Project Manage Sav (7) Visit Us at Management - Umakant.info

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Swiss-AIT-Vietnam Management Development Programme
Lesson 2:
Course:
Project Organization
& Implementation
Instructor: Dr. Tran Phuong Trinh

Project Management - 2.2
PROJECT INITIATION
1.Overview
 Project conception and
definition
 Project proposal
 Project feasibility study
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2.Project costing
 Cost components
 Types of cost estimates
 Costing problems
3.Negotiation and contract strategy

 Contract strategy
 Negotiation
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4.Risk management
 Framework
 Risk identification
 Risk classification
 Risk analysis
 Risk response
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Required readings
Avraham, Chapter 10
Harvey A. Levine, Project Initiation
Techniques: A Strategic View.
CASE STUDY
Teloxy Engineering
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Learning objectives
 After completing this lesson you should be
able to:
 List major issues that firms have to deal with
during project initiation/definition stage
 Discuss the main content of a project
proposal and major issues of the proposal
preparation process
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 Discuss the purpose of a project

feasibility study
 List different schemes to classify
project cost components
 Discuss some major techniques
used to estimate project costs
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 Explain a cost coding system and its

benefits
 Describe different types of contracts
and identify the major issues that a
contract strategy deals with
 Discuss when negotiation is needed ,
and issues project managers must
consider before starting a contract
negotiation.
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List the negotiation principles for win-win

solutions
Compare and contrast risk with uncertainty
Define what is risk management and discuss

basic components in the risk management
framework
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1. Overview
1.1 Conception
 Objectives: Collect and present
information to management in order
that a clear decision can be made
on the project concept.
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 Usual steps:
 Identify the problems: increased
competition, reduction in profit or
market share
 Identify the opportunities: new
technology - new market - new
idea – new resources.
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Identify the conditions/ constraints.

 Time constraint
 Technology constraint
 Personnel constraint
 Cultural constraint
 Money constraint
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 Prioritize the needs.

 First grasp of solution approaches
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 Development of initial concepts:

Techniques for developing &
generating new ideas.
 Research, survey, interview.
 Brainstorming.
 Concept paper for discussions.
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Beyond perceiving the need, project initiation

requires proving that the idea has merit and
can be achieved at practical cost. To cull the
few good ideas, the organization undertakes
a brief initial investigation (preliminary
feasibility). During the initial investigation the
organization tries to clarify the problem and
evaluate the merit of solutions.
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1.2 Project Definition
 Objectives: Produce an agreed

statement of what the project is
(Project Definition Report or Project
document) which will be the basis
for all project work.
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 Project objectives:
 Identify the long-term goals.
 Identify the set of objectives.
Technical objectives
Timing objectives
Budget objectives
Scope guidelines
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 Prioritize the objectives -

Identify the relationship of the
objectives.
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 Project priority:
 Used to compare with other
competing project.
Based on many factors, ranging
from top management's preference
to the environmental impacts.
 Factors may change over time.
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 Impacts:
 profit, market share, technological
competence, reputation
 Social impacts.
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 Managerial aspects:
 Consistency with parent
organization’s goals and
strategies.
Predict potential/ conflicts,
changes.
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If, after the initial investigation, the idea

is found to warrant a full-scale, detailed
investigation of the alternative solutions,
approval is given for the next stage,
feasibility
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1.3 Project proposal
Written document presenting the

design & plan of the project
submitted for evaluation and
approval.
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 Types of proposals:
 Internal proposal for approval
by top management.
External proposal for client to
offer some services/products
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External proposals again have 2 kinds:

 Qualification proposal responds to client
request for proposal (in this case, the client
typically choose to bring in a contractor
who will carry the project feasibility study),
providing information on the company's
capability to carry out some work or to
provide some services/products.
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 Commercial proposal involves commitment

from the authors (i.e. a contractor) of the
proposal. Examples includes bids for projects.
This kind of proposal - because of the
commitment involved - requires careful review,
planning and approval of top management
before sending out. This normally requires a
feasibility analysis by the bidder.
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 Bid/No bid decision for commercial

proposal:
 Is the company capable to
complete the work?
 Is the company willing to do the
work?
 Is there a chance to win the bid?
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- The commercial proposal preparation is

itself a project - with cost constraints, a
deadline for submittal, and performance
requirements - and it should be
managed like one.
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 Who is responsible for preparing the

