Professional Documents
Culture Documents
Cristián Gaedicke*
California State University, Hayward, California, USA
Farzad Shahbodaghlou
California State University, Hayward, California, USA
Farnaz Ganjeizadeh
California State University, Hayward, California, USA
With the shift from the Design-Bid-Build approach to new project delivery methods in the
context of projects that are more and more complex, it has become increasingly important to
understand the risks associated with construction projects. This work proposes a methodology
for identifying project risks and analyzing their impact on project cost. The methodology uses
Monte Carlo simulation to combine the conventional deterministic estimate, the variability of the
estimate, and the elicited project risk to create a Risk Based Estimate (RBE). The probabilistic
cost curve from the RBE provides insightful information about project cost. In a pilot
implementation, the methodology effectively predicted that an infrastructure project in Northern
California would suffer a significant reduction in profit. This methodology can be used by the
project team and decision-making practitioners to better justify their decisions and to implement
strategies that mitigate project risk.
Keywords: risk management, construction, design-build, infrastructure, Monte Carlo
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
50
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Build delivery methods are value-based, which project (Jin, et al., 2010), and risk management
allow for the owner, construction manager has therefore gained increased importance
(i.e., general contractor) and architect/engineer within the construction industry (Akintoye et
to work as a unified team. In these delivery al., 1997; Xie, et al., 2007). With the increased
methods, contracts are not awarded on the degree of risk associated with construction
basis of the lowest bid alone. Rather, there is a projects, in which uncertainties can lead to
points system that is used to select the most higher costs, delays, safety issues, and reduced
qualified contractor. quality overall, many companies are creating
In the Design-Build delivery method, their own risk management departments or
the responsibility for both design and reaching out to external consultants.
construction are given to the same entity Despite research showing the benefit of
which is usually a joint venture between an risk identification and assignment of risk to the
architect-engineer firm and a general parties best able to manage it, not every
contractor. In this approach, the construction contractor has the background to effectively
team is involved in the design process from the perform this task. Generally contractors review
beginning, therefore eliminating many of the the risk associated with the project during the
design issues that may surface during bidding phase and in the construction phase,
construction. This also eliminates any finger after the risk has occurred. With the shift away
pointing between the design and construction from low-bid contracting (Design-Bid-Build)
teams in case of any issues arising during to more robust contract forms, project
construction, because both are part of the same managers must understand, identify, and
team. evaluate the risks associated with each stage of
The Construction Management (CM) a project beforehand.
delivery method puts a Construction The overall goal of this article is to
Management firm in charge of the day-to-day delineate ways in which managers can
management of the project, without assuming identify, analyze, and mitigate the risks
any financial risk. The Construction associated with each stage of a project.
Management firm acts as an agent of the
project owner and all construction contracts II. LITERATURE REVIEW
are between the owner and the general
contractor and between the general contractor 2.1. Risk in Infrastructure Projects
and subcontractors. The CM @ Risk delivery
method is a revised version of the CM A risk is a chance that an event could
approach in that the construction management have a potential positive or negative effect on
firm assumes some of the risks of the project a project’s overall objective. A properly
in the form of forfeiture of part of their fee. conducted Risk Management process will
These approaches have helped owners increase the likelihood and impact of positive
achieve reduced costs, shorter project delivery events, and decrease the impact and likelihood
times, and appropriate allocation of risks to the of negative events. The Project Management
parties who are best able to manage them. Body of Knowledge (PMBOK, Project
Within these new project delivery frameworks, Management Institute, 2012) provides a
the identification, analysis, and mitigation of comprehensive guide to handle the Project
risks are critical for achieving project Risk Management process by following these
objectives on time and within budget. five steps: (a) plan the risk management
Furthermore, the impact of risk increases with process, (b) identify the risks, (c) perform a
the size, complexity, and time constraints of a qualitative and quantitative analysis, (d) plan
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
51
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
risk responses (risk mitigation) and (e) control are likely to be observed by construction
risks. management professionals, specialized
The Risk Management Plan defines expertise is needed to properly account for and
how risks associated with a project will be mitigate their impacts.
identified, analyzed, monitored, controlled and Kaplan and Mikes (2012) propose a
reported throughout the life of the project. It new framework to elicit risk , which consist of
also provides templates for tracking and identifying and classifying risks in three
reporting risks. The Risk Management Plan categories: (a) preventable risks, which have
will provide the necessary information that always a negative impact and shall be
senior project managers will use to make eliminated or mitigated by implementing an
informed decisions when preparing the project integrated corporate culture and compliance
estimate prior to construction and to mitigate model, (b) strategy risks, which are taken to
risk before and during construction. achieve superior strategic returns, and should
Researchers and practitioners have be managed by allocating resources to critical
applied and adapted the steps outlined in the risk events, and (c) external risks, which are
Project Risk Management process to uncontrollable but can be mitigated by
incorporate risk analysis and mitigation into envisioning the risks using techniques such as
infrastructure projects. For instance, research tail-risk assessment, scenario planning, and
by Tummala and Burchett (1999) proposed the war-gaming.
use of a risk management process (RMP), Cretu et al. (2011) identified three
structured in a similar fashion to a quality main methods to conduct risk elicitation in
management process, to assess and mitigate infrastructure projects: (1) one-on-one, (2)
risk for both external and internal customers. large-group, and (3) small-group interviews.
