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Risk Management in Building - no longer an oxymoron -


Risk Management in Building - no longer an oxymoron - Tony Williams Building Value Limited May 2002 Synonyms of risk Synonyms of manage Synonyms of building ... – PowerPoint PPT presentation

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Title: Risk Management in Building - no longer an oxymoron -

Risk Management in Building- no longer an
oxymoron -
Tony WilliamsBuilding Value Limited
  • May 2002

Synonyms of risk
Synonyms of manage
Synonyms of building
Alternative synonyms of building
Definition of risk
  • Risk means chance of injury or loss due to
    uncertain danger, peril or hazard
  • A particular decision or course of action is said
    to be subject to risk when there is a range of
    possible outcomes.
  • .then, objectively known probabilities can be
    attached to these outcomes

Risk vs uncertainty
  • Risk is, thus, distinguished from uncertainty,
    where there is a plurality of outcomes where
    objective probabilities cannot be assigned
  • Many situations, which in practice are called
    risky are, on a strict definition, really
    subject to uncertainty not risk
  • ..and finally,if you are Zurich IC Squared,
    risk is an investment

Definition of Risk Management (RM)
  • Involves anticipating and/or identifying
    potential risks and taking steps to avoid them or
    to mitigate the resulting harm
  • The aim is to minimise the sum of
  • - retained losses
  • - insurance or other risk transfers
  • - loss control expenses

A builders definition of RM
  • Risk is an uncertain event, feature, activity or
    situation that can have a positive or negative
    effect on an object
  • Note, that this encompasses both the upside and
    downside of risk
  • RM is a formal process that identifies, assesses,
    plans and manages the risk

Why builders have RM?
  • A risk aware organisation, capable of
    identifying and managing uncertainty in order to
    maximise opportunity deliver max. value
  • Its primary aim is to help maximise business
    value by doing the right projects, right the
    first time.
  • RM quality and the successful identification,
    reduction, communication and control of risk are
    key issues and performance drivers.

Why builders have RM?
  • The group assesses and manages risk to ensure
  • - the public, our employees and the environment
    are safe from the potential hazards in our
  • - that new essential assets are created to the
    maximum obtainable benefit of their intended
    users and the community at large
  • - the potential for damage to our clients and
    the Groups corporate reputation and/or financial
    loss to our stakeholders is minimised

Insurance Management (IM)
  • Underwriting focuses on the past e.g. historic
    losses, litigation, court decisions
  • Insurance coverage is designed empirically
  • Insurance industry traditionally adopts a rear
    view mirror to predict and manage the future
  • Risk puzzle unidentified/mis-measured
  • Insurance buyers need to move from IM to RM

RM vs IM
  • Active
  • Dynamic
  • Protection orientated
  • Financial / analytical
  • Seeks responsibility
  • Broad based
  • Creative
  • Involved in companys activity
  • Reactive
  • Passive
  • Security orientated
  • Administrative
  • Seeks safety
  • Narrow
  • Responsive
  • May be involved or relies on other

RM in Building
  • Every activity/project faces full risk spectrum
  • Tied to health safety, environment,
    regulations, labour (supply/law), transport etc
  • In broad terms, risk can be divided
  • strategic
  • operating
  • financial
  • information

Strategic risks
  • Environmental
  • Natural/man made disasters
  • Political
  • Laws/regulations
  • Industry
  • Competition
  • Financial markets
  • Organisational
  • Corporate objectives strategies
  • Leadership
  • Management
  • Investor/credit relations
  • Human resources

Other types of risk
  • Operating risks
  • Workforce
  • Suppliers
  • Plant machinery
  • Protection
  • Customers
  • Financial risks
  • Capital/funding
  • Investing
  • Regulatory environment
  • Information risks
  • Systems
  • Strategic
  • Operating

RM and risk control
  • Mgt process
  • Identify and analyse exposure
  • Evaluate alterative
  • Select most promising technique
  • Implement choice
  • Monitor process and change as necessary
  • Control
  • Avoidance
  • Prevention
  • Reduction (stop losses or reduce damage)
  • Segregation of loss exposures
  • Contractual risk transfer

Building 4 types of player
  • Building materials
  • Heavy (eg Hanson)
  • Light-side (eg Novar)
  • Distribution (eg Wolseley)
  • Contractors
  • Pure (sic)
  • Mixed (e.g. PFI)
  • Plant hire
  • Housebuilders
  • Speculative
  • Public sector
  • Property development
  • Professional Services
  • Architects
  • Surveyor/engineer
  • QS/cost consultant

Building materials characteristics
  • Heavy
  • Cement, rmc, aggregates
  • Largest/Europe dominates
  • International/rationalised
  • Resource/extractive base
  • Light
  • Fragmented
  • Competitive
  • Semi-international
  • Poor performers
  • Distribution
  • Rationalised/rationalising
  • Europe cross border push
  • 10 margin best in class

Other players characteristics
  • Contractors
  • Low value/valuation
  • Awful record
  • International
  • Creeping rationalisation
  • Housebuilders
  • Rationalisation
  • International?
  • Key raw material is land
  • Undervalued
  • Professional Services
  • Move to one stop shop
  • International
  • Fee based