proposal?
 Proposal manager (normally project
designer)
Support proposal staff (normally from
marketing department, specially for
external proposals).
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 Cooperation with staff/managers

from others functional departments.
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 During the proposal preparation, the

contractor should establish a dialogue
with the user (client) to determine which
requirements are dominant among time,
cost and performance, and which
solutions the user prefers.
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Even if the RFP is clear, there is need

to confer with the user about details
of scheduling, costing, specification
and so on.
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1.4 Project Feasibility Study
 Feasibility study is the process of

investigating a problem and
developing a solution in sufficient
detail to determine if it is technically
feasible and economically viable and
worthy of development.
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A feasibility study is documented with

a report showing all the ramifications
of the project
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 Technical study:
The technical capability of the
personnel as well as the
capability of the alternative
technologies should be
considered
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 Financial Study:
 What are the magnitude of the
capital and operating costs of the
project?
 What are the source of funds and
the draw-down schedule, and are
they sufficient to cover the costs of
activities and implementation?
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 What is the projected cash flow of the

project? Do the benefits outweigh the
costs? To what extent is necessary
borrowing scheduled to meet running
deficits at activation?
 How soon do initial revenues come in
to take part or all of operating costs?
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 Administrative/Managerial Study:
 What is the appropriate
organization?
 To whom the project manager
will report? What are his links
with existing functional and
project departments?
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 What are the authority and

communication lines?
 Is there qualified key management
and technical personnel for the
success of the project? What is the
recruitment and training plan for the
project team?
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 What are the external linkages

(funding agencies, clients, regulating
agencies, etc.)?
 What are the master schedules and
plans for the project?
 What are the systems for
monitoring, controlling the project
implementation?
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 Does the plan provide for

contingencies?
 What are the standard for project
performance?
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 Economic Study
This involves the feasibility of the
proposed project to generate
economic benefits.
 Can the project objectives be
justified in terms of organization's
strategic goals, or of the national
economic needs?
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 Who are the main competitors,

and what is the anticipated
fluctuation of the supply and
demand which may influence the
performance and objectives of the
project?
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 Environmental Study
 What will be the impact of the
project on the environment?
 What are the relevant regulations?
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 Social/Political Study
 What are the project's likely social
and political impacts on the
community?
 What social, political and
institutional factors may hinder or
assist the project in achieving its
objectives?
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 Recommendations:
 Modifications to improve the
project design
 Approve/Not approve the
proposed project (justify)
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2. Project costing
2.1 Cost components

 Direct costs: costs attributed
directly to the job or piece of project
equipment.
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 Indirect costs (overhead costs or

overhead): costs covering the
provision of factory & office
accommodation, general
management & administration,
heating/air conditioning, lighting,
maintenance, etc.
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Notes :
Different interpretations by
companies on indirect/direct costs.
Both can be labor, materials or
expenses, it is always difficult to
estimate the indirect costs.
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The reasons are the implicit nature

of the costs. Many projects may
also share the overhead, which
may further complicate the
calculation.
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 Fixed costs: costs which remain

unchanged & must continue to be
incurred even though the workload
or production level may fluctuate
between zero & maximum capacity.
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 Variable costs: costs incurred at rate

depending on the level of work
activity, usually confined to direct
costs.
 Prime cost: sum of all direct costs

needed to complete a particular job
or project.
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 Factory cost: total direct plus

indirect costs needed to complete
the job or project
 Below-the-line costs: collective

name for the various allowances (for
cost escalation, exchange rate
fluctuation & other contingencies)
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 Life-cycle cost: total cost to the

organization for the ownership and
acquisition of the product over its full
time. Life cycle cost may include :
 R & D: cost of feasibility study,
cost/benefit analysis, design pilot
production and testing,
documentation etc.
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 Production/Construction:
manufacturing, assembly, testing,
materials, etc.
 Operating & maintenance, personnel,
spare parts, repairs, quality controls
 Product support, retirement & phase-
out
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2.2 Types of cost estimates
 Order-of-magnitude: first rough

estimate based on past
experiences, scale & scope of the
project, or capacity estimates.
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Common technique: using expert

opinions and statistics. Accuracy:
35%.
Example: $/m2 estimate for
construction.
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 Comparative estimate, based on well-

