1996). For example, a contrac-
BP = bid profit. tor could tender a very high bid price or stipulate condi-
tions on the bid to avoid the risks (Carter and Doherty 1974;
Phase-2: Risk Handling Strategy at the Company Level
The risk handling strategy at the company level is established Table 2. Profit Impact and Severity
annually. Its primary objective is to determine the risk-handling
Profit impact (%) Severity
methods to control the risk causes and the risk owners. The risk
handling strategy considers annual WAPIs of the risk causes and Insignificant profit decrease of <1 Very low
the risk owners in consideration of the specific circumstance of Profit decrease of 1–10 Low
a construction company. Therefore, establishing the annual-based Profit decrease of 10–20 Moderate
risk-handling strategy requires four steps: (1) calculation of the an- Profit decrease of 20–40 High
Profit decrease of >40 Very high
nual WAPIs of the risk events, (2) estimation of the annual WAPIs

© ASCE 04014090-4 J. Manage. Eng.

J. Manage. Eng.
 Baker et al. 1999). Another example to avoid the potential risks Table 3. Risk Response Strategies
is that the contractor could apply an alternative construction Risk response Response
method that is not affected by rain to keep the construction sche- strategy Risk-handling method code
dule if the current construction method is susceptible to rain
Risk avoidance • Increase unit cost or overhead RA-1
(Wang and Chou 2003). Similarly, the contractor can eliminate • Develop alternatives for risk events RA-2
the risk source by not bidding on the construction projects in • Remove risk events by avoiding them RA-3
politically and financially unstable countries (Al-Bahar and Risk transfer • Use insurance companies RT-1
Crandall 1990). • Make a subcontract RT-2
• Risk transfer: Risk transfer shifts risk responsibilities to other Risk mitigation • Train or educate employees RM-1
contracting parties. For example, a contractor can transfer the • Provide best supplies (e.g., computer, RM-2
risk to the subcontractors through the contract documents of software, equipment, and so on)
a construction project. This type of risk transfer specifies provi- • Develop a strategic staffing plan RM-3
• Use proven construction methods RM-4
sions in a contract document such as indemnity clauses or con-
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and materials
tractual adjustments. The contractor can also use the insurance • Safeguard both workers and property RM-5
companies for possible financial losses resulting from risk Risk retention • Prepare contingency planning RR-1
events. Contractors usually prefer insurance companies for • Accept profit losses RR-2
handling more serious financial loss exposures (Al-Bahar and
Crandall 1990).
• Risk mitigation: Risk mitigation (also called risk reduction) is a
strategy to reduce the possibility that the potential risk hap- Results of Protocol Application
pens, or the expected financial losses if the risk occurs (Project
Management Institute 1996). For example, a well-maintained Description of Case Study and Risks
fire sprinkler system in a building could reduce the financial
losses from the lowered severity of casualties and property To demonstrate the developed protocol, a comparative case study is
damage by fire (Al-Bahar and Crandall 1990). An antitheft de- conducted on three construction projects that a midsized construc-
vice on construction equipment could reduce the likelihood of tion company has completed within one fiscal year. The construc-
the potential risk of theft. Using proven methods and materials tion company operates a total of six departments [e.g., human
in a construction project could also reduce the probability of resources (HR), accounting (A), design (D), bidding (B), purchas-
