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 07-01

CHAPTER SEVEN

Risk Management
Chapter Outline

PROJECT PROFILE

Haitian Earthquake Relief

INTRODUCTION

PROJECT MANAGERS IN PRACTICE

Mohammed Al-Sadiq, Saudi Aramco Oil Company

7.1 RISK MANAGEMENT: A FOUR-STAGE PROCESS

Risk Identification

Analysis of Probability and Consequences

Risk Mitigation Strategies

Use of Contingency Reserves

Other Mitigation Strategies

Control and Documentation

PROJECT PROFILE

Collapse of Shanghai Apartment Building

7.2 PROJECT RISK MANAGEMENT: AN INTEGRATED APPROACH

Summary

Key Terms

Solved Problems

Discussion Questions
 07-02

Problems

Case Study 7.1 Classic Case: de Havilland’s Falling Comet

Case Study 7.2 Classic Case: Tacoma Narrows Suspension Bridge

Internet Exercises

PMP Certification Sample Questions

Integrated Project—Project Risk Assessment

Notes
 07-03

TRANSPARENCIES

7.1 RISK VERSUS AMOUNT AT STAKE

 07-04

7.2 TYPICAL RISK FACTORS

1. FINANCIAL RISKS

2. TECHNICAL RISKS

3. COMMERCIAL RISKS

4. EXECUTION RISKS

5. CONTRACTUAL OR LEGAL RISKS

 07-05

7.3 QUALITATIVE RISK ASSESSMENT MATRIX

 07-06

7.4 QUANTITATIVE RISK ASSESSMENT

CALCULATIONS
 07-07

7.4 QUANTITATIVE RISK ASSESSMENT

CALCULATIONS (CON’D)
 07-08

7.4 QUANTITATIVE RISK ASSESSMENT

CALCULATIONS (CON’D)
 07-09

7.5 CONTINGENCY DOCUMENT FOR ADJUSTMENTS

TO PROJECT PLAN

Probable
Event ADJUSTMENT TO PLANS

Absenteesim

Resignation

Pull-aways

Unavailable
Staff/skills

Spec Change

Added work

Need more
training

Vendors late
 07-10

DISCUSSION QUESTIONS

1. Do you agree with the following statement: “With proper planning it is possible to
eliminate most/all risks from a project.” Why or why not?

It is not possible to eliminate risk from a project regardless of planning. The role of risk
management is to identify and analyze potential risks associated with a project. Once
risks have been identified, preventative action or contingency plans may be established to
reduce the impact of the risk on the success of the project. While this presents a way to
help control the effects of risk, it does not eliminate risk from the project management
equation.

2. In evaluating projects across industries, it is sometimes possible to detect patterns

in terms of the more common types of risks they routinely face. Consider the
development of a new software product and compare it to coordinating an event,
such as a school dance. What likely forms of risk would your project team face in
either of these circumstances?

A new software product would include a higher amount of risk than a school dance. The
software project would be subject to risk related to market volume/price, technical risk,
financing, scheduling, resignation, organizational, and operating risk. Coordinating a
school dance would run risks associated with availability of staff and an appropriate
facility as well as adequate funding. Both projects would involve risk variables such as
cost estimate risk, integration risk, “acts of God”, inadequate skills availability, and
absenteeism.

3. Analyze Figure 7.2 (degree of risk over the project life cycle). What is the
practical significance of this model? What implications does it suggest for
managing risk?
 07-11

The diagram demonstrates the relationship between level of opportunity and risk
throughout the project life cycle. This is helpful in determining points at which
uncertainty is at its highest and when the greatest amount of risk may be realized. Project
teams can focus their risk analysis in these areas or use the diagram to give weight or
perspective to potential risk variables. The diagram also depicts the risk-reward
(opportunity) tradeoff for various stages of a project. Managers can use this information
to determine if risk at a certain point is worth the potential payoffs.

4. What are the benefits and drawbacks of using the various forms of risk
identification mentioned in the chapter (e.g., brainstorming meetings, expert
opinion, etc.)?

Brainstorming, expert opinion and multiple assessment approaches share similar benefits
and drawbacks. The benefits include a variety of experience and multiple angles of
analysis due to different points of view and areas of expertise. Synergy among group
members may also create a wider range of risk identification. Although there are
shortcomings to these approaches. It may be difficult to come to an agreement or
consensus in such processes due to conflicting opinions and personal issues.
Brainstorming, expert opinion (when performed in a forum setting rather than through the
Delphi approach) and multiple assessments may also have difficulty reaching consensus
due to egos/authority issues and functional biases (when members of different
departments are present). When the Delphi technique is employed many of these issues
are resolved because members do not meet face-to-face. The process becomes
anonymous reducing interference of egos and personal problems. However, the Delphi
approach can take considerable time to complete successfully.

