PART III - RISK MANAGEMENT

Every project manager understands risks are inherent in projects; all risks cannot be eliminated. No amount of planning can overcome risk, or the inability to control chance events. Plans are essentially the list of things to do. More often then not, what is missing from plans is serious consideration of potential project risks. Risks can be defined as chance that an undesirable event will occur and the consequences of all its possible outcomes. Risk management identifies as many risk events as possible, minimizes their impact. 

3.1 Identifying and Assessing Project Risks

Planning of risk formally addresses identification and analysis and assessment of potential trouble spots before implementing a project. This is a proactive approach rather than reactive. It is a preventive process to ensure that surprises are reduced and that negative consequences associated with undesirable events are minimized. Successful management of risks gives project manager better control over future and can significantly improve chances to reaching project objectives of on time, with in budget, and meeting required technical (functional performance. The major components of the risk management are:

1. Identifying the sources of risk

2. Analyze and assessing risk

3. Responding to risk

4. Contingency planning

5. Establishing contingency

3.1.a.  Identifying Source of Risk

Risk identification begins by making list of all areas that might cause project delays or failures and their respective outcomes. Thins that have not been done before are potential trouble spots. Specific areas can be checked to identify the risk. The effective tool to identify risks is the work breakdown structure. Use of the WBS reduces the chance a risk event will be missed. In some projects, practitioners use technical breakdown structures (TBS) to ensure all technical risks are examined. The TBS uses the WBS as the framework and identifies technical risk events for tasks and deliverables. The sources to project risks are unlimited. There are sources external to the organization such as inflation, market acceptance, exchange rates and government regulations. Apart from this there are project specific risks that must be considered. Some of the generic risk situations that apply to most projects found in practice are: 

• The undesirable event.

• All the outcomes of the events occurrence.

• The magnitude or the severity of the event’s impact

• Chances/probability of the event happening.

• When the even might occur in project.

• Interaction with other parts of this or other projects.

Having these information available facilitates the assessment of each risk event worthy of attention. Risk identification has major benefits even if there is no follow through on the remaining steps of the risk management process. 

3.1.b. Analyzing and Assessing Risks

The next step of risk assessment selects potential foreseen risks that need attention because they exhibit the high consequence of loss. Risk analysis attempts to qualify the severity of the impact of an identified risk event, sometimes its probability and its sensitivity to change. 

The risk assessment matrix is one of many approaches to risk assessment. Assessments are basically either subjective of quantities. “Expert opinions” or “Gut feeling” can carry serious errors depending on the skills of the person making the judgment call. Quantitative methods usually require more analysis of facts and tend to be more reliable. Typical quantitative method is ratio analysis, probability analysis, and sensitivity analysis. Typically quantitative methods require serious data collection, are frequently limited in scope and have low acceptance levels by practicing managers. In this dissertation we shall discuss some of the analysis in brief, which are often helpful for project managers. 

Scenario Analysis: This is the easiest and most used technique. It identifies what might go wrong, the magnitude of the threatening events, and the chance of the event occurring. Given the subjective judgment of these variables, an assessment is made of the alternatives of accepting or reducing, sharing or transferring risks using a subjective, cost-benefit thought process. Although risks are not quantified, they are based on experience, which in most cases is reliable. However, when experience and knowledge of experts differ, assessment of risk can become inconsistent. 

Ratio/Range Analysis: The technique use data from prior projects that are similar to the proposed project. It assumes a ratio between the old and new project to make a point of time, cost, or technology and a low and high range for the estimate. The ratio typically serves as a constant. For example, a past project has taken 10 minutes per line of computer code; a constant of 1.10 (which represents an increase of 10 present increase) would be used for the proposed project time estimates because the new project will be more difficult than prior projects. Given the computed estimates for the new project, the percentage ranges for the past project can also be reviewed and the downside of the range assessed.

Hybrid analysis Approaches: Managers are often reluctant to accept quantitative methods of their restrictive assumption and scope. To these managers such models fail to utilize the full breadth and knowledge they gain from experiences. Managers are comfortable using rules of thumbs combined with subjective judgments and will continue to use them. A few researchers have included these rules of thumb in knowledge-based expert system to pick up the benefits of the manager’s experiences/Knowledge and historical quantitative databases. 

Probability Analysis: There are many statistical techniques available to the project manager that can assist in assessing project risks. Decision trees have been used to assess alternative course of action using expected values. Statistical variations of net present value (NPV) have been used to assess cash flow risks in projects. PERT (Program Evaluation Review Technique) and its simulation can be used to review activity and project risks. The use of PERT simulation is increasing because it uses the same data required for PERT, and software to do the simulations readily available. (Refer to Appendix – A; for insight on PERT) 

Scenario Analysis: Project managers are often reluctant to use or provide probabilities for risk analysis. Such as information would allow risk analysis to be more vigorous, robust, and valuable. The challenge is to articulate project team risk in words. This information can be very practical and at the same time provide some of the benefits of probability and utility theory. 

