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What is so risky about risk: a sketch of risk in the construction industry
Risk is not a rare word in the construction industry at all. In this article, it firstly begins with the discussion of the importance of choosing the definition of risk. Then different ways of defining risk are introduced. An analysis of risk categories in the construction industry is comprehensively conducted from different perspectives. Some practical matters are then addressed at the end.
Overall, this article aims at revisiting risk in the construction industry by addressing some root questions and providing some new insights for this topic.
1. Why is it important to choose your definition of risk?
To begin with, there is no one singe correct and advanced definition of risk among all. As highlighted by Fischhoff et al. (1984), there is no single definition of risk that could be suitable for all problems and applied to every scenario. Instead, defining risk is a political choice, which reflects someone’s views regarding to the importance of different adverse effects in a special situation.
Thus, to develop a definition of risk is also to make series of explicit value judgements. From another perspective, by looking at someone’s choice of defining risk, we can also tell his/her explicit value judgements and the priority among different adverse effects.
2. Brief of risk analysis history and the definitions of risk
Even the formal discussion and definition of risk only start in modern studies, the first recorded risk analysis dates far back to 3200 B.C. in Tigris-Euphrates valley, where the priest-like Asipu would recommend the most favourable choice among all the alternatives for local people to make a wise decision for a forthcoming risky venture, like a windy and/or rainy day in which hunting is more difficulty, etc.
In modern risk analysis, with the help from Blaise Pascal’s seminal work in probability theory and the scientific methods for identifying causal relationship rather than correlations only, researchers in risk management after 18th century started expressing their analysis and results in terms of mathematical probabilities and confidence intervals instead of trying to read the signs of the God like priest-like
Asipu used to do (Covello & Mumpower, 1985). Thus, modern risk analysis has its twin roots in both mathematical theories of probability, and the scientific methods for identifying causal relationship.
In 20th century, one of the most famous definitions of risk is from Frank Knight (1921). He tried to clarify the most important debate during the time, which is the subjective versus objective interpretations of the probability. According to objective interpretations, probabilities are real, while the subjective interpretations see probabilities as somethings created by human and can be different to subjective views. According to subjective interpretations, probabilities are human beliefs. They are not intrinsic to nature. Individuals specify them to characterise their own uncertainty. Frank claimed that we may discover probability by logic or estimate them through statistical analyses.
Frank Knight (1921) wrote from the competing objectivist perspective. He believed that propositions have intrinsic probabilities of being true or false. Probabilities may seem to depend on an observer’s particular lack of information, but Frank Knight (1921) distinguished between necessary and mere factual ignorance and distinguished between probabilities obtained in the following two manners as well.
- A priori probabilities are derived from inherent symmetries, as in the throw of a die.
- Statistical probabilities are obtained through analysis of homogenous data.
In the former the “chances” can be computed on general principles and logic, while in the latter one, probabilities can only be determined empirically based on historical data.
Frank Knight (1921) didn’t define risk directly but still had influence on the following researchers by making the distinctions between risk and uncertainty. The practical difference between risk and uncertainty is that the distribution of the outcomes in a group of instances is known for risk while it is not true for uncertainty. Thus, either the group of outcomes or the probabilities for the outcomes are unknow for uncertainty. However, both the outcomes and their probabilities are known for risk, either through calculation a priori or from statistics of the past experience. While in the case of uncertainty it is not true. The general reason is that it’s impossible to form a group of instances, because the situation dealt with is in a high degree unique and thus less information is available.
Under the discussions of Frank Knight (1921), risk could be defined and calculated as the result of Probability (a statistical probabilities obtained through analysis of homogenous data) of the occurrence of a defined event times the Consequences of the occurrence of that event, or R=P*C. This definition is still very popular in studies in the recent decades.
In the late 20th century, researchers in risk management switched their attention from the previous health and life issues to risk analysis in financial problems (Holton, 2004).
Since 21st century, risk analysis becomes popular in other disciplines, including construction project management. Different definitions of risk from various professional bodies are summarized in the Table 1 shown below.