Past history is a unique approach to the other three. It uses historical facts to reach
conclusions, which removes many obstacles that the other techniques encounter. The
benefits of risk identification through past history is that, if past projects were well
 07-12

documented, information related to similar projects can easily be found and project teams
can avoid pitfalls by learning from the mistakes of others. Unfortunately, the drawback is
that past performance does not always predict future performance. Project-specific data
(i.e. competitive environment, economy, etc.) is unaccounted for. Thus, past history may
do little to forecast present risks.

5. What are the benefits and drawbacks of using a qualitative risk assessment matrix
for classifying the various types of project risk?

Qualitative risk assessment matrix is beneficial in providing a visual depiction of

potential risk factors. The matrix enables the project team to prioritize risk based on
severity of consequences and likelihood of occurrence. For instance, those that rest in the
“high” portion of both consequences and likelihood would be top priorities during project
planning. Drawbacks of the matrix may revolve around differences in opinion as to
where risk variables should be placed on the matrix. It may also create tunnel vision
where the team fails to acknowledge the significance of tasks that fall outside of the high
priority areas.

6. What are the benefits and drawbacks of using a quantitative risk assessment tool
such as the one shown in the chapter?

One benefit of such tools is in the ability to set thresholds based on calculations of
probability and consequence. A numerical point system creates an easy way to compare
different risk variables. This point system also provides more detail than a matrix in
depicting the level of risk. Additionally, once the point system is designed it can be used
over and over to compare risk factors of future projects. Problems with these tools may
arise in disagreement over assigning points and creating thresholds. Also, the point
system is not an exact science. It relies on rules of thumb and may be subject to
interpretation.
 07-13

7. Give some examples of projects using each of the risk mitigation strategies
(accept, minimize, share, or transfer). How successful were these strategies? In
hindsight, would another approach have been better?

This question requires students to do some online research, investigating projects and
analyzing them in terms of various risk mitigation approaches. One suggestion is to
assign a specific project, such as the new Airbus A-380 and have the students research it,
address relevant risks factors, and the mitigation strategies the company employed.

8. Explain the difference between managerial contingency and task contingency?

Contingency reserves are provisions set aside in case of unforeseen problems. The
primary differences between task and managerial contingency are that managerial
contingency is applied at the project level while task contingency is applied at the
individual task or work package level. Managerial contingencies are budgeting buffers
that teams can fall back on in case of natural disasters, severe divergence from original
process or technical plans or other “acts of God.” Task contingencies are established
because estimates (made during initial planning) for individual tasks may be unreliable.
Reserves for these contingencies may be adjusted as the project advances and estimates
become more accurate.

9. What are the advantages of developing and using a systematic risk management
approach, such as PRAMs methodology? Do you perceive any disadvantages
with this approach?

PRAMs and other similar systems are advantageous because they provide a detailed step-
by-step approach to risk management. This helps project teams work through each part
 07-14

of risk management effectively before moving on to subsequent tasks. This way the team
does not get stalled at one stage or leave out a vital step altogether. PRAMs adds an
additional feature – the feedback loop – that acts as a built-in safeguard to overlooking
risk associated with project changes. The loop also keeps varying levels of managers and
team members up-to-date on project and risk adjustments. The disadvantage to the
PRAMs model is that it may be too involved for low-budget or otherwise small projects.
The amount of time required to learn and institute the steps may be unreasonable in a
short-term, low-budget initiative. Also, it may not be feasible for smaller companies who
do not have the resources or time to devote to such a system.

10. Consider the following statement: “The problem with risk analysis is that it is
possible to imagine virtually anything going wrong on a project. Where do you draw
the line; in other words, how far do you take risk analysis before it becomes
overkill?” How would you respond to this observation?

The tools in this chapter address this very problem. Looking for possible risks could be
an endless process, however, it is important (as outlined in the text) to approach risk in a
systematic way. The early stages of risk management may best answer this question.
The prioritization of risks makes the process manageable, and when done properly, will
prevent a situation of overkill. After potential risks have been identified (using a
supervised, controlled method such as brainstorming, expert opinion, etc.), managers can
use qualitative and quantitative tools to sift through scores of risks to identify what is
probable enough to worry about. Once vital risk variables have been identified, then
mitigation and contingencies can be established. This process does not ensure that all
risks will be identified or that the right contingencies will be created. All the same, the
benefits of taking part in risk management far outweigh the danger of not preparing for
potential problems.
 07-15

CASE STUDIES

Case Study 7.1: de Havilland’s Falling Comet

The de Havilland story is a fascinating example of a well-respected organization that

sought to be first to market with a radical new technology and cut some important safety
corners, with disastrous results. The story highlights the problems when innovations in
design are pushed too far, too quickly. With its unique design and all the additional
features that made it radical, the Comet should have been slowly integrated into
production and use, instead of being rushed to market. De Havilland knew that Boeing
was at work on its own design, the 707, and felt the need to be first to market. In this
rush, they cut a number of safety corners with disastrous results.