Sensitive Analysis: This approach can incorporate techniques form the very simple to high complex. Fundamentally, project variables are given different values to identify different outcomes and the severity of each. It is similar to scenario analysis, but it typically uses a modeling approach that is very detailed and numerically oriented. 

3.1.c. Responding to Risk

When a risk event is identified and assessed, a decision must be made concerning which response is appropriate for the specific event. Responses to risk can be classified as reducing/retaining, transferring, or sharing. 

Reducing/Retaining Risk: Reducing risk is the first alternative considered. An example from a bridge building project was that the continuous cement-pouting process must not be interrupted. Any interruption would require that whole cement section to be torn down and started over again. An assessment of the possible risk centered on the delivery of the cement form the factory. Trucks could be delayed, or the factory could break down. Such a breakdown would result in tremendous rework and delays. Having two additional portable cement plants build 20 miles on the highway from the construction site reduced the risk. These portable plants carried all the raw material for the bridge construction. Extra tucks were on immediate standby if continuous-pouring was required. Similar risk reduction scenarios are apparent in system and software development projects where parallel innovation processes are used in case one fails. 

Transferring Risk: Passing risk to another party is common. This transfer does not change risk. Passing risk to another party almost always results in paying a premium for this exemption. Fixed priced contracts are one of the examples of transferring risk from owner to a contractor. The contractor understands that his/her firm will pay for the any risk event that materializes; therefore monetary risk factor is added to the contract bid price. Another way to transfer risk is insurance. However in most cases this is impractical because defining the project risk event and conditions to an insurance broker who is unfamiliar with the project is difficult and usually expensive. 

Sharing Risks:  Risk sharing allocates proportion of the risk to different parties. An example of risk sharing was the Airbus A300B. Research and development risk are allocated among European countries including Britain and France. Sharing risk has drawn more attention in recent years as a motivation for reducing risk and in some cases, cutting project cost.  

More effort given to the risk response before the project begins, that is during the planning stage; the better chances are for minimizing project surprises. Knowing that the response to a risk event will be retained, transferred, or shared greatly reduces stress and uncertainty when risk even occurs. And further to this control is possible with this structured approach. 

3.1.d. Contingency Planning

 A contingency plan is an alternative plan that will be used if a possible foreseen risk event becomes a reality. The contingency plan represents preventive actions that will reduce the negative effect of the risk event. In the absence of contingency plan, when risk event occurs, can cause a manager to delay or postpone the decision to implement a remedy. This postponement can lead to panic, crisis mismanagement and acceptance of first available solution. Contingency planning evaluates alternative remedies for possible foreseen events before the risk event occurs and selects the best plan among alternatives. This early contingency planning facilitates a smooth transition to the remedy or work around plan. The availability of a contingency plan could significant increase chances for project success. 

Conditions for the implementation of the contingency plan should be decided and clearly documented. The plan should estimate cost estimates and identify source of funding. All parties to agree to the contingency plan and have authorities to make commitments. As implementation of a contingency plan embodies disruption in the sequence of work, all contingency plans should be communicated to team members so that surprise and resistance is minimized. 

Here is an example of a high-tech niche computer company intends to introduce a new platform product at a very specific target date. All the team members agree that delays will not be acceptable. The risk matrices show their concerns.

 3.2 Types of Risks 

Sometimes unforeseen risk events occur midway in a project. Because no contingency plan is available, one must quickly be developed. For example, a new computer chip plant half way through construction faced an injunction to stop construction because of an environmental lawsuit claiming damage to wetlands. Development of a contingency plan required go/on-go decision and a whole additional set of new players in the project such as biologists, hydrologists, lawyers, etc. The new contingency plan involved heavy damage control and a go ahead on construction with significant changes in design and cost. As in this example, risk events that arise from the sources external to the project tend to cause more disruption than internal risk events. Contingency plans that respond to external events frequently involve new team players. Such player may be unfamiliar with the project organization and have goals in conflict with project goals, presenting still another problem. 

Contingency plans are designed to ensure that project goals are reached. Plans typically cover schedule, cost, and technical risks. Clearly, all projects are different and managers should choose those considerations that are relevant to their project.  