the risk events (Project Management Institute 1996). Education ing (P), and equipment (E)] in its organizational structure to support
and training within the organization of a construction com- construction projects. The company also deploys project site teams
pany are another effective method for risk reduction by making (ST) to the construction sites to successfully perform the projects.
the employees aware of the potential risks. Consequently, edu- The site teams are considered as the cost centers that reside in
cation and training can help reduce the risk exposure in the the profit centers because they spend the project costs to generate
working environment (Flanagan and Norman 1993; Baker profits for the company. Table 4 describes the summaries of the
et al. 1999). responsibilities of the seven cost centers, that were identified after
• Risk retention: Risk retention accepts the existence of the pro- discussion with the company. Defining the responsibilities is nec-
ject risks. A construction company that handles the risks bears essary to clarify the obligation of each cost center within a con-
the financial consequences resulting from retaining the risks. struction project as well as to identify the relationships among the
Risk retention can be either active (or planned) or passive (or cost centers.
unplanned; Merna et al. 2010). Active risk retention is an inten- Because of the limitation of sample projects considered for
tional risk management strategy after a cautious evaluation of the protocol demonstration, it is required to assume that the three
the possible losses compared with the costs of alternative ways construction projects have the same owner (O), design consultant
to retain the risk. On the other hand, passive risk retention oc- (DC), subcontractor (S), and suppliers for material (MS) and equip-
curs when a construction company neglects identifying the po- ment (ES) to show the process of evaluating their rating scales.
tential risks (Baker et al. 1999). The passive risk retention even Table 5 describes three profit centers (PC-1, PC-2, and PC-3) as the
happens in the underestimation of the potential losses of the case studies with the information such as project type, bid value,
identified risks by the construction company (Al-Bahar and project cost, overhead, operating profit, and gross profit margin.
Crandall 1990). The example of the active risk retention is the
development of an emergency plan in case that the risk event
occurs. Accepting a lower profit caused by the occurrence of the Table 4. Responsibilities of Cost Centers
risk events is the example of the passive risk retention (Project Cost Center Responsibility
Management Institute 1996).
As a result of the review of four risk response strategies, Table 3 Design Design review/quantity takeoff/project schedule
estimation/field survey
summarizes the risk-handling methods in terms of the risk re-
Bidding Project cost estimation/new construction projects
sponse strategies as well as the associated risk codes. The risk- search
handling methods were identified through the literature review. Purchasing Material procurement/material delivery/
Those methods are to handle the risk causes and the risk owners documenting for owners’ approval
in the consideration of their annual WAPIs. Some of the risk Equipment Procurement of new equipment/equipment
causes and the risk owners might have multiple risk-handling maintenance/equipment delivery
methods. The application of the correct risk-handling methods Accounting Cash and investment control/budgeting/payroll/
depends on the business constraints of a construction company, accounts receivable and billing
for example, the business goal, financial conditions, efficiency of Human resources Recruitment of employees/training employees/
business operations, company competitiveness in the market, and employee placement
Site team Project management
so on.

