Tools for Managing Project Risks

No construction project is risk free. Risks need to be carefully identified, defined, analysed and allocated to the parties involved on the project. The contracting arrangements should allocate risks. The steps need to be undertaken to mitigate the impact of the risk and its consequences upon the program and the out turn cost.

Following are the risk management tools:

1. Early Warning Notices (EWN)
2. Program
3. Target Cost Arrangement + Pain / Gain mechanism
4. Key Performance Indicators (KPIs)
5. Monthly Reporting
6. Supply Chain Management.

1. Early Warning Notices

The Contractor and the Project Manger give an early warning by notifying the other as soon as either becomes aware of any matter which could:

• Increase the contract price
• Delay completion or meeting a key date
• Impair the performance of the works in use.

The Project Manager enters early warning matters in the Risk Register. Early warning of a matter that has already been notified as a claim for money and time does not need to be notified as a separate early warning. The Project Manager or the Contractor may instruct the other to attend a risk reduction meeting. In the risk reduction meeting each may instruct other people to attend if the other agrees. This could include instructing the Employer, other consultants, other contractors and any of the sub-contractors to attend.

At risk reduction meetings, the attendees co-operate in making and considering proposals for how the effect of the registered risks can be avoided or reduced. The solutions are sought and decisions are made on actions and who would take them. The risks which have already been avoided or passed can be removed from the risk register.

The Project Manager revises the Risk Register to record the decisions made at a risk reduction meeting and issues the revised Risk Register to the Contractor. If a decision made at a risk reduction meeting needs a change to the Specification/Employer’s requirements, the Project Manager issues a variation at the same time as he issues the revised Risk Register to the Contractor. The Project Manager gives an instruction as a variation in accordance with contract. The variation mechanism and the valuation rules in the contracts would apply to the variation.

The EWN process works well, if each and every contractor, consultant and supplier has the same mechanism in its contract in order for the risks to be notified up and down the supply chain. The Contractor should have these mechanisms in its supply chain contracts otherwise the Contractor will never know (until it is too late) the risks faced by its supply chain or have any chance to help reduce or avoid risks. The EWN should not be seen as a pre-cursor to claims but a process for managing risk during the project lifecycle.

2. Program

The intention of a detailed program is to:

• Manage and monitor the progress of the works;
• Manage any interfaces between the Contractor and any other contractors the employer may have employed in respect of other projects and
• To assess changes to the time for completion and any key dates/milestone dates arising out of claims for delay under the contract.

The program is an important document for the management of works and as a reporting tool on the progress of the works. The program should indicate float, time risk allowance and terminal float.

The Contractor shall submit a detailed time program to the Employer within 28 days after receiving a notice. The Contractor shall also submit a revised program whenever the previous program is inconsistent tithe actual progress or with the Contractor’s obligation. Each program shall include:

• The order in which the Contractor intends to carry out the works including the anticipated timing of each stage of design (if any), contractor’s documents, procurement, manufacturer of plant, delivery to site, construction and testing
• Each of these stages of work by each nominated sub contractor, the sequence and timing of inspections and tests specified in the Contract, and
• A supporting report which includes a general description of the methods which the contractor intends to adopt and the major stages in the execution of works and details showing the Contractor’s reasonable estimate of the number of contractor’s equipment required on the site for each major stage.

Unless the Engineer, within 21 days of receiving a program gives notice to the Contractor stating the extent to which it does not comply with the contract, the Contractor shall proceed in accordance with the program, subject to his other obligations under the contract. The Employer’s personnel shall be entitled to rely upon the program when planning their activities. The Contractor shall promptly give notice to the Engineer of specific probable future events or circumstances which may adversely affect the work, increase the contract price or delay the execution of the works The Engineer may require the Contractor to submit an estimate of anticipated effect of the future event or circumstances and/or a proposal.

If at any time, the Engineer gives notice to the Contractor that a program fails to comply with the Contract or to be consistent with the actual progress and the Contractor’s stated intentions, the Contractor shall submit a revised program to the Engineer.

3. Target Cost Arrangements + Pain / Gain Mechanism

It is commonly used on complex infrastructure projects, where the parties share the price risk through the pain / gain share mechanism. The Contractor is financially rewarded and effectively incentivised to find saving on high risk project. If the Contractor is incentivised to generate savings (and the savings are split equally under the pain / gain share mechanism) then the employer will also save money.

Typically under the target cost contract the Contractor is paid his actual costs to execute the works until such time as the pain/gain share is calculated at the end of the project. The actual cost will consist, namely, staff and labour resources, plant, material, equipment, preliminaries, other pre-defined costs (utility costs, licence costs, import costs to name a few) and a fee (to cover the Contractor’s profit).

