Appropriate risk allocation on major construction projects goes a long way to helping avoid cost overruns, delays and disputes.
THE success, or otherwise, of resources projects will have a significant bearing on Australia’s economic growth over the next decade.
It is surprising, therefore, that at a time of headline grabbing cost blow-outs on major Western Australian projects, the industry still has not come to terms with how it manages risk. Unless these approaches to risk are addressed, industry in WA will continue to operate below its peak potential, which will have significant effects on our economy.
A huge amount of construction work will be undertaken in WA in the short to medium term. This is underpinned by a large number of large resource projects. As at April 2011, more than $173 billion worth of resource projects were planned or committed in WA over the next few years.
With such large numbers of projects in the pipeline, and with limited funding and resources available, it is important that they are carried out as effectively and efficiently as possible.
Recent research undertaken by Blake Dawson into construction, infrastructure, energy and mining projects has revealed that about one in three projects has inappropriate risk allocation, which leads to increased cost overruns, delays and disputes.
For example, 58 per cent of contractors felt that all, or the majority of, risk was imposed on them and 43 per cent thought the risk allocation was inappropriate.
Although the research focused on developing a better understanding of risk identification, a key finding was that, despite some improvement in the industry’s approach to risk, there were several areas of concern, including:
• in 30 per cent of projects, key risks were first identified after contract signing had occurred; even more concerning, in 10 per cent of projects, no formal risk identification process was undertaken at all; and
• in projects where formal risk identification processes were undertaken, they were considered ineffective in more than one third of cases.
These findings are quite concerning and the research identified the following real consequences.
• Of the projects that experienced cost overruns as a result of inappropriate risk allocation, almost one third experienced a cost overrun of more than 20 per cent. The scale of this adverse outcome is illustrated by projects with a value of more than $1 billion;10 per cent of these projects reported cost overruns of more than $200 million.
• Of the projects that were late due to inappropriate risk allocation, more than one quarter experienced delays of 12 months or more.
In the most extreme cases these cost overruns can result in projects closing and owners or contractors going insolvent. What is comforting is that this is an issue that can be resolved if we can understand where and why industry is going wrong.
As an engineer and a lawyer, I have seen that it is not through a lack of trying that industry is getting the allocation and management of risk wrong.
The research comments on a blinkered black-and-white approach to risk allocation where the party with the stronger negotiating position forces as much risk as possible onto the other party. While a negotiating team may be applauded for this approach when a contract is signed, I have seen that allocating risk in this way can have significant consequences over the life of a project as the party bearing all of the risk struggles to manage it effectively.
Another example of poor risk allocation is with the type of delivery method that owners select. The majority of resources projects in WA use an approach under which the engineer produces a design and also manages the purchasing of equipment and construction.
However, the research indicates that in recent years only 13 per cent of projects that use this approach were delivered on time and budget. This suggests the industry should be thinking a lot more about the best approach for a particular project before simply adopting the norm.
It is not enough to deal with risk only when negotiating contract documents or to pre-determine how risks should be allocated based on past deals. Parties should step back and try to identify all the risks that could delay or impede successful delivery of the particular project and then plan how to deal with them – by taking pre-emptive action to reduce them or most efficiently and effectively allocating, pricing and managing the risks.
Of course, the appropriate treatment of risk for each project will be different, depending on a variety of factors unique to that project.
Managing risk during a project is as important as the selection of the delivery method. Less than a quarter of projects that do not have, or do not apply, effective risk policies and procedures will be completed on time, budget or to the required quality.
My advice would be to get the right people involved at the outset, and keep them involved over the life of a project. These people will be familiar with the contract and will be able to effectively communicate and implement risk strategies to reduce the impact of risks when they occur. Giving these people sufficient time and budget to continue to focus on monitoring and managing risk throughout project delivery is critical.
Finally, once projects are completed, project experiences should be captured.
Improving the efficiency of construction, infrastructure, energy and mining projects will ultimately benefit us all. The economy will benefit as more projects are delivered on time and budget, contractors develop more positive relationships with their clients, and financiers have certain and consistent project outcomes.
A big part of improving such efficiency is learning how to manage risk in a more mature and sophisticated manner.
• William Coulthard is a construction partner at Blake Dawson.