Excerpts from the scientific research on risk conducted among the largest Polish contractors

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1 Piotr Tworek * Excerpts from the scientific research on risk conducted among the largest Polish contractors Introduction Risks occur in business operations of every company, including construction and assembly companies. Contractors have to identify risks on a case-by-case basis as there are no two identical investment projects and every time risks in the construction industry may be different. In practical terms, risk is an inherent and indispensable element of management over construction investment projects. Along with a rise in the number of projects a contractor has in its portfolio and the complexity of these projects, in terms of techniques and production technology, the global risk becomes more important in the contractor s activities (portfolio risk). Also risk sources in the construction business may vary as risks aren t limited to construction and assembly production in strict sense, but may also result from e.g. the macro-environment. Another source of risks are third parties involved in the investment and construction process. The difficulties contractors face are often due to the behaviour demonstrated and mistakes made by investors and designers. In particular, sometimes investors may bring contractors to the verge of bankruptcy, which is quite a frequent phenomenon in the construction industry. Appropriate identification of these threats and, in particular, the ability to recognise factors, which cause risks in operations of typical large construction and assembly companies is an effective way of supporting the processes of corporate management and investment execution. These issues are addressed in the paper, which aims to identify the categories of risks that may appear in operations of the biggest construction and assembly companies. Due to the complexity of processes running in these companies, risks tend to occur there much more often than in case of small and medium-sized contractors, which often act as subcontractors and undertake some minor projects. Only big construction and assembly companies are able to carry out the biggest and most sophisticated projects and they usually have to bear all the risks related to the investment project. Furthermore, the paper also illustrates and describes the results of the related empirical research conducted among the group of twenty five, out of one hundred, largest construction and assembly companies in Poland. The research, based on face-to-face interviews, was performed in 2009, within the framework of the author s own scientific project, in the Department of Investments and Real-Estate, the University of Economics in Katowice. The * A Ph.D., Department of Investments and Real-Estate, Division of Investment Project Economics, Faculty of Finance and Insurance, Investments Economics Unit, University of Economics in Katowice, piotr.tworek@ue.katowice.pl

2 114 Piotr Tworek criterion for the selection of the sample was the value of construction and assembly production sold in the previous financial year, according to the ranking published by Rzeczpospolita daily. The author mainly focuses on risks, which occur in production activities carried out by the companies surveyed. The deliberations presented in the paper are supplemented by the findings and conclusions formulated by the author, based on his extensive experience and the knowledge acquired during his long-term studies on risk management in the construction industry. In the article the author outlines the selected problems from this area in a synthetic way. The article is mainly empirical in its character and the author uses deduction, among other methods, to formulate the conclusions. 1. Risk in activities of construction and assembly companies selected survey research The findings of the research carried out among the largest construction and assembly companies operating in Poland show how risk is practically evaluated in the construction industry (by contractors). The empirical research shows that the most frequent risks indicated by the contractors include, in sequence: the cost overrun risk (42.4% of the respondents), the project schedule risk (34.6% of the respondents), the risk of a lack of safety on a construction site (13.4% of the respondents), the risk of a failure to meet investor s quality requirements (9.6% of the respondents). This is illustrated in Fig. 1. Figure 1. Cost, schedule, quality and safety risks in activities of surveyed companies quality risk 2 cost overrun risk 3 schedule risk 4 safety risk Source: Prepared by the author on the basis of the replies given. As can be seen in Fig. 1, irrespective of the approach to risks in the construction industry, the four main categories, i.e. the cost overrun risk,