The fee element may be a fixed fee or a variable fee. If the fee is treated as a fixed fee (this will be adjusted in the same way as the contract price (i.e. the target cost) as the fee is fixed to the duration of the Program.

If the fee is variable, this is a percentage against the actual costs. Typically Employers do not like fees which are variable as it encourages the Contractor to increase its actual costs as this will in turn increase its fee entitlement. This is more likely to be the situation if the target cost is unrealistic.

FIDIC do not publish a form of target cost contract. Therefore conditions of contract would need to be bespoke to deal with this type of arrangement.

Practical considerations for Target Cost arrangement are as follows:

• The target cost and the share percentage will need to be agreed. This is likely to be achieved in a mini-tender environment but may be more time consuming if a contract is awarded directly to the Contractor
• The target contract price is adjusted in the same way as a contract price is adjusted under a lump sum fixed price contract. For a target cost arrangement to work effectively, the target cost should be realistic or there is a risk of it being too low or over-inflated, bearing in mind the nature of the works to be executed under the contract.
• If the target cost is too low, the Contractor will not be able to make cost efficiencies and will, inevitably, look to find other ways to save costs. This may result in poor workmanship of the completed works. This is likely to be the case if the target cost contract operates as a guaranteed maximum price contract (where the contractor is liable to pay 100% of any cost overruns if the actual costs exceed the target cost.
• If the target cost is over-inflated, the Contractor may be rewarded even where it has not made any cost efficiencies or generated any savings in executing the works
• The costs the Contractor can recover as part of its actual costs has to be clear in order for the Contractor to know which costs it will be paid as for the Engineer to know the items of costs they may certify as payable to the Contractor.
• The Contractor’s actual costs are recorded on an open book basis. The Engineer will need to audit the Contractor’s record in order to verify the Contractor’s actual costs. This should include any of the costs the Contractor incurs to its sub-contractors (this may be time consuming and quite labour intensive for the Engineer to administer a target cost contract).
• The Contractor is normally paid his actual costs even if they exceed the target cost. The costs reconciliation is not normally undertaken until the reconciliation of the final actual costs against the target cost during the Final Account stage. In this case the Employer would need to be satisfied it can recover any cost overruns from the Contractor pursuant to any bonds/guarantees.
• Will the Employer be looking to limit its liability for any savings it may wish to pay the Contractor through the pain/gain mechanism? This type of mechanism is frequently requested by employer clients. However, if such a provision is included it may be counter-productive as the Contractor is not encouraged to generate savings it may otherwise have made if it will not receive any financial benefit for any saving/efficiencies made.

The advantages of target cost arrangements are:

• The aim of a target cost contract is to share the cost risk on complex infrastructure projects between the Employer and the Contractor.
• If the target cost is appropriately set a target cost contract may help the Employer generates cost saving and achieve value for money

The disadvantages of target cost arrangements are:

• Target cost contracts are not suitable where the scope of works is likely to change as the target cost may be over-inflated to compensate for the number of variations issues
• May be time consuming to agree the target cost due to the fact that if the target cost is incorrectly set, the Contractor pays for the cost overruns
• Labor intensive to administer a target cost contract due to time required to audit and verify the costs.

4. Key Performance Indicators (KPIs)

KPIs are frequently used in an attempt to incentivise the Contractor as opposed to penalising the contract through sanctions in the contract. We see incentive schedules being developed to focus on the objectives of the Employer to include:

• Incentives for meeting stages of the works by milestones dates or none time related activities
• Incentives for no breach of health and safety or accidents on site
• No defects at take-over or during the defect liability period
• Completing work under budget (where KPI regime is used similar to a pain / gain share mechanism)
• Training / knowledge transfer to the client.

A contractor may want to consider the impact on the KPIs (especially where there is a date and payment attached to it for meeting it) where:

• Delays occurred caused by risks carried by the Employer
• Suspensions instructed by the Employer
• Termination by the Employer, especially if there is a termination at will clause.
• Breach or act of prevention caused by the Employer

5. Monthly Progress Reports:?

Following consideration should be given in the preparation of monthly progress reports:

• Remove away from traditional, largely narrative type reports
• Report data driven and graphical – colour photographs showing the stages of the work at dates
• This helps to reduce the size and improve overall readership.

The reports cover:

• Achievement to date
• Goal so far
• Key issues for resolution

Executive matters included are:

• Health and safety
• Environmental
• Security incidents
• Insurance claims
• Stakeholder relations

Besides, scheduled performance and cost performance indicators are included in the reports.

6. Supply Chain Management

It includes:

• Influencing critical procurement pre-award and then through monitoring seeking to highlight and mitigate supplier failure post award
• Requesting completed procurement schedules for sub contracted work from Contractors
• Competitive tendering / evaluation criteria
• Mandating the use of tier-2 conditions of contract prepared by the Employer
• Monitor solvency of the Contractor’s supply chain.