outlined project design and similar
projects in the past.
Technique: using cost estimating
relationships such as Cost-
Capacity factor. It is expressed by
the following equation
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x
 Q2 
C 2  C1  
 Q1 
where C1 = cost of an existing plant C2 =
cost estimate for a similar plant Q1 =
capacity of the existing plant
Q2 = capacity of the new plant, and. -
x = cost-capacity factor
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The X are empirically derived

factors based on well-
documented historical records for
different kinds of projects.
Accuracy: 15-20%.
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 Feasibility estimate: based on the

detailed project design (building
/construction specification, site
data, provisional layouts,
drawings), quotations for major
project equipment's & subcontracts.
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Technique: Work breakdown

structure (WBS) and Cost
breakdown structure (CBS).
Accuracy 10%.
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 Definitive estimate : when most

design work has been finished, all
major purchase orders have been
placed at known prices.
Accuracy: 5%.
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Notes :
(i) Learning curve:
A principle in cost estimating
based on the fact that skill and
productivity in performing tasks
improve with experience &
practice.
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The rule of thumb: Human performance

improves by a fixed percentage each
time production doubles.
Formula: Tn = T0nr
Where:
Tn = time required for the n-th unit T0 =
time requirement for the initial
unit
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n =number of units
r = log (fixed percentage) / log 2
Example: In aerospace industry ,

where the production is in batches,
the unit production cost is reduced
by about 20% every batch..
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A learning curve
(ii) Work breakdown:

Process of breaking the whole project
successively into smaller units until all
meaningful tasks have been identified
and the cost of each task can be
individually estimated. The work
breakdown structure will be basis for the
cost breakdown structure (cost coding)
and budget.
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Cost coding: System assigning to each

task of the work breakdown structure
(WBS) a number which can convey
essential data about the task. A code
may consists of several identifiers:
project identifier, item identifier,
operation identifier, etc.
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Benefit of cost coding:

 facilitate analysis, editing and
reporting;
 facilitate the application of
computers in project
management.
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An effective coding system must be

 Clear and logical
 Exhaustive
 Consistent
 in company
 in industry
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2.3 Costing problems:
 Cost escalation: amount of

expenses over run the budgeted
cost estimate.
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Cost escalation of up to 20% are

quite common with most
projects.
Large, complex, high technology

projects have greater potential
for escalation
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 Following are the reasons – some

are avoidable, some are not:
Uncertainty and lack of accurate
information
Changes in design or
requirements
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 Economic and social variables

in the environment
 Work inefficiency, poor
communication, and lack of
control
 Kind of project contract
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3. Contract Strategy and Negotiation

3.1 Contract Strategy
 Contract:
A contract is an agreement between
two parties wherein one party (the
contractor) obligates itself to perform
a service, and the other party (the
client) obligates itself to do something
in return – typically make a payment.
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Most project contracts are

written documents
Can contain unilateral or
bilateral agreement
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 Different kinds of contract provides

different advantages to the client and
the contractor. Depending on the risk
of the project and the degree of
difficulty in estimating costs, the client
and contractor try to negotiate the
type of contract that best serves their
own interests.
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 Two fundamental types of contracts:

Fixed price contract: the price is
agreed upon and remains fixed as
long as there are no changes to the
scope or provisions of the agreement
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Cost reimbursable contract: the

contractor is reimbursed for all of the
expenses incurred during the
performance of the contract, so as the
result, the final price is unknown until
the project is completed.
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Fixed price contract
Firm fixed price contract

(“Lump sum” agreement)
 The contractor agrees to perform all
work at a fixed price.
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 When a project is readily specified in

details, this type of contract is preferred
by both contractor and client.
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Client’s viewpoint: less need to

supervise the project
Contractor’s viewpoint: clients are less
likely to request changes or additions to
the contract.
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Disadvantages:
 more difficult and costly to prepare
some incentives for the contractor
to use cheaper materials, perform
marginal workmanship, etc.
 the contractor may run the risk of
underestimating
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Fixed price with redetermination

 The initial price is negotiated
with the stipulation that it will be
re-determined at intervals so that
the price can be based upon
actual cost data.
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 This type of contract is appropriate

where: engineering and design efforts
are difficult to estimate, in long-term
quantity production contracts
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Disadvantages:
The only requirement to renegotiate
the price is substantiating cost
data, therefore this type of
contracts tends to induce
inefficiencies.
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Fixed price with escalation provisions

Contracts with long lead time
may have escalation provisions.
For example, the price may be
tied to an inflation index so it can
be adjusted in the advent of
inflation.
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Fixed price with incentives