Marcelino-Sadaba et al. (2013) proposed a fast Though one-on-one interviews lack group
and clear documentation method to create synergies, large-group interviews can lead to
records for making decisions throughout the group think and the opportunity for an
project. Olson (2007) proposed that risk individual to take over the meeting with his or
should be considered for each function of the her own agenda. Through one-on-one and
management process (i.e., sales, marketing, small-group interviews, it is easier to obtain
and technical) to ensure a comprehensive risk the true risks within a project as long as the
analysis. right experts are involved. Lam, Wang, and
Lee (2007) proposed that subject matter
2.2. Risk Elicitation experts be recruited to aid in the elicitation
process. These experts should have experience
One key aspect of risk management is with similar projects and direct knowledge of
risk elicitation, which consists of proper risk project delivery methods.
identification and assessment. The PMBOK
(Project Management Institute, 2012) 2.3. Risk Analysis and Monte Carlo
recommends the use of a data flow chart to Simulation
facilitate the identification of project risks.
They advise to interview professionals After each risk has been elicited, a
involved in the management of the project, mathematical model is needed to compute the
team members and subject matter experts to overall effect on the project. Different methods
identify all relevant project risks. Sadeghi have been proposed. For example, Jui-Sheng
(2010) proposed the use of human experts et al. (2009) focused on a probabilistic
during initial risk elicitation. While most risks simulation to develop a likely distribution of
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
52
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
project cost. Jong et al. (2009) proposed the IV. PROPOSED METHODOLOGY
use of a Bayesian belief network to manage The proposed methodology aims to
risk in large engineering projects. Van Dorp evaluate the cost effect that variability and risk
and Duffy (1999) analyzed statistical have on the deterministic cost estimate of a
dependence in risk analysis within project. Therefore, the methodology is based
construction projects at the project network on three main components: (1) the
level. Jaffari (2001) used a life-cycle project deterministic base estimate, (2) the variability
management approach to manage uncertain of the base estimate, and (3) the occurrence of
risks within a project. Peckienea et al. (2013) risks. Each risk is assumed to be independent
proposed the use of cooperative game theory and defined by the probability of its
for risk allocation to the construction parties. occurrence and its stochastic impact.
Dikmen et al. (2008) developed a tool for post- The process is initiated by breaking
project risk assessment. Samani and down the deterministic cost estimate for the
Shahbodaghlou (2012) used the Fuzzy project into different categories, as shown in
DEMATEL Method to quantify risk in a large Figure 1. This initial estimate follows the same
bridge project. cost categories used for most construction
While different methods are available projects, including materials, labor,
to analyze the combined effect of different equipment, subcontracts, and miscellaneous
risks, the Monte Carlo simulation has been expenses. After the deterministic estimate has
most widely used due to its relative simplicity been completed, the base cost variability for
and capacity to evaluate a large number of each category is determined. The base cost
risks and calculate overall project cost and variability is defined as an eventless
economic risk (Wei et al., 2009; Zhao and Liu, uncertainty (Cretu, 2009), which assumes that
2008; Li et al., 2008). This method has been the project is completed in an environment
applied to such large projects as the free of risk events. The variability (Vi) of each
construction of an electric power plant (Wei et category (i) is modeled using a symmetric
al, 2009) and transportation infrastructure PERT-Beta curve (Davis, 2008), in which the
(Cretu, 2009). deterministic estimate for that category is used
as the most likely (MLi) value, and the lowest
III. PROJECT OBJECTIVE (Li) and highest (Hi) values are determined by
adding or subtracting the variability to or from
The primary goal of this paper is to the most likely value as shown below:
develop an applied methodology to assist
project managers in identifying, classifying, Hi = MLi *(1+ Vi/100) (1)
analyzing, and mitigating the impact of risks
for infrastructure construction projects. Such Li = MLi *(1- Vi/100) (2)
methodology enhances the owner’s ability to
plan, mitigate, accept, avoid, or transfer These three variables (Li, MLi, and Hi)
(assign) risks to the most appropriate parties. define the symmetrical PERT-Beta
A secondary objective of this project is to distributions that determine cost fluctuations
streamline the evaluation of project risks by for each cost category. The use of symmetric
creating a Monte Carlo-based risk analysis PERT-Beta distributions ensures that the effect
interface that can be used effectively by of variability is cost neutral and that there is a
project managers in the office or field. higher probability that the cost for each
category will be close to its most likely value.