3.2.a. Schedule Risks

Use of Slack: When some managers see network slack, they cease to worry about completing their activity on time. Unfortunately that slack may be required for some other activity on the path that now must start later and leave little or no slack available because that path slack has already been used up. Managing slack can be an excellent method for reducing schedule risk. Use of slack moves more activities near their late start and thus the risk of project delay is increased. Two of the situations are examined below: 

Imposed Duration Dates: About 80% of all projects have imposed duration dates. Usually this means someone with authority has determined that the project or milestone can or must be completed by a specific date. Examples might be completing a road by January 1^st, or developing a video game before Christmas for the Christmas market. The specific project duration is frequently a top-down decision that does not include bottom-up planning and often understates the normal time required to complete the project. If this is the case then meeting the project specified date will result in activities being performed more rapidly then the normal, low cost method. This hurried approach increases cost and the chances of activities being late and reduces flexibility in the total scheduling system.  

Compression of Project Schedules: Sometimes before or midway through the project, need to shorten the project duration arises. Shortening project duration is accomplished by shortening one or more activities on the critical path. Shortening an activity increases the direct cost. In addition, compressing the critical path decreases total slack on other paths, and more paths become critical or near to critical. Some contingency plans could avoid costly procedures. For example, schedules can be altered by working activities in parallel or using start-to start lag relationships. Also, using best people for high-risk activities can relieve or lessen the chance of risk events occurring. 

3.2.b. Cost Risks

Given some of the cost overruns, cost risks are significant and carry heavy consequences. Most cost risks are created in schedule and technical estimate errors and omissions. In addition, some management decisions actually increase cost risks. A few selected cost risks found in practice are as follows: 

Time/Cost Dependency Link: There is a dependency link between time and cost and technical problems and cost. For example, if the activity “develop process prototype” requires 50% more time than the original estimate, it can be expected that the cost will also increase. Thus, time and cost do not occur independently. Neglecting to consider this interactive dependency can result in significant cost risk errors. 

Cost Flow Decisions: Some cash flow decisions can heighten schedule risks. For example, financial analysis will make comparison of early-start schedule versus a late-start schedule. Theoretically they conclude that by delaying activities, the future value of the money is greater the value today. Alternatively the money can be used elsewhere. The increased risk of reducing slack is sometimes ignored or significantly underestimated. Using schedule to solve problems should be avoided if possible; it should be done with clear recognition of an increase in schedule risk and the fact that late schedules usually result in higher costs.   

Final Cost Forecast: When the project is about 20% complete, managers are worried how close to the budget, when the project finishes. Because re-estimating all costs is too time consuming, there are three quick methods to this approach. 

1. The first method is used widely and it’s the most dangerous. This method compares budget versus actual cost at a particular point in time i.e. if the actual cost is 4% over budget to date, the conclusion is drawn that project completion cost would be 4% over the total budget. Experience shows that this is seldom true. The reason is that the estimates to date are in error by 4%, It is unlikely that the estimates for the remainder of the project would be better. In most cases the percentage over run increase as the project progresses towards completion.

2. Another more accurate and reliable approach is to forecast final project cost using the earned value concept. This model applies a cost performance index based on completed work to predict the costs remaining. The costs remaining plus actual costs to date predict the final project cost at completion.

3. Finally some analysts use S-shaped phenomenon of the cumulative project cost curve to forecast final project and cash flows. This approach uses complex statistical techniques that compare budget and actual costs to date to predict cost at completion. In the field, the cost forecasting risks with this model appear to be greater than with the models suggested earlier that depends on more reliable cost performance index.

Price Protection Risks: Project of long duration need some contingency for price changes, which are usually upward. The important point is that when reviewing price avoid using lump sum to cover price risks. For example if the inflation is running about 3%, some managers would add 3% for all resources used in the project. This lump-sum approach does not address exactly where price protection is needed and fails to provide for tracking and control. Price risks should be evaluated item-by-item. Some purchases and contracts will not change over the life of the project. Those that may change should be identified and estimates made of the magnitude of change. This approach ensures control of the contingency funds as the project is implemented.

3.2.c. Technical Risks

Technical risks are problematic; they can often cause the project to be shutdown. Contingency or backup plans are made for those possibilities that are foreseen. In addition to contingency plans, project managers need to develop methods to quickly assess whether technical uncertainties can be resolved. The use of sophisticated CAD programs have greatly helped to resolve design problems. It is suggested that one should identify the high-risk technical areas, then build models or design experiments to resolve the risk as quickly as possible. By isolating and testing the key technical questions early on in a project. In this way project feasibility can be determined and necessary adjustment made such as reworking the process or in some cases closing down the project. Usually the owner and the project manager make decisions make decisions concerning technical risks. 

3.3 Project Time Consideration: 

There are few circumstances in which a project manager or owner would not wish to reduce the time to complete a project. Reducing the time of a critical activity in a project can be done but almost always results in a higher direct cost; thus the manager faces a cost-time trade-off problem. Is the reduction in time worth? Cost time situation focus on reducing the critical path that determines the project completion date.