 The contractor negotiates to perform
the work for a target price based upon a
target cost plus target profit. A ceiling
price and a ceiling profit are also
negotiated.
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 If the total cost ends up being less than

the target cost, the contract make a
higher profit up to the ceiling profit. If
cost overrun, the contractor absorbs
some of the overrun until a profit floor is
reached.
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 This type of contracts applies to long

term or large production projects. It is
not applicable to projects where the
target cost is difficult to estimate.
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 This type of contract alleviates some of

disadvantages to the client of a fixed
price contract because it stimulates the
contractor to reduce costs and improve
efficiency.
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Disadvantages:
It invites contractors to negotiate
unrealistically high target cost so
that extra profits can be made.
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Cost reimbursement contracts

Normally applied when requirements
are uncertain, and it is impractical to
expect the contractor to assume the
risks without providing extensive
contingencies. A fee is usually added
contingent on satisfactory
performance.
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Cost plus fixed fee (CPFF)
The contractor is reimbursed for

all direct allowable costs plus an
additional fixed amount to cover
overhead and profit.
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This type of contracts puts the burden of

risk on the client.
There is little incentives for the

contractor to control costs, finish on
time or do anything beyond minimum
requirements.
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Cost plus incentive fee
 This is similar to CPFF in that

costs are reimbursed, but fee is
based on an incentive formula.
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 The contract starts with a specified

target cost, and guarantees a maximum
or minimum fee which is the percentage
of the actual cost. Maximum fees
establish the outside limits on a
contractor’s profit.
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Time and Materials Contract
 A simple form of agreement that

reimburses the contractor for
labour costs and materials as
incurred.
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 It provides for payment of direct labour

hours at an hourly rate which include
the direct labour cost, indirect costs,
and profit.
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 Charges for services such as

electricians, carpenters, etc. are usually
based on time and materials.
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 Contract Strategy deals with

 division of the project into
separate contracts
 the timing of contract awards
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 the type of the contract most

likely to encourage satisfactory
completion while providing
controls and opportunities to the
owners to rectify problems before
they cause serious difficulty to
the project
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3.2 Contract Negotiation
 Negotiation is a dynamic process in

which parties with differing objectives
reach an acceptable agreement on a
matter of common interest through a
process of communication and
compromise.
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 The purpose of negotiation is to identify

completely to the satisfaction of all the
parties the scope of the work to be
done, to clarify technical or other terms
in the contract and to reach agreement
on time, schedule, and performance
obligations.
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 On-going negotiations improves

communication and helps the client and
contractor reach mutual understanding
and expectations about the jobs.
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 Final negotiation before a

contractual agreement is reached
is the last opportunity to correct
mis-perceptions which might
have slipped through the RFP
and the proposal process.
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When negotiation is needed?
Negotiation is not necessary on

standardized items for which terms are
simple and cost are fairly well known.
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Negotiation is commonplace on
complex system which requires
much development work and
involve considerable uncertainty.
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Even if there is a free tendering

process, and the selection of the future
contractor is made according to the
established rules, negotiation between
the client and the contractor is still
needed.
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The negotiation principles for win-win

solutions
Separate the people from the problem

The conflicting parties are often highly
emotional. To minimize the likelihood that the
conflict will become strictly inter-personal, the
negotiators should:
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 Define carefully the substantive

problem
 Put oneself in the other parties’
position to see the situation from their
point of view and to recognize and
understand their emotions.
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Focus on interests, not positions

 The goals of the parties usually
can be reasonable reconciled so
that both parties win.
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 To accomplish this, the negotiators

should not be committed to specific
positions and defend those position
without examining other ways of
achieving the overriding goals.
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 Knowledge of the other party’s

underlying concern allows a negotiator
to suggest solutions that satisfy both
parties’ interests without agreeing with
the other’s position.
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Generate creative options prior to

begin negotiation
 As soon as the substantive
problems are spelled out, effort
should be devoted to finding a
wide variety of possible solutions
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 Solutions that advance the shared

interests of the conflicting parties can
be presented and the preferences of the
other party can be solicited.
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Insist that results be based on some

objective criteria
The best way to resolve the
remaining conflicts is to base the
solution on an objective standard
(industry practice, allocation of risk
based on investment, etc. ) rather
than the will of the parties involved.
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Analysis of negotiation situation