Industry EBIT margins
  • Cement
  • Aggregates/rmc
  • Light materials
  • Distribution
  • Contracting
  • Housebuilding
  • Professional Services
  • 20-30
  • 15-20/10-15
  • 10
  • 4-8 (TPK 10)
  • 1-3 (pretax)
  • 10-20
  • 5-30

Drivers of change
  • Todays focus is on the UK US, at least on par
  • Continental Europe is five years behind
  • LSE FSA inspired corporate governance
  • First Cadbury, now Turnbull (Sept. 1999)
  • Internal Control, Guidance for Directors on the
    Combined Code of Corp. Governance
  • Widespread endorsement and application

Drivers of change2
  • Latham Report 1994
  • Agile Report 1998 variation in control of
    project cost and payment leads to an
    unpredictable outcome
  • Two thirds of projects over budget and
    three-quarters run late site deaths at 2-3 per
  • Egan Rethinking Construction 1998
  • Industry needs total new approach to delivery of
    construction product

Drivers of change3
  • Aftermath of 11 September
  • A major insurance broker is currently concluding
    renewals in range from 20-200
  • A small private building material company
    (revenue of circa 130m), has been told to
    budget for a minimum of 50 in premiums

Heavy Building Materials
  • A case study

HBM approach to risk
  • Corporate Governance umbrella unfurled by
    internal auditors who act as scribes however,
    managers manage the programme
  • Regular review of all business units and overall
    risk management structure
  • Biggest risk, of course, is a commercial one i.e.
    product prices fall or demand collapses and you
    cannot insure against it
  • Insure for what you cannot control

HBM risk process
  • CFO is custodian of risk and risk management
  • Group co-ordinates with single broker
  • Insurance carried for liability, property, people
    etc with normal array of cover after assessing
    how much is claimed plus uninsured loss
  • In addition, there is third party and contractual
    risk (fire, flooding etc), but company carries a
    threshold of risk

HBM management
  • For managers, there is no such thing as
    insurance they should manage all principal and
    operational risk
  • If the premium is high and you insure to the
    first 1, this will spoil management
  • Eg motor insurance is 3rd party only
  • Could pay big premium and avoid bearing risk
    internally but this is costly removes
    responsibility from managers

HBM Health Safety
  • Health Safety (HS) is paramount but industry
    record is poor
  • Dupont was used as facilitator
  • Attitude is critical hearts and minds plus
    dismissal for HS contravention
  • HS is first item on monthly board agenda
  • Prevention is better than cure eg separating
    people from moving vehicles driving school
  • Particular problem is use of external
    contractors governed by company HS rules but do
    not always adhere

HBM the environment
  • Sophisticated environmental management is vital
    in an extractive industry
  • Each and every site is reviewed many risks can
    be removed eg water leakage etc
  • Above all, company needs to guard against loss
    of right restoration, community relations,
    being a good citizen are vital

HBM liability
  • Company also has catastrophe insurance
  • In US, based on infamous case of ready mix lorry
    colliding with school bus 300m claim
  • Sadly, in terms of cost it is better for someone
    to be killed than injured
  • In other areas such a legal liability,
    compensation, sexual abuse etc, company is self
    insured with a range of thresholds
  • The US is much more expensive, because there are
    more cases

HBM costs 6-9 of EBIT
  • In terms of products and materials performance
    there is product liability
  • However, the key avoidance method is continuous
    testing so as to establish integrity
  • All insurance premiums account for 3-5 of EBIT
    plus self insured risk/loss is an additional
    3-4 this includes catastrophe insurance
  • In past ten years the cost has not grown
    commensurately with the business

  • A word of warning

Structural issues remain
  • Operating climate improving eg partnering, PFI
  • Immense skills exist
  • But..accounting is a black art
  • The risk/reward ratio is lamentable
  • There is notorious ease of entry
  • Financial record is poor investors do not (will
    not) understand
  • Corruption remains rife

Clients are no angels
  • Project cost rule of thumb land (one third)
    materials (one third) all fees (one third)
  • Everyones an expert love to beat up
  • Given industry margins of 1-3, a modest
    concession could win immodest co-operation
  • UK government is also hard nosed
  • Former Railtrack CEO saw no reason why rail
    maintenance should attract more than the normal
    contractors margin i.e.1

Capital adequacysomething for another day
  • A contractor generally works on negative capital
    employed (thus on ROE)
  • Like a bank, he makes a large part of his return
    in assuming contractual obligations and holding
  • The key concept is capital adequacy the
    relationship between shareholders funds and
    companys total commitments
  • A new category called orders in hands (net of
    cash received and work performed) would be
    created and added to the asset base

Capital adequacysomething for another day
  • On the other side of the balance sheet are
    contract obligations the contract value of all
    work the firm has undertaken to deliver
  • These are stated net of invoiced sales but
    include a separate line for provisions (i.e. not
    netting them off work-in-progress).
  • For example, a contractor has shareholders funds
    of 100m (including orders in hand) and
    contract-related assets of 825m
  • His capital adequacy ratio would be 12.1x