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
53
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
As shown in Figure 1, each cost the inherent variability in the cost of the
category is not defined by one single value, project produced by the standard variation in
but is instead described by one symmetric cost of materials, labor, equipment,
PERT-Beta distribution. These distributions subcontractors, and miscellaneous items
are the inputs for the Monte Carlo simulation without considering any potential risk events
for variability, which uses different sets of in the project. Previous research (Cretu, 2009)
random numbers to calculate possible results, has demonstrated the importance of keeping
which in turn generate an output distribution. the variability risk neutral to accurately
After the Monte Carlo simulation has been identify the true effect of risks on the
completed (10,000 iterations), the variability outcomes of the project.
based estimate (VBE) is obtained. The VBE is The next step in the process is risk
a statistical distribution that combines the elicitation, which consists of identifying and
deterministic estimate and the variability, as describing each potential risk, classifying it,
shown in Figure 1. This distribution represents assessing its probability of occurrence, and
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
54
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
55
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
The algorithm shown in Figure 2 is are a third random number (R3) and the elicited
used to evaluate the occurrence or non- lowest (L), most likely (ML), and highest (H)
occurrence of a risk in a given Monte Carlo impact, as shown below:
iteration. First, the random probability of
occurrence (i.e., [Pmin +(Pmax - Pmin)*R2]) is
calculated by using a random number (R2) plus Impact = fPERT-Beta (R3, L, ML, H) (5)
the high (Pmax) and low (Pmin) probability of
occurrence as shown below: A second Monte Carlo simulation is
performed to assess the combined effects of
Random probability of occurrence variability and elicited risks on the project
= Pmin +(Pmax - Pmin)*R2 (3) estimate. This assessment is achieved by
adding the effects of the risks using the
The random probability of occurrence defines algorithm in Figure 2 to the variability-based
a probability that can have any value between estimate (VBE), as shown in Figure 1. A risk-
the elicited Pmin and Pmax for a given risk. based estimate (RBE) is achieved after 10,000
As shown below, if the random cases (i.e., iterations) of the second Monte
probability of occurrence (i.e. [Pmin +(Pmax - Carlo simulation have been completed. The
Pmin)*R2] ) is greater than the first random RBE is a statistical distribution that combines
number (R1), then it can be assumed that the the effects of the deterministic estimate, the
identified risk has occurred, and its cost impact variability, and the elicited project risks.
is calculated. If the described condition is The RBE distribution provides
false, then the risk did not occur and its impact insightful information that can be used to
is zero. accurately assess the adequacy of
contingencies in a project proposal. As shown
[Pmin +(Pmax - Pmin)*R2] in Figure 3, the cumulative probability
distribution of the RBE can be used to assess
TRUE Risk occurs cost impact the probability of breaking even on a project.
If the contingencies in the cost proposal are
> R1 (4) insufficient, then the probability of breaking
even becomes lower, consuming the profit and
FALSE Risk does not occur potentially even creating losses for the general
zero impact contractor.
A second relevant application of the
The impact of a risk is established RBE is the evaluation of risk mitigation
during the elicitation process by defining the strategies, which consists of holding post-
lowest (L), most likely (ML), and highest (H) elicitation meetings to discuss ways to reduce
cost that it could have on the project. These the impact of different risks on the project.
three variables are used to define a PERT-Beta Once such strategies are identified, a new RBE
distribution, which is not necessarily can be calculated based on the new probability
symmetric (i.e., if elicitors determine that the and impact of the mitigated risks. This post-
most likely cost is closer to the highest cost or mitigated RBE can be compared to the original
vice-versa). Finally, if the risk does occur RBE to identify the most cost-efficient
based on the decision algorithm defined in strategies to reduce the risks.