To be in the most knowledgeable and
competitive position, the project
manager must
Learn about the client to determine,
for example, if the client
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 Is under pressure to make a

particular decision
 Needs a system as soon as
possible
 Has historically shown a
preference for one particular
approach over the others
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Learn about the competitors

 Their likely approach, costs,
competitive advantages and
disadvantages Information can be
derived from historical data of past
projects, published materials, etc.
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To be able to negotiate trade-offs, the

project manager must be intimately
familiar with the technical details of the
design, related costs and the project
schedule and time-cost tradeoffs.
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4. Risk Management
4.1 Risk Management framework
 Definition
Risk management is an organized
means of identifying and measuring
risk and developing, selecting, and
managing options for handling these
risks.
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Risk management, in the project

context, is the art and science of
identifying, analyzing, and responding to
risk factors throughout the life of a
project and in the best interest of its
objectives
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Risk and uncertainty
 Risk and uncertainty characterize

situations where the actual outcome for
a particular event or activity is likely to
deviate from the estimate or forecast
value.
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 Risk arises when it is possible to make a

statistical assessment of the probability
of occurrence of a particular event.
 In decision making under risk, there are

assigned probabilities for each of the
states of nature.
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 Under uncertainty meaningful assignment

of probabilities are nonexistent.
 Hence, the difference between risk and

uncertainty is a knowledge of the
probability of occurrence of each state of
nature.
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Example:
A company wishing to invest $50 million
to develop a new product. The company
has three design options: A, B, and C.
The company decides that the states of
nature will be either: a strong market
demand, an average market demand or
a low market demand.
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The company has determine the

following the payoff table for this
development project.
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Payoff table (Profit in millions)

Design States of Nature (Probability of
strategy occurrence)
Strong Average Low (50%)
(25%) (25%)
A $50 $40 $90
B $50 $50 $60
C $100 $80 $-50
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The best choice of strategy is design A.
( Id e n t if y s o u r c e & t y p e
R is k Id e n tific a tio n
o f r is k )
(T y p e o f r is k a n d its
R is k C la s s ific a tio n
e ffe c ts )
(E v a lu a te c o n s e q u e n c e
R is k A n a ly s is & im p a c t o f r is k )
R is k A ttitu d e
(A ttitu d e o f p e o p le
in v o lv e d )
R is k R e s p o n s e (H o w r is k s h o u ld b e
h a n d le d )
R is k M a n a g e m e n t
4.2 Risk Identification and Classification
 The first step in risk management is to

identify and assess all potential risk areas.
The thoroughness with which this
identification is accomplished determine the
effectiveness of risk management.
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 Not all risks are high-level risks that will

have a critical impact on a project.
However, the cumulative effect of
combining low-level risks could have a
severe impact.
 It is useful to work closely with the project
team and to consider explicitly these areas
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 Risks internal to the project

 Non technical: labor stoppages,
safety issues, cash flow problem
 Technical: change in technology,
design issues, operation/maintenance
issues (unproven technologies,
inadequate logistic support, etc.)
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 Legal: subcontractor performance,

patent rights, licenses, etc.
 Risks external to the project
 Government regulations, natural
hazards, etc.
 Borrowing rates, raw material
availability
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Principle sources of risks
Physical
Loss or damage by fire,
earthquake, flood, accident, land
slip
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Environmental
Ecological damage, pollution,
waste treatment
Public enquiry
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Design
New technology, innovative
applications, reliability, safety
Detail precision and
appropriateness of specifications
Design risk arising from surveys,
investigations
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Likelihood of change
Interaction of design with method
of construction
SAV
SDC
Logistical
Loss or damage in the transportation of
materials and equipment
Availability of specialized resources -
expertise, designers, contrattors,
suppliers, plant, scarce construction
skills, materials
SAV
SDC
Access and communications

Organizational interfaces
SAV
SDC
Financial
Availability of funds, adequacy of insurance
Adequate provision of cash flow
Losses due to default of contractors,
suppliers
Exchange rate fluctuations, inflation
Taxation
SAV
SDC
Legal
Liabilities for acts of others, direct
liabilities.
Local law, legal differences between
home country and home countries of
suppliers, contractors, designers
SAV
SDC
Political
Political risks in countries of owner
and suppliers, contractors - war,
revolution,
changes in law
SAV
SDC
Constructional
Feasibility of construction methods, safety
Industrial relations
Extent of change
Climate
Quality and availability of management
and supervision
SAV
SDC
Operational
Fluctuations in market demand or
product or service
Maintenance needs
Fitness for purpose
Safety of operation
SAV
SDC
R is k C la s s ific a tio n
C o n s e q u e n c e o f r is k T y p e o f r is k Im p a c t o f r is k
P u r e ris k S p e c u la tiv e r is k com pany M a rk e t/