Questions:

1) How could risk management have aided in the development of the Comet?

De Havilland was producing an aircraft that was so revolutionary in so many ways that
they may have become overawed by the push in technology for its own sake. Certainly,
the original Comet included several radical design elements (embedded engines in the
wing root, square windows, pressurized cabin, and so forth) that any one of them could
have been a significant advance on its own. Putting them all together into the same new
aircraft design without adequate testing was a disaster. The question of how much testing
is enough is difficult to answer but certainly, with so many innovations in one design, it is
clear that they did not engage in sufficient risk assessment and design testing.

2) Discuss the various types of risk (technical, financial, commercial, etc.) in relation
to the Comet. Develop a qualitative risk matrix for these risk factors and assess
them in terms of probability and consequences.
 07-16

This question asks students to identify the wide variety of risks that were present in this
aircraft. Commercially, de Havilland had a huge investment in its success and perceived
that first-mover advantage would allow them to pick up a big piece of the commercial jet
aircraft market if they were first off the mark. Technically, the aircraft had so many new
and radical features that several of them could have been perceived as risky in their own
right. All of them together were simply too much risk, too fast. Although in might be
difficult for students to reasonably comment on probability of failure, there is no question
that consequences would be catastrophic (as they were).

3) Given that a modified version of the Comet (the Comet IV) is still in use with the
British Government as an anti-submarine warfare aircraft, it is clear that the
design flaws could have been corrected given enough time. What, then, do you
see as de Havilland’s critical error in the development of the Comet?

Over time, the fundamental aircraft design (minus the original square windows) has been
proven to be a success, though the company never again attempted to launch it in the
commercial jet market. De Havilland tried to do too much too fast and created an unsafe
design due to inadequate testing. Students are quick to recognize this basic error on de
Havilland’s part. It is often instructive to note that this foray into the commercial jet
aircraft market was de Havilland’s last and they never returned to the level of technical or
commercial success they had enjoyed during and just after the Second World War.

4) Comment on the statement: “Failure is the price we pay for technological

advancement.”

This question can generate several opinions from students as evidence demonstrates
again and again that organizations continue to push the edges of the technological
envelope with new designs for buildings, aircraft, automobiles, etc. The issue that we
have to address is just how far one should be allowed to push this envelope and at what
point does some system of controls come into play. Clearly, the greater the consequences
 07-17

of failure, the greater the oversight needed to ensure that sufficient risk analysis and
management has taken place prior to opening Pandora’s Box.

Case Study 7.2: Tacoma Narrows Bridge

The famous story of the bridge that shook itself to pieces is familiar to many students.
The background of the story is not as well-known and illustrates what happens when we
attempt to be too innovative without recognizing the full implications of our choices.
The Tacoma Narrows Bridge (TNB) was built at a sight with numerous design challenges
and difficulties, including physical location, size and length of the bridge, use of non-
optimal materials, and so forth. From a risk analysis perspective, the TNB represents
another example of journeying too far into the unknown and only belatedly recognizing
the implications of major design decisions.

Questions:

1) In what ways was the project’s planning and scope management appropriate and
when did they begin taking unknowing or unnecessary risks? Discuss the issue of
project constraints and other unique aspects of the bridge in the risk management
process. Did they take them sufficiently into consideration? Why or why not?

It is easy, in hindsight, for students to criticize several elements in the TNB development
and construction; however, it is important that instructors not allow them to take the easy
way out and focus on the result of the construction. Rather, it is useful to examine how
the development of this bridge actually led to the understanding of an entirely new field
of engineering – aerodynamics. It was thought, up to that point, that bridge-building was
simply a static engineering problem, concerned with downward loads. It took this failure
for engineers and scientists to understand the implications of entirely new forces. In
developing the answers to this question, it is useful to consider all the constraints (known
 07-18

and discovered) that they were dealing with at the sight and with the design they had. In
those circumstances, ask student what they did correctly and where they ignored ample
warning signs of problems to come.

2) Conduct either a qualitative or quantitative risk assessment on this project.

Identify the risk factors that you consider most important for the suspension
bridge construction. How would you assess the riskiness of this project? Why?

This exercise allows faculty to tease out the various risk factors that the TNB project
encountered. After listing them on the board develop a qualitative risk matrix and ask
students to help classify the various risk elements. Ask the question: Why was so little
risk analysis done at the time? The answer is that they did not recognize the risk in the
design, sighting of the bridge, or construction until after it had been constructed.

3) What forms of risk mitigation would you consider appropriate for this project?