© ASCE 04014090-5 J. Manage. Eng.

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 Table 5. Descriptions of Three Profit Centers steel, the increased cost was $98,600. Consequently, it caused the
Bid items Profit center-1 Profit center-2 Profit center-3 profit loss of $102,544 as the overhead is 4% of the direct cost
Project type Water pipeline Landscaping Residential ΔC × ð1 þ rOH Þ
PI ¼ × 100ð%Þ
installation building BP
Bid value $12,678,400 $12,546,000 $3,200,000 98,600 × ð1 þ 0.04Þ
Project cost $11,320,000 $10,200,000 $2,500,000 ¼ × 100ð%Þ ¼ 7.55% ð6Þ
Overhead $452,800 $816,000 $200,000 1,358,400
Operating profit $905,600 $1,530,000 $500,000 The profit impacts are also assigned to the WBS to identify the
Gross profit margin (%) 10.714 18.699 21.875 work activities that are affected by the risk events. Therefore, the
construction company can utilize the profit impacts to estimate
the costs of the work activities for future construction projects ac-
The gross profit margin is defined as the difference between cording to the suggested risk-handling methods. For example, Fig. 2
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the total revenue and total cost of sales, that is, gross profit shows the profit impacts on the WBS of profit center-1. The exca-
margin ð%Þ ¼ ðprofit þ overheadÞ=bid value × 100ð%Þ. As an ex- vation activity for the earthwork has a total profit impact from three
ample, the gross profit (%) of profit center-1 is risk events of 5.25% (¼ 0.23% þ 1.19% þ 3.83%; see Table 6) on
the bid profit of profit center-1. Because its total profit impact
ðBid value − Project costÞ includes the increase by the overhead rate (= 4%), the total profit
× 100% impact because of the increase of the direct costs is 5.04%
Bid value
(¼ 5.25% × ð1 − 0.04Þ). Therefore, as it assumes that there are no
ð12,678,400 − 11,320,000Þ
¼ × 100% ¼ 10.714% ð5Þ methods to control the risks but increasing the costs of the work
12,678,400 activity, the company should increase the excavation costs by
5.04% on the bid profits for the projects scheduled for the next
coming year. It notices that Fig. 2 does not show the profit impact
Risk Analysis Results (= 3.83%) caused by the project owner’s financial incapability (see
At the project level, three profit centers were analyzed through the the first row in Table 6) that consequently made the construction
steps of Phase-1 such as: (1) identification of the work activities company borrow more money from the banks that resulted in gen-
showing increase in their original costs, (2) investigation of the risk erating additional interest (i.e., increase in overhead only).
events and the associated risk causes from Table 1, (3) revelation of The profit impacts of the risk events from the three profit centers
the risk owners and the counter-partners for the risk events, and were utilized to generate the annual WAPIs of the risk events that
(4) estimation of profit impacts of the risk events using Eq. (2). are subsequently added up for the annual WAPIs of the risk causes
The risk analysis result of profit center-1 is presented in Table 6 and the risk owners. That is, applying Eq. (3), the weighted values
as the only example due to editorial constraints. The result shows of the three projects can be computed as follows:
a total of nine risk events caused by two external relationships
1,358,400
(e.g., O and MS) as well as by five entities (e.g., D, B, E, P, w1 ¼ P ¼ 0.31 ð7Þ
and ST). ð1,358,400 þ 2,346,000 þ 700,000Þ
In Table 6, the profit impact ranges from 0.23% caused by the
design cost center to 7.55% caused by the bidding cost center. The 2,346,000
w2 ¼ P ¼ 0.53 ð8Þ
total profit loss is $476,494 on the original bid profit of $1,358,400, ð1,358,400 þ 2,346,000 þ 700,000Þ
showing that the profit impact of all risk events is 35.08%
[¼ 476,494=1,358,400 × 100ð%Þ]. The highest profit impact by 700,000
w3 ¼ P ¼ 0.16 ð9Þ
the bidding cost center, as an example, computed by Eq. (1) is de- ð1,358,400 þ 2,346,000 þ 700,000Þ
scribed in Eq. (6). That is, the bidding department in the company
did not properly predict the extent of the inflation in the steel mar- Accordingly, the WAPIs of risk events are calculated by Eq. (4).
ket price at the bidding phase. When it ended up purchasing the For example, the risk event, inflation of the steel price between the

Table 6. Analysis of Profit Center-1

Profit
Risk Counter- Incurred impact
Risk cause Risk event Result owner partner cost (%)
Financial incapability Delayed payments to the contractor Loan from the bank causing O A $52,000 3.83
extra interest
Delays in material supply Inability of supplying material in time Supply the material from the MS P $78,000 5.74
local vendor
Incompleteness of design review Error in pipe size (250 mm → 200 mm) Application of lower price D B $72,800 5.36
Incompleteness of design review Higher water table than expected Increase in the dewatering cost D B $3,086 0.23
Cost underestimation Inflation of the steel price between Increase in the purchasing cost B P $102,544 7.55
bidding and purchasing phase of the steel
Poor equipment management Frequent breakdown and repair Rental equipment to avoid delays E ST $16,224 1.19
Delay in material procurement Did not arrive to the site in time Penalty by the owner P ST $20,800 1.53
Poor site management skills Stolen formwork ($14,560) and Repurchase of the material ST PC $14,560 1.07
safety signs ($64,480) $64,480 4.75
Poor site management skills Telecommunication cable was damaged Penalty to the contractor ST PC $52,000 3.83
$476,494 35.08

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Fig. 2. Mapping WBS for profit center-1 into the risk events

bidding phase and the purchasing phase, was caused by cost under- respectively, as prioritized in Fig. 3. The annual WAPIs of the risk
estimation in profit centers-1 and -2. Its profit impacts (PI) on profit owners are justified in terms of the severity levels based on Table 2,
centers-1 and -2 were analyzed as 7.55 and 11.74%, respectively. so that the risk-handling methods can be developed for the risk
Therefore, the WAPI of the risk event is owners considering the associated risk causes.