Table 1. Definitions of risk from different professional bodies and studies
|
Resource |
Time |
Definition of Risk |
| The Orange Book-Management of Risk-Principles and Concepts
by UK Government |
2023 | Risk is the effect of uncertainty on objectives. Risk is usually expressed in terms of causes, potential events, and their consequences:
|
| PMBOK 7th Edition
by PMI |
2021 | Risks are an aspect of uncertainty. A risk is an uncertain event or condition that, if it occurs, has a positive or negative effect on one or more project objects. |
| NRM1, 3rd Edition
by RICS, UK |
2021 | A probability or threat of liability, loss or any other negative occurrence that is caused by external vulnerabilities, errors, or oversights and that may be avoided by pre-emptive action. |
| APM Body of Knowledge 7th Edition by APM | 2021 | The potential of situation or event to impact on the achievement of specific objectives. |
| ISO 37000:2018 Risk management | 2018 | The effect of uncertainty on objectives. This can include
the organization’s purpose, vision, and values as well as the goals and targets articulated at different levels in the organization. They can also include the factors that are important to a particular decision. |
| Management of Risk 1st Edition by RICS | 2015 | A risk can be defined as an uncertain event or circumstance that, if it occurs, will affect the outcome of a programme/project (note that where this guidance note refers to a project it could also refer to a programme). |
| ISO Guide 73:2009, British Standard | 2009 | Risk is effect of uncertainty on objectives. An effect is a deviation from the expected — positive and/or negative. Objectives can have different aspects (such as financial, health and safety, and environmental goals) and can apply at different levels (such as strategic, organization-wide, project, product and process). Risk is often characterized by reference to potential events and consequences, or a combination of these. Risk is often expressed in terms of a combination of the consequences of an event (including changes in circumstances) and the associated likelihood of occurrence. |
| ISO/ICE Guide 73:2002 | 2002 | Risk is a possible future event combining the probability or frequency of occurrence of a defined threat or opportunity and the magnitude of the consequences of that occurrence. |
| Management of Risk: Guidance for Practitioners, OGC | 2002 | Uncertainty of outcome (whether positive opportunity or negative threat). It is the combination of the chance of an event and its consequences. |
| British Standard No. 4778 | 1991 | A combination of the probability, or frequency, of occurrence of a defined hazard and the magnitude of the consequences of the occurrence. |
From the definitions shown above, it is clear to see the influence of Frank Knight (1921) in the early days as these definitions pay attention to both the chance of an event and its consequences. Then the definitions of risk after could be divided into two general categories, including: 1) treating risk with neutral view; and 2) treating risk from a negative view. The definitions in the first category propose that risk can have either positive or negative effects on achieving objectives while the ones in the second category take risk as something that will lead to loss or any other negative occurrence.
These definitions confirm what has been discussed in the first part of this article, which is the definition of risk is a political choice that reveal someone’s explicit values and judgments. Thus, it is worthy to reach a mutual understanding of risk during the communication as risk may mean one thing for this person while mean a different thing for another person. This has often been ignored in a conversation.
3. Categories of risk in the construction industry
Same as the definition of risk, there are various ways of categorizing risk in the construction industry. Some of the categories are made based on the cause of risk, some of the categories are made based on the party who takes the risk, some of the categories are made based on the consequences of the risk, etc. While there are also categories made based on the practical ways of doing it from the industry empirically. I often find the categories from the practice seem random on the first sight while realize that there is explicit logic buried deep down, which could only be discovered if industry people pause and ask themselves or being asked by us from academic. From the basis of which the categories are made, it is also clear to see the emphasize made by the party for risk management.
The following review of risk categories in the construction industry is made based on the timeline as some of the categories are harder for me to directly tell the embedded logic and basis behind it.
Moon et al. (2022) identified seven risk categories from a literature review. The categories and the definition for each are shown below.
- Payment: Payment or compensation for a certain task. It is about the payment or compensation of the construction project.
- Temporal: Temporal statement (e.g., duration) for a certain task. It corresponds to clauses concerning the deadline or due date.
- Procedure: Methods and steps for a certain task. The ‘procedure’ is relevant to most of the clauses in the specification, including the methods and steps for testing, working, finishing, and referencing.
- Safety: Safety issue for a certain task. ‘Safety’ clauses describe safety precautions as well as safety tools and installations.
- RNR: Role and responsibility for a certain task. The ‘role and responsibility’ is linked to the roles and responsibilities of engineers, contractors, or other project participants.
- Definition: Definitions and terminologies. The ‘definition’ matches clauses about definitions of and terminologies concerning objects, materials, tests, references, and organizations.
- Reference: Code, regulations, or other referral documents. ‘Reference’ clauses indicate the documents referred to within the specification.
Faraji et al. (2021) classified risk into Cost, Schedule, Quality, Safety, Environment. They have also analysed the obligations specified in the contract documents. It is clear that their emphasis of risk management is on the consequences of risk.
