Risk Management in Cost Engineering[39457]

Risk Management in Cost Engineering 1.0 Introduction Risk management is defined as the identification, evaluation, and prioritization of uncertainty on objectives. All novel engineering activity involves a degree of risk and the professional cost engineer is well-placed to be involved in initiating, developing and carrying out processes to ensure effective risk management. This paper is based on methods used on large oil & gas projects and may be useful in other industries, where budget, schedule, health, safety and the environment are critical.

Risk management should be applied in the control of costs, from establishing the control estimate, the project schedule and change control, to delivery and lessons learned. Risks are not only negative: positive risks or opportunities should also have emphasis. The risk management process must involve all project stakeholders at all levels.

Risk can be minimised by the use of decision gates. Prototypes are used in product development to develop ideas at low cost. In large project development, a Front End Engineering Design is often completed before commitment to detailed design. Subsequent decision gates are approved for distinct project phases, for example, before start of manufacture or construction.

There are two main risk management evaluation approaches: Qualitative and quantitative methods.

Qualitative methods are used for identifying and assigning priorities for health, safety and environmental risks and project risk registers (see fig.1). They are easier for non-experts to understand and thereby encourage participation.

Quantitative methods are used for determining the size of cost and schedule contingencies using statistics.

2.0 The Control Estimate Cost control starts with the estimate and the consideration of risk. For small or repetitive projects of which the estimator has reasonable experience, a standard percentage may be applied to cover contingency.

For large or critical projects a quantitative risk process, with a band of values for each estimate item, could be used to determine the contingency A typical issue at this stage, when limited time is available, is that priority has to be given to technical input from engineering, leaving insufficient time for the estimator’s work and proper checking procedures.

Corporate management will have its own risk appetite depending on corporate policy, conditions of contract, and external market competition, which will affect the estimator’s approach. The estimator should be aware of this systemic or organisational risk, particularly if it is perceived by corporate management that the estimate is too high for the project to go ahead, or that it will be lost to a lower bidder. Unless this risk is properly considered, it may be interpreted as undue pressure on the estimator to reduce the estimate.

Risk Management in Cost Engineering Fixed price contracts, where possible, rely on requisitions converted to fixed price purchase orders to minimise risk.

When the estimate is finalised and approved, the estimator liaises with cost and planning engineers, to develop and maintain regular reporting.

3.0 Project Execution A crucial project control appointment at the start of a project is that of a Risk Manager.

A valuable initial introduction within the project management team is to carry out a SWOT analysis, to identify the project strengths, weaknesses, opportunities and threats, and to review lessons learned from previous projects.

Next is to compile a risk register. An effective approach is to hold a facilitated meeting of managers and lead engineers, starting with a brainstorming session where participants discuss and record ideas and post these on a meeting board.

Participants are then free to move and group comments which can be developed into more specific risk definitions. A useful technique is to agree two-part statements: IF followed by THEN, to define the risk followed by the possible impact. Both budget and schedule must be considered.

The IF statement is also useful in identifying occurrences which might trigger risks. For example: If there is bad weather, then the tower crane could become a hazard. A wind speed could be determined at which crane operations would be required to cease.

The next stage is to score each risk. An example of a risk matrix or heat map is shown in figure1. Risks are assigned a number which is placed in each square of the matrix and coloured according to priority, taking account of probability and severity. The result is the first draft of a risk register for approval from stakeholders in the management team, then an explanation to project team members from technicians upwards. Opportunities also need to be considered, but may be managed separately.

Risk Management in Cost Engineering

Figure 1: Risk Matrix

A risk register review becomes an important part of regular management meetings and reporting. For each risk, a risk owner is appointed from the management team. The owner categorises the risk action as follows: Avoid

– eliminate or transfer (e.g. insurance)

Reduce - take action to reduce probability Mitigate - take action to reduce impact Accept

- take no action and provide for occurrence

4.0 Cost and Planning Reporting The cost engineer prepares the man-hour and cost reports, recording current budget from the approved estimate, approved changes, potential changes, commitment, expenditure, forecast cost and variance. The potential changes are derived from discussions with lead engineers and they become potential triggers for the risk register. Hours for supervision may be separated from direct manhours allocated to specific tasks. Cost engineers and planners coordinate so that useful indicators can be used to validate the forecast. Man-hours to go and manning level forecasts, productivity ratio, planned versus actual progress, and milestone achievements should all be consistent. Reports at the highest detail should be at document level. Detailed plans for drawing issues should be consistent with document control data and monitored. As a project proceeds there will be milestone stages where a schedule ought to be revised to include the additional detail that becomes available. This does not imply that schedule and cost need to be increased.

Reporting needs to be concise and easy to digest using graphics as in the earned value curve in Figure 1.

Risk Management in Cost Engineering

100%%% %

% Complete

0% now Time Figure 2: Earned Value curve 5.0 Contingency management A monthly project management meeting will typically include cost and planning reports, change control, and a risk register review. Funding needs to be allocated to individual risks according to their priority on the risk matrix. The risk owner prepares a change request processed through the project change control procedure.

Corporate reviews will address the company’s risk portfolio and systemic risk.

Project management may wish to withhold some contingency and establish targets for individual disciplines.to aim for. This can be done using quantitative methods to determine three values, the most likely value for project reporting, a more conservative value, say 80% for corporate reporting, and a stretched target, say 40% for individual disciplines, to encourage discipline engineers to propose creative methods to approach or achieve their targets.

There is a range of quantitative methods available, such as Monte Carlo Analysis, available in common spreadsheet form or as commercial packages. A computer model is built using selected probability distributions, which randomly selects thousands of variables from which a probability curve is generated of probability versus outcomes.

There are schedule risk analysis programmes used in conjunction with critical path analysis that should be used before the cost risk analysis.

Because the cost risk analysis needs to done in conjunction with discipline engineers and with their full understanding, an approximate but simple method of constructing the probability distribution curve is recommended.

Risk Management in Cost Engineering Probability calculations derived from an approximate normal distribution: a = worst b = best m = most likely expected value = (a + 4m + b)/6 standard deviation (spread) = (b - a)/6 one standard deviation from mean ≈

68%

two standard deviations from mean ≈

95%

Most likely (expected) Probability Approximate distribution Normal distribution

Best

Worst

Cost

Figure 3: Probability outcomes

(normal distribution)

Consider four main distributions: Normal, skewed left and right, and yes/no (either/or).

At regular, say six-monthly intervals, carry out interview reviews with each discipline lead, addressing each deliverable and its range of outcomes. Run the analysis every six months.

Figure 4: Six monthly analysis on a two year project

Risk Management in Cost Engineering 6.0 Project Close Out There is a high risk to the budget at completion. With the close out of a project phase the content of the remaining work and the required resources have to be planned in detail. Communication with the work force is key: the best contractor personnel will be seeking alternative employment. Any follow-on project phase, design to construction, for example, will require good quality support, probably with personnel relocation. So, consideration should be given to recruiting key members of the construction phase team during design to facilitate a smooth handover.

Details of lessons learned should be recorded during the project and finally analysed and published for future projects.

Peter Astley MSc CEng FIMechE FACostE Worked 29 years in the oil & gas industry from cost engineer to project services manager. Previously worked in manufacturing engineering in the USA and UK. During retirement, co-authored Oxford English for Careers- Engineering (OUP).

Taught cost engineering short courses and developed an on-line course for Cranfield University.