3 Excerpts from the scientific research on risk conducted among relating to a failure to stay within the cost budget for the project, the safety risk, relating to accidents on the construction site, the quality risk, relating to a failure to execute the investment projects under the quality standards and requirements, and the schedule risk, relating to delays in the execution of the investment project, are always brought to the forefront. All these categories combined show a general picture of risks in the construction business, we can, however, identify a number of component risks within these categories as well 1. ( ) This constitutes the contractor s global risk, which can be divided into: the contractor s own risk, the contractor s risk from the investor, the contractor s risk from the designer and the contractor s risk from other sources [Tworek, 2010, p. 106]. From the point of view of construction and assembly production as such, risk may be interpreted there as the total of all the construction and assembly risks. That is why the insurance products offered to the construction industry are called CAR insurance (Construction All Risks) and EAR insurance (Erection All Risks) [Tworek, 2009, p. 2]. Looking from the economic perspective, risks faced by construction and assembly companies may also be defined and perceived in a number of ways. In particular, when analysing risks which occur in the construction industry, two categories, i.e. project price and project cost, should always be kept in mind. Many engineers, however, confuse these two terms. A project price includes costs related to the project execution, the profit expected by the contractor and the risk calculated by this company, seen as separate items. In practical terms, the contractor needs to recognise, each time as separate items, any possible deviations in costs which may occur during the execution of the investment project and, in particular, determine the maximum level of such deviations they find acceptable, in order to evaluate a potential risk of the investment project. As indicated by the results of the research, contractors are predominantly exposed to risks in the investment and construction process at the construction execution stage, i.e. as many as 70% of the respondents state that risks they have to face occur at the stage when construction and assembly works are performed and only 1 of the surveyed entities states that they occur at the project operation stage. Furthermore, 28% of the entities state that they most frequently need to deal with risks when preparing their investment projects for execution. Such results come as no surprise as this is the nature of risks in the construction industry and their industry-specific profile. The empirical research shows that contractors, when executing their projects, mostly need to handle risks related to financing. This is mainly about the difficulties in timely collection of payments from investors, as well as financial problems experienced by contractors themselves, e.g. financial liquidity problems. Currently, i.e. at the time of the global 1 See more: Flanagan R., Norman G. (1993), Risk management in construction. Blackwell Publishing, Oxford, p. 8; Edwards L. (1995), Practical risk management in the construction industry. Thomas Telford, London, p. 7 ff.; Boothroyd C., Emmett J. (1996), Risk Management. A Practical Guide for Construction Professionals. Witherby & Co. Ltd., London, pp ; Equitable Risk Allocation. Research Summary Construction Industry Institute, The University of Texas at Austin, Austin, September 2006, pp

4 116 Piotr Tworek economic crisis, contractors have to deal with such problems quite frequently. Nevertheless, 16% of the contractors point out that they experience difficulties connected with the organisation of project execution and the human resources risk, i.e. 13% of the respondents indicate absences from work due to workrelated accidents. Then, 12.5% of the respondents indicate so-called force majeure risks. These are the most significant risks, which tend to occur at the project execution stage. Other risks, which may potentially appear in the construction business, are listed in tables 1 and 2. Table 1. Risk Checklist for Sources of Potential Negative Risk Risk Source Potential Events Cost Budget or bid unreasonable. Failure to account for bid items or Escalation requirements to fully complete project. Failure to meet budget. Schedule Unreasonable schedule. Delays from others e.g. owners, suppliers, Delay subcontractors, or consultants. Delayed permit process or site access. Failure to meet milestones. Labour Problems Project Management Issues Safety Problems Excessive Change Orders Unforeseen Conditions Environmental Concerns Equipment Issues Inflation Weather Complexity Client or Owner Initiated Fire Suppliers Availability and productivity issues. Unskilled labour force. Strikes or working to rules. Inexperienced project managers. Lack of cohesiveness in team. Inappropriate contract type or construction delivery method. Personal accidents from minor to fatal. Damages to property. Structural failure. Poor design, capricious owner, new requirements. Fast track construction. Underground or hidden site conditions. Required regulatory approvals take longer than anticipated. Mitigation of environmental concerns cost more than anticipated. Equipment failure. Selection of inefficient equipment. Material, equipment, labour and overhead cost increases. Adverse weather. Time of year work is scheduled causes low productivity. Extreme events e.g. hurricane, lightening strikes, or floods. Level of difficulty or technically challenging. Mistakes or rework. Potential owner s representatives, architects, engineers, and inspectors are overly critical or difficult to work with. Bankruptcy of owner. Loss of political support. Late payments. Operations that require open flame or sparks. Work requiring explosives. Non-performance from vendors, subcontractors or suppliers. Working with unknown suppliers. Defective materials.