Khalef et al. (2021) classified risk by the party of which risk is taken. It is worthy to mention that they have done the risk related to contract document specifically. It includes: Complementarity of the drawings and specifications, Discrepancy between electronic and printed versions of the contract documents, Unenforceability of any contract document provisions under the legal system, Verification of figures and field measurements in relation to the contract documents, Review of contract documents, Reporting discrepancies, Resolving discrepancies, Requirements of the contract documents, Decision on the requirements of the contract documents, Inability to provide a decision or interpretation in relation to the contract documents.
Lee et al. (2020) categorized the following contractor-friendly clauses in the project and paid attention to what are the missing contractor-friendly clauses in contract documents. The clauses are categorized as follows.
- Assignment: A condition that neither party shall assign the whole or any part of the contract or any benefit or interest in or under the contract.
- DSC (Differing site conditions): A condition under which the contractor is responsible for the site conditions only to the extent that is practicable (taking account of cost and time).
- Employer’s financial arrangement: A condition that the employer shall submit reasonable evidence that financial arrangements have been made and are being maintained that will enable the employer to pay the contract price.
- Adjustment for changes in legislation: A condition that the con- tract price shall be adjusted to take account of any increase in cost resulting from a change in the laws of the country.
- Payment: A condition that if the contractor does not receive payment, the contractor shall be entitled to receive financing charges.
- Extension of time for completion: A condition that the contractor shall be entitled to extend the time for completion if some exceptionally adverse conditions happen.
- Settlement of dispute: A condition that any dispute between the parties shall be finally settled by arbitration, not the decision of employer’s side.
- Variation: A condition that the contractor can give notice to the engineer stating that the contractor cannot readily obtain the goods required for a variation.
- Limitation of liability: A condition that the total liability of the contractor to the employer shall not exceed the accepted con- tract amount.
Lee et al. (2019) identified 11 risk categories, including: Differing site conditions (DSC), assignment, delay, delays by authorities, priority of documents, payment, settlement of disputes, right of access to the site, adjustments for changes in legislation, contractor’s claims, and termination-related poisonous clauses.
Artan Ilter and Bakioglu (2018) focused on subcontracting contract and identified eight risk factors from the literature review. The risks they have identified and defined are shown below.
- Subcontractor risks: Insufficient manpower or personnel, insufficient material/machinery/equipment, risk related to coordination of subcontractor’s vendors, subcontractor’s cash flow risks, compliance with the health and safety environment (HSE) rules, compliance with contract rules, risks related to quality problems in subcontractor’s work, risk related to subcontractor’s management performance, risk related to technical sufficiency and experience of subcontractor, and risk related to quality control and assurance performance of subcontractor.
- Contractual risks: Ambiguity in definition of responsibilities in the contract, inconsistencies in contract clauses, scope and variations risk in the contract, harsh penalty clauses, risks related to applicable law in the contract, and excessive amendments to general conditions of the contract.
- Financial risks: Currency-parity risk, fluctuation of material/ equipment/labor prices, macroeconomic risks (country risk), cost estimation error risk, insufficient insurance risk, owner’s insufficient financial resources, low offer risk, and interruption in project financing or incentives.
- Permit and approval risks: Delays in permits and approvals, complicated permit procedures.
- Site risks: Unforeseen ground conditions, delays due to extremely bad weather conditions, natural disaster risk, archaeological remains risk at site, requirement for infrastructure displacement at site, risk related to groundwater level, insufficient site investigations and lack of site information, and delay in site handover.
- Construction risks: Planning and delay risk, insufficient site organization and coordination, risks due to using improper construction technique, risks in the supply of raw materials, risks in the supply of material/machinery/equipment problem, occupational safety risk, acceleration request of owner, and import and export restrictions risk.
- Design risks: Design variations risk, design defects risks, insufficient technical specifications, design approval delay risk, and missing drawings and technical specifications.
- Regional risks: Political risks (war or terrorist attack risk), legal strike, and transportation and shipping risk
Zou et al. (2007) ascertained 25 key risks based on the questionnaires collected in the construction industry in China. They have combined the stakeholder analysis, objectives of project, and risk management together. The risk analysis framework is shown below in Table 2.