WAPIR−1 ¼ 0.31 × 7.55% þ 0.53 × 11.74% þ 0.16 × 0% Development of the Risk-Handling Methods
¼ 8.56% ð10Þ On the basis of the risk analysis result, the risk-handling methods
were developed considering the risk causes, the risk owners, and
Table 7 shows the list consisting of the risk causes, the risk the annual WAPIs and their severity levels for both. Table 8
events, and the risk owners that are identified by investigating the presents the risk-handling methods developed by the construction
relationships among cost and profit centers and externals on the company for the case study. During the analysis year, the risk cause
associated risk events. Also, Table 7 includes the profit impacts of cost underestimation was a major source to reduce the annual gross
those risk events in each profit center as well as WAPIs based on profit of the company by 8.56% of the total bid profit for the year.
the risk events and the risk causes. The list is arranged in high pri- It implies that the construction company might have an annual
orities by the WAPIs of the risk causes. For example, cost under- profit reduced by 8.56% from the expected bid profit because of
estimation (= 8.56%), followed by poor site/project management the same risk. The risk owner for the risk cause is the bidding cost
skills (= 6.65%), in Table 7 was the leading risk cause to negatively center in the company’s organization structure, and the severity
affect the profit of the construction company. level of the profit impact is low. With this information, the construc-
The risk owners’ WAPIs were also computed by adding up the tion company established three risk-handling methods for future
WAPIs of the risk events as shown in Fig. 3. For example, the bid- projects based on Table 3 as follows:
ding cost center has responsibility for two risk events, inflation of • RA-1: Increase unit cost of the work items,
the steel price between bidding phase and purchasing phase and • RT-2: Make a subcontract to procure the material that shows
mistake in including the cost of concrete work in Table 7. Their price instability, or
WAPIs are 8.56 and 0.73%, so the total comes to 9.29%. As a re- • RR-2: Accept profit losses.
sult, the risk owners that had significant impact on the profit were The application of those strategies for construction projects de-
the bidding and the site team cost centers with 9.29 and 6.65%, pends on the business constraints of the construction company and

© ASCE 04014090-7 J. Manage. Eng.

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 Table 7. Annual Weighted Average Profit Impacts by the Risk Causes and Events
Risk PC-1 PC-2 PC-3 WAPI of risk WAPI of risk
Risk cause Risk event owner (%) (%) (%) event (%) cause (%)
Cost underestimation Inflation of the steel price between bidding B 7.55 11.74 — 8.56 8.56
phase and purchasing phase
Poor site/project management Stolen formwork and safety signs ST 5.82 — — 1.80 6.65
skills Telecommunication cable was damaged 3.83 — — 1.19
Difficulties in supplying labors in local areas — 6.91 — 3.66
Delays in material supply Buy the material at local area MS 5.74 — — 1.78 1.78
Incompleteness of design review Error in pipe size (250 mm → 200 mm) D 5.36 — — 1.66 1.73
Higher water table 0.23 — — 0.07
Errors and omissions in design Mistake in surveying the garden level DC — 2.76 — 1.46 1.46
Financial incapability Delayed payments to the contractor O 3.83 — — 1.19 1.19
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Poor equipment management Frequent breakdown and repair E 1.19 1.38 0.42 1.17 1.17
Lack of skilled labor Recruit unqualified engineers for design HR — 0.69 — 0.37 0.84
Delay in hiring new construction manager — — 2.96% 0.47
Lack of skilled labor Mistake in including the cost of concrete work B — 1.37% — 0.73 0.73
Delay in material procurement Did not arrive to the site in time P 1.53% — 0.97% 0.63 0.63
Lack of skilled labor Mistakes in surveying D — 0.39% — 0.21 0.61
Mistake in taking off quantities — — 2.50% 0.40
Total 25.35

Table 8. Candidate Risk-Handling Methods Based on Risk Causes and

Owners
WAPI Candidate
of risk Risk risk-handling
Risk cause cause (%) owner method
Cost underestimation 8.56 B RA-1, RT-2,
RR-1, RR-2
Poor site/project management 6.65 ST RT-1, RM-5
skills
Delays in material supply 1.78 MS RA-2, RA-3, RT-2
Incompleteness of design 1.73 D RM-1, RM-2
review
Errors and omissions in design 1.46 DC RA-3, RT-1
Financial incapability 1.19 O RA-1, RR-2
Poor equipment management 1.17 E RT-1, RM-1
Lack of skilled labor 0.84 HR RM-1, RM-3
Lack of skilled labor 0.73 B RM-3
Delay in material procurement 0.63 P RM-1
Fig. 3. Annual weighted average of the profit impacts by the risk re- Lack of skilled labor 0.61 D RM-1
sponsible owners