5 Excerpts from the scientific research on risk conducted among Property Loss Theft, sabotage or vandalism. Design Incomplete design causes expensive changes and delays. Quality Problems Rework. Failure to meet specifications. Systems not working or fitting together properly. Source: [Bender, Table 2. Risk Checklist for Sources of Potential Opportunistic Risk Cost Efficiencies Activities cost less than anticipated. Use method that requires fewer resources. Perform work under budget. Schedule Activities take less time than anticipated. Change CPM logic. Efficiencies Use overtime, shift work or extra crews. Complete work ahead of schedule. Labour Increased use of equipment, modular units, robots, or new Efficiencies Project Management technologies. Better job site layout, appropriate level of resources, technological productivity enhancements. Experienced team that have worked together before. Equipment Purchase or lease of more productive equipment. Management Weather Schedule work activities to take advantage of windows of opportunity. Suppliers Opportunities for strategic partnerships. Design Constructability improvements. Source: [Bender, The origins of risks in the investment and construction process are shown by the research findings, as illustrated in Fig. 2. Figure 2. Risks vs. participants of the investment and construction process risks coming from the investor, i.e. 40% of the respondents 2 - risks coming from other contractors (subcontractors), i.e. 25.7% of the respondents 3 - risks coming from the designer, i.e. 31,3% of the respondents 4 - risks coming from other entities, i.e. 3% of the respondents Source: Prepared by the author on the basis of the replies given. The research findings shown in Fig. 2 are quite clear, i.e. in business practice, the investor is mostly responsible (40% of the respondents) for the

6 118 Piotr Tworek risks the contractor needs to address. Investors most often fail to settle payments in due time, which is probably caused, to a big extent, by their poor financial standing and financial problems. Then, 31.3% of the contractors state that the risks they are exposed to are caused by the designers behaviour. As many as 25.7% of the respondents state that risks are mostly caused by other contractors, i.e. subcontractors and suppliers of construction materials and equipment. Only 3% of the respondents indicate that risks in their operations are due to the reasons caused by, and the behaviours shown by, other entities, i.e. environmental organisations, public institutions etc. When it comes to the consequences of risks, however, it should be emphasised that 76% of the contractors have faced certain financial liquidity problems over the last few years of their activities. However, 24% of the respondents have not noticed any difficulties of this type. Such a result is the straightforward confirmation of high risk frequency in the construction business and, consequently, illustrates the financial aspect of risk consequences. The research findings also show that along with the economic crisis, the financial situation of the surveyed entities has deteriorated (64% of the respondents). The results may also lead to the conclusion that the majority of the contractors (60% of the respondents) feel the positive effects of Poland s accession to the European Union. Due to the opening up of European construction services markets, contractors are now free to participate in bidding processes for construction works in all EU countries. Here, it may be advisable to mention the results of the surveys by the Central Statistical Office of Poland (Główny Urząd Statystyczny - GUS), which carries out regular analyses of principal barriers that construction entrepreneurs have to overcome. According to GUS ( ) the biggest difficulties faced by entrepreneurs who report the barriers are connected with labour costs (58% in September 2011, 52% in the corresponding month of 2010) and competition on the market (56% in the current month, 57% a year ago). ( ) Compared to September 2010, the barriers which have increased most are the ones connected with costs of materials (from 28% to 37%) and labour costs; the ones which have decreased, however, are the barriers connected with weather conditions (from 28% to 18%) and insufficient demand (from 38% to 34%) [GUS, 2011, p. 2]. Such results should not raise any eyebrows, as at the times of economic downturn business operating costs go up, which leads to increased competition on the market and a rise in unemployment in the economy and, consequently, a rise in business risk. There are, of course, industries which are more affected by the global economic crisis than others, and an increase in global risk contributes also to a rise in the number of risky projects carried out in the construction industry. It should be noted however that ( ) this crisis in Poland ( ) has not hit so heavily and has not been as severe as in other European countries, e.g. Greece or Hungary [Tworek, Valouch, 2011, p. 32]. The research also shows that only 28% of the contractors collect data about risks in purpose-built databases. As many as 72% of the respondents, however, do not collect such data at all. In the research the contractors are also

