Beating Volatility Today for More Project Wins Tomorrow
April 06, 2022
Managing risk in the preconstruction process is key for producing a winning strategy for new projects. Owners, engineers and contractors are all affected by risk and share some common approaches for managing their relative exposure and avoiding common volatilities.
Risk mitigation is a way of minimizing exposure to such volatilities. Sometimes these risks are “known unknowns” meaning we know we will run into these certain difficulties during the course of the project and will need a way of handling them when they arise. Others are referred to as “known knowns” where specific mitigation strategies are already understood to be necessary. Let’s explore some of those strategies to provide you with a blueprint of ideas for implementing them on your next project.
Establish a Realistic Construction Contingency Fund
One way of creating a buffer for risk is to develop a construction contingency fund that can be used to offset unexpected risks (the “known unknowns”). In many cases, this contingency is derived based on other project costs, and its percentage of these other costs typically varies as a project passes through various project stage gates. For instance, early in a candidate project’s life cycle, there may not be enough detail available about the project’s specifics to build an accurate cost model, so we would expect a relatively high percentage of the project’s overall costs to be set aside as a construction contingency reserve.
However, as the project’s details become more refined and the candidate project proceeds through its various approval stages, we would expect the level of detail in the cost estimate to grow, and the percentage set aside for contingency to drop. For instance, in an early stage, rough order of magnitude (ROM) estimate, the contingency percentage could be as high as 30 to 50% of the project’s estimated costs. As the project advances through stage gates, the engineering and design (in theory at least) should become more detailed where the level of detail in the estimate is sufficient enough to where the contingency percent may drop to 10 – 20 percent of the project’s estimated value.
Get the Most Out of Your Risk Register
Another strategy for mitigating risk is to define and track project risks in a risk register. This lends itself more to the “known knowns” we may encounter. Discrete risks are listed, along with a mitigation strategy, and can be ranked as to how likely they may be, as well as how much of an impact the risk would have on the project’s cost and duration. Advanced modeling can be performed (e.g., running a Monte Carlo style simulation with a thousand iterations), along with specifying a target probability of meeting or beating the estimate (say, a probability value of P75). The results of this modeling indicate how much contingency should be set aside if we want a 75% likelihood of meeting or beating our budget for the project. This quantitative risk analysis would also include the estimated costs of employing each discrete mitigation strategy.
Benchmark for Stronger Construction Contingency
As organizations collect data from individual projects, trends can be identified to help predict the impact of risks on future projects. Many organizations may benchmark their contingency spend as a percentage of the construction costs of the project, while others may use other determinants, such as the quality of the project scope definition, design and/or engineering work that leads up to the project’s execution.
In other cases, for instance a major shutdown, turnaround or outage of an existing plant, the level of contingency may have more to do with the regular maintenance and repair cycle of the equipment being worked on. In these cases, the discovery phase of execution is where project teams can actually assess how much work is required to perform the required maintenance based on the equipment’s condition.
Benchmarking attempts to provide a data-driven approach to objectively measuring risk and setting aside appropriate amounts for construction contingency, while minimizing the effect of optimism bias, or the desire to think that this project will be unaffected by all of those pesky issues that have affected other projects.
Plan for Consistent Draw Down and Monetization
For any of this to work properly, organizations need to have consistent definitions of what contingency reserves should be used for, and to follow a disciplined process of “drawing down” that contingency amount when needed. For instance, many organizations won’t allow construction contingency reserves to be used for net new additions of scope; instead, those will need to seek “net new money” so contingency funds can be used for more focused purposes, like escalation costs of labor and materials within a pre-defined, acceptable range.
Finally, just as risk should be considered during the preconstruction stages of a project, it is equally important to use the same level of discernment to identify and monetize opportunities. For instance, if several projects require the same materials and services within a portfolio or program, opportunities may exist to leverage additional purchasing power when negotiating with vendors and contractors.
Risk affects projects from all angles, but having a clearly defined construction contingency and mitigation strategy helps ensure that you can start winning the battle against volatility more often.
Ready to take a deeper dive? InEight can help get your projects where they need to go and help you create a solution or view that matches your needs while leveraging your teams’ existing strengths. Let us show you how.