consultant. For the risk caused because of the project owner, the
the construction market condition. For example, if the probability construction company made two strategies for the projects deliv-
of winning a bid on a project is high, the company should take the ered by the owner. First, the company would increase the overhead
strategy RA-1. Otherwise, the company would consider either RT-2 rates by 1.19% (RA-1) for projects if the project owner solicits
or RR-2. bids for the project types such as irrigation, sewage and sanitary
The risk-handling methods suggested in Table 8 also include systems, pump stations, and potable water pipelines for which
ones for the three risk causes (e.g., delays in material supply, errors the company has relatively high competitiveness to win the bid.
and omissions in design, and financial incapability) that occurred Or, they are willing to accept possible profit losses for those types
because of the relationships with the external entities such as the of projects such public buildings and roads, which the company is
material supplier (MS), design consultant (DS), and the project planning to expand their business area, in order to build construc-
owner (O). First, the risk caused by the material supplier affected tion credits
the annual total bid profit at 1.78%, which is classified as low se-
verity. Therefore, the best scenario for the company is to avoid the
supplier (RA-3). However, in the case that the supplier might be the Discussion and Conclusion
only provider for a specific material, the construction company
made two options not to reduce an expected annual gross profit Project risk management is a systematic process to control risks on
from the risk cause: applying an alternative construction material construction projects through a series of processes such as the iden-
(RA-2), or making a subcontract to procure the material (RT-2). tification of risks that affect the projects, risk analysis in terms of
In the same way, the construction company developed the risk- prioritizing risks by assessing their probability and impact, and de-
handling methods (RA-3 or RT-1) for the risk caused by the design velopment of risk response strategies to reduce the impact of the

© ASCE 04014090-8 J. Manage. Eng.

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 risks. However, there are some limitations that prevent construction such as owners, subcontractors, material and equipment suppliers,
companies from adopting project risk management processes. For and financial institutions and 30 straightforward guidelines for
example, establishing risk response strategies are really dependent future projects in terms of cost estimation, contingency plans, con-
on the precision of the input data for the qualitative and quantitative struction contracts, and so forth.
risk analyses that often become ambiguous from their inherent un- In spite of the contributions of the protocol, there are limitations
certainty. Furthermore, construction companies, particularly small with the research, which lead to further research recommendations.
to midsize, have concerns in embracing qualitative-based risk First, the results of the case study verify that the proposed protocol
analysis for their business activities so as to enhance their profit- can be implemented properly at the company level. However, it
ability from the limited knowledge and practice of risk manage- does not validate how the application of the risk-handling methods
ment, lack of qualified professionals, lack of time and resources, suggested by the protocol effectively reduces the profit loss in
cost-effectiveness, and so on (Colquitt et al. 1999; Lyons et al. future projects. Second, determination of the risk-handling methods
2004; Liu et al. 2007). is dependent on the decision maker’s subjective judgment con-
Therefore, the protocol to manage the risk causes and the risk sidering the business constraints of the company and the market
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owners, which drive the loss of an annual gross profit, has been condition. There is clearly a need to develop a computer-based
developed for those construction companies having difficulties in decision-making process such as an expert system for reliable risk
taking on the project risk management. The protocol was built on management strategies. Also, the decision-making process should
the project breakdown structures such as WBS, OBS, and CBS be- come with the development of a database that stores all analysis
cause the integration of developing risk mitigation strategies into data used for the protocol. Therefore, a construction company can
those structures help (1) identify the work activities affected by risk monitor the effectiveness of the annual-base risk-handling methods
events, (2) find the organizational units responsible for the risk with profitability enhancement. Finally, the integration of positive
events, and (3) estimate the cost impacts caused by the risk events. risk events, which result in profit gains, into the development of
In particular, to define the entities that are responsible for the risk risk-handling methods will enable construction companies to pro-
causes, the protocol identified the risk causes in the consideration actively establish risk management strategies.
of all types of relationships among the projects participants.
The proposed protocol mainly consists of two phases. The first
phase is to obtain the risk analysis information at the project level, References
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