( s p e c if ic r is k ) (m a r k e t ris k ) In d u s t r y
- N o p o t e n tia l g a in - P o s s ib ility lo s t E n v iro n m e n t P ro je c t/
o r g a in In d iv id u a l
F r e q u e n c y S e v e r it y / P r e d ic ta b ilit y A s s e t re la te d o r C a p ita l r e la te d
Im p a c t b u s in e s s r is k o r f in a n c ia l r is k
 Any sources of information that allows

recognition of a potential problem can
be used for risk identification. These
include
 System engineering documentation
 Life cycle cost analysis
 Work breakdown structure
SAV
SDC
 Brainstorming
 Past projects Lessons
SAV
SDC
4.3 Risk analysis
 Attempt to capture all feasible options

and to analyze the various outcomes of
any decision.
SAV
SDC
 The impact of a risk can be quantified

as follows
Impact of a risk = Probability of risk

x Consequence of risk
SAV
SDC
 Describing and quantifying a specific risk

and the magnitude of that risk usually
require some modeling. Typical methods
for use in risk analysis are:
Decision Analysis
Probability Matrix
Decision Tree
SAV
SDC
Sensitivity Analysis
Sensitivity table
Spider diagram
SAV
SDC
Simulation (Monte Carlo)

Scenario Analysis
SAV
SDC
Risk Attitude:
Risk loving: prefer to accept risk

even when the expected
(monetary) benefit is negative
SAV
SDC
Risk averse: is unwilling to accept

risk even when the expected
benefits is positive
Risk neutral: base the decision on
the expected benefit
SAV
SDC
Note: Risk attitude differs from one

person to another person. Even for a
person, the risk attitude may vary
depending on the nature and magnitude
of the risks and benefits involved as
well as other internal and external
factors.
SAV
SDC
4.4 Risk Response
 The techniques for handling risk fall into

the following categories
 Avoidance
 Reduction (or Mitigation)
 Retention
 Transfer
SAV
SDC
 Fundamental considerations which

govern the allocation of risk
 Who can best control the source

of the risk
 Who can best manage the risk if
is occurs
SAV
SDC
 Is it preferable to retain an
involvement in the management of
risk
 Who should carry the risk if it is
not controlled
 Whether the risk premium is
reasonable and acceptable
SAV
SDC
 Is the transferee likely to be able

to sustain the consequence of risk
 If the risk is transferred, whether it
leads to the possibility of risks of
different nature being transferred
back
SAV
SDC
Risk transfer:
 Project manager transfers all or part of

a risk(s) to another party by some form
of contract.
SAV
SDC
 Insurance
The type of contract (will determine
how the risk is shared between the
customer and the contractor)
SAV
SDC
Remark: Risk transfer does not

reduce the criticality of the source
of risk. In some cases, risk transfer
even increases the risk (e.g. when
the receiving party is not aware of
the risk, or is not capable of
absorbing the risk).
SAV
SDC
Risk Retention:
Acknowledgement of the existence

of risk but decide to accept the
consequences if failure occurs.
Usually accompanied by some
contingency budget
SAV
SDC
Risk Reduction
By redesign the project
By training and education
By a process of continually sensing
the condition of a project and
developing options to permit
alternative lower-risk solutions.
SAV
SDC
Example of risk control options:

process of developing alternative
sources for production, parallel
development for a critical research
and design component, getting
priority for critical materials, etc.
SAV
SDC
Risk avoidance:
Avoid to accept the option which
have the potentially unfavorable
results.
Usually achieved by use of
exemption clauses in the contrac
SAV
SDC
Event-Likelihood of damage to adjoining
buildings as a result of pile driving
Improbable Rare Possible Probable Very likely