Table 2. Risk analysis framework
|
Category of risks |
The 25 key risks identified | With significant impact on | ||||
| Cost | Time | Quality | Safety |
Environment |
||
| Risks related to clients | Tight project schedule |
✅ |
✅ | ✅ | ✅ |
✅ |
| Project funding problems |
✅ |
✅ | ✅ | ✅ | ✅ | |
| Variations by the client |
✅ |
✅ | ✅ |
✅ |
||
| Risks related to designers | Design variations |
✅ |
✅ | ✅ | ||
| Inadequate program scheduling |
✅ |
✅ |
||||
| Inadequate site information (soil test and survey report) |
✅ |
✅ |
||||
| Incomplete or inaccurate cost estimate |
✅ |
|||||
| Risks related to contractors | Contractors’ poor management ability |
✅ |
✅ | ✅ | ✅ |
✅ |
| Contractors’ difficulty in reimbursement |
✅ |
✅ | ✅ | ✅ |
✅ |
|
| Poor competency of labourer |
✅ |
✅ | ||||
| Unavailability of sufficient professionals and managers |
✅ |
✅ |
||||
| Without buying insurance for major equipment |
✅ |
|||||
| Without buying safety insurance for employees |
✅ |
|||||
| Inadequate safety measures or unsafe operations |
✅ |
|||||
| Lack of readily available utilities on site |
✅ |
|||||
| Unavailability of sufficient amount of skilled labourer |
✅ |
|||||
| Prosecution due to unlawful disposal of construction waste |
✅ |
|||||
| Serious air pollution due to construction activities |
✅ |
|||||
| Serious noise pollution caused by construction |
✅ |
|||||
| Water pollution caused by construction |
✅ |
|||||
| Risks related to subcontractors/suppliers | Low management competency of subcontractors |
✅ |
||||
| Suppliers’ incompetency to deliver materials on time |
✅ |
|||||
| Risks related to government agencies | Bureaucracy of government |
✅ |
✅ |
|||
| External issues | Excessive procedures of government approvals |
✅ |
✅ |
|||
| Price inflation of construction materials |
✅ |
✅ |
||||
Different from China, UK has different business environment for the construction project. Bing et al. (2005) created a risk checklist based on the construction projects in the UK, which is shown in Table 3.
Table 3. Risk checklist for UK construction projects
|
Risk meta-level |
Risk factor category group |
Risk factor |
| Macro level risks | Political and government policy | Unstable government |
| Expropriation or nationalisation of assets | ||
| Poor public decision-making process | ||
| Strong political opposition/hostility | ||
| Macroeconomic | Poor financial market | |
| Inflation rate volatility | ||
| Interest rate volatility | ||
| Influential economic events | ||
| Legal | Legislation change | |
| Change in tax regulation | ||
| Industrial regulatory change | ||
| Social | Lack of tradition of private provision of public services | |
| Level of public opposition to project | ||
| Natural | Force majeure | |
| Geotechnical conditions | ||
| Weather | ||
| Environment | ||
| Meso level risks | Project selection | Land acquisition (site availability) |
| Level of demand for project | ||
| Project finance | Availability of finance | |
| Financial attraction of project to investors, High finance costs | ||
| Residual risk | Residual risks | |
| Design | Delay in project approvals and permits | |
| Design deficiency | ||
| Unproven engineering techniques | ||
| Construction | Construction cost overrun | |
| Construction time delay | ||
| Material/labour availability | ||
| Late design changes | ||
| Poor quality workmanship | ||
| Excessive contract variation | ||
| Insolvency/default of sub-contractors or suppliers Operation cost overrun | ||
| Operation | Operational revenues below expectation | |
| Low operating productivity | ||
| Maintenance costs higher than expected | ||
| Maintenance more frequent than expected | ||
| Micro level risks | Relationship | Organisation and co-ordination risk |
| Inadequate experience in PPP/PFI | ||
| Inadequate distribution of responsibilities and risks | ||
| Inadequate distribution of authority in partnership | ||
| Differences in working method and know-how between partners | ||
| Lack of commitment from either partner | ||
| Third party | Third Party Tort Liability | |
| Staff Crises |
4. Implications for the industry
By revisiting some root questions related to risk management in the construction industry, I hope to address the following attentions and implication for the industry while doing risk management in construction project.
- It is worthy to have mutual understandings of how to define risk among the parties while doing risk management. Defining risk reflects someone’s value judgements explicitly.
- Risk should be treated neutrally as it can have either positive or negative effects on achieving objectives (my own preference of defining risk is clearly shown here).
- Perspective should be clarified while conducting risk management. It could be from the perspective of client, main-contractor, sub-contractor, or project as a whole entity. A positive effect on one side could be a negative effect on another side. Thus, the position should be made clear from the very beginning.
- The categories and/or checklist for risk could be combined with stakeholder management, project lifecycle, project objectives management, etc.
- It is always worthy to pause and ask why questions. It not only reminds us of where we come from, but also guide us to where we are heading to.
* The article originally published in Latvaian, for law journal “Jurista vārds” June 2024, No 25/26 (1343/1344)
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