Instructors can discuss various risk mitigation strategies in light of the TNB example
(share it, transfer it, etc.). It is useful to ask how each mitigation strategy might be used,
who it would be used with (which stakeholder parties), and how effective each strategy
might be.
 07-19

PROBLEMS

1. Assessing Risk Factors. Consider the planned construction of a new office building
in downtown Houston at a time when office space is in surplus demand (more office
space than users). Construct a risk analysis that examines the various forms of risk
(technical, commercial, financial, etc.) related to the creation of this office building.
How would your analysis change if office space was in high demand?

Solution:

This question can be answered by students in a number of ways. The key point is to get
them thinking in terms of potential risks that are bound to exist prior to initiating a new
project. Commercial risk is paramount here because office space is in low demand,
making any new office building project questionable from a financial perspective.

2. Qualitative Risk Assessment. Imagine that you are a member of a project team that
has been charged to develop a new product for the residential building industry. Using a
qualitative risk analysis matrix, develop a risk assessment for a project based on the
following information:

Identified risk factors Likelihood

1. Key team members pulled off project 1. High

2. Chance of economic downturn 2. Low
3. Project funding cut 3. Medium
4. Project scope changes 4. High
5. Poor spec. performance 5. Low
 07-20

Based on the above information, how would you rate the consequences of each of the
identified risk factors? Why? Construct the risk matrix and classify each of the risk
factors in the matrix.

Solution:

Student can draw a simple 3x3 risk matrix with Probability and Consequences as the two
axes. Depending upon how they view the consequences of each of the above risks, it is
possible to classify them into one of the quadrants of the qualitative risk matrix. The key
is that students justify their classification by giving a logical reason for the consequences
they perceive for each risk factor, should the problem actually occur.

3. Developing Risk Mitigation Strategies. Develop a preliminary risk mitigation

strategy for each of the risk factors identified in problem 2 above. If you were to
prioritize your efforts, which risk factors would you address first? Why?

Solution:

Students can construct a risk mitigation approach (accept it, transfer it, etc.) for each of
the risk factors identified. They must justify their mitigation strategy on the basis of how
severe the risk effect could be, the alternatives, and the reasons why they selected the
mitigation strategy they chose.

4. Quantitative Risk Assessment. Assume the following information:

Probability of Failure Consequences of Failure

Maturity = .3 Cost = .1
Complexity = .3 Schedule = .7
Dependency = .5 Performance = .5
 07-21

Please calculate the Overall risk factor for this project. Would you assess this level of
risk as low, moderate, or high? Why?

Solution:

Using the formula from the chapter, the solution to this problem is:

Pf = (.3 + .3 + .5)/3 = .37

Cf = (.1 + .7 + .5)/3 = .43

Risk Factor = .37 + .43 – (.37 x .43) = .6409, or .64

According to the severity levels, this would be classified as medium risk.

5. Developing Risk Mitigation Strategies. Assume that you are a project team
member for a highly complex project, based on a new technology that has never been
directly proven in the marketplace. Further, you require the services of a number of sub-
contractors to complete the design and development of this project. Because you are
facing severe penalties in the event the project is late to market, your boss has asked you
and your project team to develop risk mitigation strategies to minimize your company’s
exposure on this project. Discuss the various types of risk that you are likely to
encounter. How should your company deal with them (accept them, share them, transfer
them, or minimize them)? Justify your answers.

Solution:

This question is not intended to elicit a specific answer, but to make students consider all
potential issues that could arise and begin to formulate strategies for mitigating those
risks. The more interesting discussion typically emerge around the question of which
mitigation strategies are best for different risks. Some creative thinking of the part of
 07-22

students can often identify alternatives to standard approaches for risk mitigation,
although it is also useful to have them recognize that for certain low impact risks, simply
accepting them is often the best (least expensive and fastest) solution.

6. Assessing Risk and Benefits. Suppose you are a member of a project team that is
evaluating the bids of potential contractors for developing some sub-assemblies for your
project. Your boss makes it clear that any successful bid must demonstrate a balance
between risk and price. Explain how this is so; specifically, why are price and risk seen
as equally important but opposite issues in determining the winner of the contract? Is a
low price/high risk bid acceptable? Is a high price/low risk bid acceptable? Why or why
not?

Solution:

The issue of price and risk and critical for understanding the thought process that often
goes on with clients when deciding which contractor to award the project. At times, a
higher price bid can win a contract, provided that the client recognizes a lower risk level
with a certain contractor. For example, in cases where an older, well established firm
bids a contract, they may offer a higher bid but it is attractive because their obvious
project management expertise lower concomitant risk. On the other hand, an untested or
problematic contractor’s low bid may be refused because they bring unacceptable levels
of risk to the project. Price and risk thus serve as the weights on two opposite scale pans.
Too much risk requires exceptionally lower prices, whereas a higher bid can be offset
with significant reductions in risk.
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