Severity
Negligible Retain Retain Retain Retain Retain
Small Retain Retain Partial Partial Partial
Insurance Insurance Insurance
Moderate Retain Partial Insure Insure Insure
Insurance
Large Insure Insure Insure Insure Insure
Disastrous Insure Insure Cease Cease Cease
activity activity activity
Potential for systematic Risk Management
 Identification: develop checklist based

on experience :
* Some are common to all
* Some are unique to some projects
SAV
SDC
 Classification:
* Risks for which past data are available
* Risks that would be accepted by insurance
companies
* Risks where expert-based judgments are
possible
* Warning: A risk is not irrelevant simply
because there are no data regarding its
extent !
SAV
SDC
 Risk analysis: For each type of risk

factors !
 Response:
* Avoidance: Stop the tender or
proceed with only a part of the
project
SAV
SDC
* Retention: Make some financial or

other contingency for the risks
(quantitative methods may be used !)
SAV
SDC
5. Project Financing
 Definition:
Way of financing a project where
the lenders look mainly to
Earnings of the project as source
of fund for loan repayment
Assets of the project as collateral
SAV
SDC
 Why opting for project finance

New financing opportunities
Off-balance sheet borrowing:
arranging loan for a project without
affecting the sponsor’s credit
standing or balance sheet
SAV
SDC
Risk sharing: where debts is wholly

or partially non-recourse to the
sponsor all or some of the risks will
be borne by the lenders if the
project fails to produce sufficient
cash flow.
SAV
SDC
 Types of capital and debt
 Equity risk capital in the project,

with last priority in payment
SAV
SDC
 Lenders usually require equity investment

 to reduce the debt burden on the
project cash flow
 to ensure that project sponsors have
enough at stake and hence they are
motivated to see the project through a
successful completion
SAV
SDC
 Quasi equity: subordinated loans

Senior to equity but still have lower
priority in repayment than other
debts
SAV
SDC
 Senior debt: Debt which is not subordinated

to any other liability
 Unsecured loans: backed only by the
general credit of the borrower and is not
secured by any asset
 Secured loans: where assets securing
the debt have value as collateral
(marketable and readily converted to
cash)
SAV
SDC
 Example of common types of project

financing
Build-Operate-Transfer (BOT)
Most popular form for funding infrastructure
projects
A private group invests in, construct, and
operate a facility for a concession period.
The investment is repaid during this period
SAV
SDC
At the end of the concession period,

the facility is transferred free of
charge to the host country
government
SAV
SDC
Major advantages:
- Reduce public spending
- Increase efficiency (through
privatization)
SAV
SDC
Major disadvantage:
Financing structure is highly
complex, resulting in a very long
and expensive negotiation phase
SAV
SDC
 Build-Own-Operate
The ownership of the facility is
retained in perpetuity by the private
developer.
SAV
SDC

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SAV

Instructor: Dr. Tran Phuong Trinh

3.Negotiation and contract strategy

 Discuss the purpose of a project

 Explain a cost coding system and its

List the negotiation principles for win-win

Compare and contrast risk with uncertainty

Define what is risk management and discuss

Identify the conditions/ constraints.

 Prioritize the needs.

 Development of initial concepts:

Beyond perceiving the need, project initiation

1.2 Project Definition

 Objectives: Produce an agreed

 Prioritize the objectives -

If, after the initial investigation, the idea

1.3 Project proposal

Written document presenting the

External proposals again have 2 kinds:

 Commercial proposal involves commitment

 Bid/No bid decision for commercial

- The commercial proposal preparation is

 Who is responsible for preparing the

 Cooperation with staff/managers

 During the proposal preparation, the

Even if the RFP is clear, there is need

1.4 Project Feasibility Study

 Feasibility study is the process of

A feasibility study is documented with

 What is the projected cash flow of the

 What are the authority and

 What are the external linkages

 Does the plan provide for

 Who are the main competitors,

2.1 Cost components

 Indirect costs (overhead costs or

The reasons are the implicit nature

 Fixed costs: costs which remain

 Variable costs: costs incurred at rate

 Prime cost: sum of all direct costs

 Factory cost: total direct plus

 Below-the-line costs: collective

 Life-cycle cost: total cost to the

2.2 Types of cost estimates

 Order-of-magnitude: first rough

Common technique: using expert

 Comparative estimate, based on well-

The X are empirically derived

 Feasibility estimate: based on the

Technique: Work breakdown

 Definitive estimate : when most

The rule of thumb: Human performance

Example: In aerospace industry ,

(ii) Work breakdown:

Cost coding: System assigning to each

Benefit of cost coding:

An effective coding system must be

2.3 Costing problems:

 Cost escalation: amount of

Cost escalation of up to 20% are

Large, complex, high technology

 Following are the reasons – some

 Economic and social variables