Figure 2, then its impact on the cost is
calculated using a PERT-Beta function (Davis,
2008). The inputs for the PERT-Beta function
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
56
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
57
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
V. RISK ASSESSMENT AND of that risk. The contract will define the extent
MITIGATION STRATEGIES of responsibility for the subcontractor, in case
such delay occurs. Table 1 shows examples of
Risk identification involves the project typical construction project risks classified by
teams and appropriate stakeholders. It includes category and subcategory:
the assessment of contractual, environmental,
organizational factors and the project plan VI. METHODOLOGY
including scope, schedule, quality, and cost. IMPLEMENTATION AND CASE
This assessment should be conducted STUDY
throughout the life of the project, with risk
categorized as pre-construction, construction,
and post-construction and subcategorized as The proposed methodology was
financial, operational, political, and strategic. implemented on an infrastructure project in
Risk should be categorized as: (1) pre- Northern California. The project scope was to:
construction, which includes all risks prior to (1) furnish and install ramp meter signals at
the construction of the project, (2) on-ramps of interchanges within a highway
construction, which includes all risks corridor, (2) place asphalt overlay, (3) install
associated with the actual construction of the overhead extinguishable message signs, some
project, and (3) post-construction, which of which were on elevated sections of on-
includes all risks associated with the final ramps, and (4) install state-furnished control
acceptance of the project. Risk should then be hardware and software including platforms for
subcategorized in each category as: (a) cellular phone communications.
financial, which includes all monetary or The project was awarded to the general
margin risk including credit, liquidity, market, contractor (referred to as GC to maintain his
etc., (b) operational, which includes all risk anonymity) for $10,841,045. The GC had
associated with processes, technical failure, estimated a cost of $7,696,013 and was
human error, or external events, (c) political, expecting a 29% profit based on his
which includes all risk associated with deterministic estimate. The actual cost of the
government action leading to changes in project at completion was $10,166,391.60,
regulations, and (d) strategic, which includes yielding an actual profit of 6.2%, which was
all risk associated with incorrect business far below the GC's expectations. The
decisions, poor decision implementation, and implementation of the proposed methodology
inability to adapt to changes. to this case assesses the project risk faced by
The probability and impact of the GC based on the proposal submitted.
occurrence for each identified risk should be
assessed by the risk eliciting teams and 6.1. Deterministic Estimate
reviewed by the project management team. All
identified risks should have a risk response The deterministic estimate included
strategy and be reviewed at regularly set time materials, labor, equipment, subcontracts, and
intervals. All risks should have an assigned miscellaneous expenses. The direct cost for
risk owner for monitoring and controlling. The each category is presented in Table 2. Each
mitigation plan should emphasize how the risk category included an overhead to cover
response will be implemented. For example, if indirect costs. As shown in Table 2, the total
the risk of a project delay has the potential of deterministic cost of the project was
being caused by a subcontractor, then the $7,696,013.
subcontractor should be assigned as the owner
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
58
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Category Subtotal
Materials $ 1,061,737
Labor $ 1,551,829
Equipment $ 224,160
Subcontractors $ 4,604,726
Miscellaneous $ 253,561
Total Cost $ 7,696,013
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
59
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
60
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
2 Asphalt Repair/EPA issues Pre-Construction Operational Risk 0% 34% $ 25,000 $ 25,000 $ 73,000
3 In-fighting with trades Construction Political Risk 30% 50% $ 81,000 $ 81,000 $ 162,000
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
61
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
62
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Risk ID #
TABLE 5. RISK MITIGATION PLAN
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
63
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
6.3.3. Post-Mitigated Risk Based Estimate equal to or below the sales price of
$10,841,045. Essentially, the analysis confirms
The post-mitigation stage is critical for that, even after risk mitigation, any risk
proposing methods of mitigating the effect of occurrence would consume the profit. This
risks on the project. This process requires the result is consistent with the actual reduction in
use of small-group and one-on-one interviews, profit seen by the GC. Overall, the analysis
in which experts and the direct project team confirms the critical need to assess the project
are involved. Table 5 shows the proposed risk risks before submitting a proposal to the
mitigation plan and each the post mitigation owner.
probability of occurrence of each risk. It The pre- and post-mitigated RBEs are
should be noted that the probability of compared in Figure 8. They show that
occurrence for most of the risks significantly implementing a risk mitigation plan can
decreased after the risk mitigation process. significantly reduce the expected cost of the
The post-mitigated RBE, as shown in project at a fixed level of certainty. For
Figure 7, displays the recalculated probability instance, at a certainty of 75%, the mitigated
distribution for the total cost of the project cost of the project would be approximately
based on a second round of simulation using $409K less as compared to the unmitigated
the new mitigated risk values. Even after risk project cost. A plan to properly mitigate risks
mitigation, the probability of achieving a can significantly increase profitability by
project cost equal to or lower than $7,696,013 reducing the overall expected impact of risk on
is only 2.2%. Additionally, the project had a project cost.
likelihood of 97.7% of having an actual cost
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
64
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
65
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
66
Kimberly Wylie, Cristián Gaedicke, Farzad Shahbodaghlou, Farnaz Ganjeizadeh
A Risk Analysis and Mitigation Methodology for Infrastructure Projects
Journal of Supply Chain and Operations Management, Volume 12, Number 2, May 2014
67