3.3.a. Project Costs

Project Indirect Cost: Indirect cost generally represent overhead costs such as supervision, administration, consultants and interest. Indirect cost cannot be associated with any particular work package or activity, hence the term indirect cost vary directly with time. That is any reduction in time, which should result in a reduction of indirect cost. For example, if the daily cost of supervision, administration and consultants were $2000, any reduction in project duration would represent a saving of $2000 per day. If direct costs are significant percentage of total project costs, reductions in project time can represent very real savings. (Assuming that indirect cost can be utilized somewhere else). 

Project Direct Cost: Direct costs commonly represent labor, material, equipment and sometimes subcontractors. Direct cost are assigned directly to a work package and activity, hence the term. The ideal assumption is that direct costs of an activity time represent normal costs, which typically mean low-cost, efficient methods for a normal time. When project durations are imposed, direct costs may no longer represent low-cost. Cost for the imposed duration date will be higher than for a project duration developed from ideal normal times for activities. The sum of the cost for all the work packages or activities represents the total direct cost for the project.

3.3.b. Shortening Project Time

Methods for shortening project time are limited. Reducing quality is one alternative that may reduce the time of an activity on the critical path. However, sacrificing quality is rarely an acceptable or used method. Another method for shortening the project time is to subcontract an activity the subcontractor may have access to superior technology or expertise that will accelerate the completion of the activity. Subcontracting also frees up resources that can be assigned to critical activity and can result in shorter project duration. This alternative has to be considered in the early planning stages, so it may not be a viable means for shortening the schedule at a late date. 

The most common method used for shortening the project time is to assign additional manpower and equipment to the remaining activities. There are limits, however, as to how much speed can be gained by adding manpower. The relationship between manpower and progress is not linear. Doubling the size of the work force will not necessarily reduce completion time by half. The relationship would be correct only when tasks can be partitioned so no communication is needed between workers, as in harvesting a crop by hand. Sometime it is better to add extra manpower in the early stage in the schedule than adding it later, because new people always have an immediate negative effect on progress.

It is sometimes possible to rearrange the logic of network so that critical activities are done in parallel rather than sequentially. This alternative is good one if the situation is right. Changing the activities form sequential to parallel requires closer coordination among those responsible for the activities affected. Finally another common method for meeting critical deadlines is to reduce the scope of the project. Care should be taken in reducing the scope of the project to accelerate progress so that essential requirements are not compromised.

3.3.c. Project Cost-Time Graph

1.  Find total direct cost for the selected project durations.

2. Find total indirect costs for selected project durations. 

3. Sum direct and indirect costs for these selected durations.

The most difficult task in constructing a cost-time graph is finding total direct costs for specific project duration over a relevant range. The central concern is to decide which activities to shorten and how far to carry the shortening process. Basically managers need to look for critical activities that can be shortened with the smallest increase n cost per unit time. Knowing the slope of activities allows manages to compare which critical activities to shorten. The less steep the cost slop of an activity, the less it cost to shorten one time period; a steeper slope means it will cost more to shorten one time unit. The cost per unit of time or slope for any activity is computed by the following equation:

Cost of slope  =   Rise         =  Crash cost – Normal cost      =  CC - NC

                             Run             Normal time – Crash time          NT - CT

From the figure 3.01, computing the cost per unit time as above equations:

Cost of slope  =  $800 - $400     =   $400     =  $80 per unit of time

                               10 – 5                   5

 3.4 Kinds of Resource Constrains 

People: This is the most obvious project resource. The skills they bring to the project – For example, programmer, mechanical engineer, welder, inspector, marketing director, and supervisor usually classify human resources. In rare cases some skills are interchangeable, but usually with a loss of productivity. The many different skills or human resources add to the complexity of scheduling project.

 Materials: Material shortage has been blamed for the delay of many projects. When it is known that a lack of availability of materials is important and probable, materials should be included in the project network plan and schedule. For Example, delivery and placement of an oil Rig tower in Siberian oil field has a very small time window during one summer month. Any delivery delays means one year. Scheduling materials ahs also become important in developing products where time-to-market can result in loss of market share.

 Equipment: Equipment is usually presented by type, size quantity. In some cases equipment can be interchanges to improve schedules, but this not typical. Equipment is often overlooked as a constraint. The most common oversight is to assume the resource pool is more than adequate for the project. For example, if the project needs one earth-moving tractor six month from now and the organization owns four, it is common to assume that the resource will not delay the pending project. However when the earth-moving tractor is due on site in six months, all four machines in the pool might be occupied in the other projects. It is therefore prudent to use a common resource pool for all projects. This approach forces a check of resources availability across all projects and reserves the equipment for specific project needs in the future.

 Working Capital: In a few projects situations such as construction, working capital is treated as a resource because it is limited in supply. If the working capital is readily available, a project manager may work on many activities concurrently. If the working capital is in short supply because progress payments are made monthly, materials and labor usage may have to be restricted to conserve cash flow problem.