  • A case study

Risk catalyst
  • Every construction company knows about the
    principal of risk
  • Historically, there was no single or formal
    approach to RM
  • Initiation can spring from failure/disaster
  • In its wake, questions are asked, causes
    identified and solutions proffered
  • Indeed, a failure can be a powerful catalyst for
    a serious change in management

Need for proactive RM
  • How to manage risk especially with incoming
  • Began with Health Safety, spread into internal
  • However, Risk Manager was purely an insurance
  • Part of the solution is insurance, claims etc
    however, proactive RM is vital (not simply a pass
    off) some things cannot be insured

Audit, benchmark Turnbull
  • An audit of risk assessment
  • It was modest, reactive variable (with
    comparison impossible)
  • Extra mural, best practice was benchmarked
  • Plus external impetus, starting with Cadbury and,
    then, Turnbull
  • However, company was well on the way,
    pre-Turnbull and, three years ago, employed
    external consultants

External help
  • AEA Technology (Atomic Energy Association) was
    used as technical consultant plus broker
  • Leading implementation experts signed up
  • Steven Male (value management) and Nigel Smith
    (risk management), both professors at University
    of Leeds
  • Representatives from its main business areas
    appointed as champions not just top down

  • 18 months into the process, an externally
    designed software package was rolled out
  • Currently launching second version, on which
    company has had more impact
  • Mark II is reckoned to be one of the better
    construction based packages and to afford a
    marketing edge

One size fits all
  • In oil power industries, RM is first class but
  • A large contractor may have 1000 sites (and
    10-20,000 employees) its RM, needs to be
  • Application, however, must be homogeneous
    i.e.one size fits all
  • A concise Group framework for RM now exists,
    including, Uniform Risk Assessment

Consensus application
  • Training of personnel is essential
  • The strength of the process was to win consensus
    everyone has to be behind risk review
  • RM also needs to be applied to each stage of a
    bid initial identification pre-qualification
    design pricing on site and living with it (eg
    PFI facilities management for, say, 25 years)

Value management
  • Seek to enhance value management over life (
    maintenance) of the project
  • Take a concept and ask how it can be value
    engineered what can be done differently
  • In accounting terms the costs rise but the value
    management increases five fold
  • Client involvement facilitates the process

Knowledge is the key
  • The key to RM is knowledge and maximisation of
    information flow through life of the project
  • It is also important to record what courses of
    action were rejected
  • On site, previously rejected ideas may be
    (re)considered it is thus vital to know why they
    were shelved
  • In the future, when a new project is planned, an
    empirical history of analysis and action exits a
    working register

Risk grading
  • RM is now used almost everywhere in the company
    and all major contracts are required to use it
  • This includes generic risk assessment, where
    appropriate eg repetitive tasks
  • The process can also be quantified with the Risk
    Grading Tool via a 10-15 minute electronic menu

What it looks at
  • This encompasses a number of formal stages,
    involving the identification, definition and
    assessment of
  • - business or project objectives
  • - relevant risks according to nature, causes or
  • sources and consequences
  • - the likelihood or risks

Risk categories
  • Key headings of analysis (comprising some 80
    separate risks) are
  • - Client
  • - Contractual
  • - Resource
  • - Design
  • - Regulations
  • - Financial/commercial
  • - Scope of work/location/technical difficulty
  • - Compliance HS, legal etc

Colour coded risk
  • The output is a matrix on which all principal
    risks are plotted
  • The Y axis registers consequences, while X caters
    for likelihood
  • The matrix is colour coded top right is Red
    (no) bottom left is Green (yes) with Orange
    and Yellow in between

Quantitative risk
  • A total numerical risk score is also calculated,
    plus individual category risk scores (1-5)
  • Numerically, if a score is less than 25 and there
    is no individual risk greater than 5, the risk is
    low and the project is a go
  • Conversely, with 25 and a number of 5s, it is

Mitigation of risk
  • Once this is complete, the identification of
    effective controls and action plans is enacted
  • Steps are taken to
  • - avoid the risk altogether
  • - reduce the opportunity for risk to occur
  • - reduce the impact of risk if it occurs
  • However, system allows risks to be analysed and
    mitigated eg changes to design etc
  • Mitigation reduces likelihood and/or severity of

Colour approval
  • Activities with residual risks and a Red rating
    can only proceed with main board approval
  • All Red risks are also sorted and stored in a
    critical reference process
  • Orange risk can commence with appropriate
  • Yellow is in the middle, but appropriate
    arrangements already exist or will be developed
    at the relevant stage
  • Green appropriate normal monitoring and review
    procedures are in place

Focus on risk its cause
  • All risk needs to be identified but the company
    also needs to win work
  • Once a risk has been converted into a value, do
    not lose sight of what is behind it all
  • The focus must be on the risk, and its cause, not
    the financial impact

If you take no risks, you will suffer no
defeats. But if you take no risks, you will win
no victories R M Nixon (1913-94)
PresentationbyTony Williams
  • 44 (0) 1394 410 073
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