7 Excerpts from the scientific research on risk conducted among asked to answer the following question: Do you create reserves for covering any possible losses due to business risk? In reply, 56% of the respondents state that they create reserves and the rest of them state that they do not create such reserves. The main aim of the reserves is to prevent the escalation of risk consequences in case of a loss. The ultimate risk consequences for the contractor are also connected with a need to incur expenditure. Reserves are created for losses which have occurred, in business terms, before the balancesheet date but their size and time of occurrence will not become known in detail until after this date [Adamek Hyska, Tworek, 2010, p. 6]. The value of a likely loss for which a reserve is created is calculated as the difference between the expected income and the total of all costs of the given business transaction which have already been incurred [Adamek Hyska, Tworek, 2010, p. 6]. The similar research carried out among the selected group of the largest companies in Poland, i.e. investors, shows that 70% of entities create reserves which are seen by them as an instrument used to alleviate the risk consequences [Marcinek, Foltyn Zarychta, Pera, Saługa, Tworek, 2010, p. 86]. However, if we take into account risk identification methods, which are used in investment and construction business, the research shows that 68% of the contractors use brainstorming as the basic risk identification method [Tworek, 2010, p. 425]. It means, in particular, teamwork of a group of employees involved in the investment projects. The second most popular method is an interview with key project participants (48% of the respondents) [Tworek, 2010, p. 425]. Next, 18% of the contractors carry out construction site inspections in order to identify risk. [Tworek, 2010, p. 425]. In the surveyed companies, this is done by most experienced, long-serving employees. Conclusions Currently, the global risk in the construction industry is affected by the world economic crisis. In Poland, along with the crisis, the financial situation of 64% of the respondents has deteriorated. Nevertheless, most of the contractors, i.e. 60% of the respondents, can feel the positive effects of Poland s accession to the European Union. This is due to general availability of EU funds, which enable the execution of numerous projects, especially in infrastructure. Summing up, the empirical research may lead to the following conclusions: in business activities carried out by the surveyed companies, risks are mostly generated by the environment in which the companies operate and the risks most frequently experienced by contractors occur mainly at the stages, when construction and assembly works are performed (70% of the respondents). The cost overrun risk, in turn, is the main risk category in this area, as indicated by 42.4% of the respondents, currently, when executing construction projects, the contractors face the biggest problems in the area of project financing, as indicated by 23.2% of the respondents,

8 120 Piotr Tworek in most cases, the investors are responsible for the contractors own risk (40% of the respondents), i.e. the investors most frequently do not settle their payments in due time, which is now mainly caused by their deteriorating financial condition (because of the crisis). At the same time, as many as 76% of the contractors have experienced financial difficulties (e.g. financial liquidity problems) over the last few years of their activities, only 28% of the contractors collect data about risks in purpose-built databases, 56% of the contractors create special reserves for covering possible losses that are the consequences of risks occurring in a company, according to the contractors (65.2% of the respondents), the most significant risk factors in the construction industry are calculation errors made by their own employees and competition on the investment and construction market, which forces them to lower the prices they offer in bidding processes, it has been found out that in Poland, along with the economic crisis, the business operation risk borne by the surveyed entities has been rising. References 1. Adamek Hyska D., Tworek P. (2010), Provisions for payables as an instrument used by construction and assembly companies in Poland to reduce consequences of risk in their operations. 12 th International Scientific Conference of Finance Department, Finance and Risk 29 th 30 th November, Bratislava. 2. Bender J.W., A risk based cost control methodology for constructing complex structures with the mobile offshore base as a case study, Webpage: 3. Boothroyd C., Emmett J. (1996), Risk Management. A Practical Guide for Construction Professionals, Witherby & Co. Ltd., London. 4. Edwards L. (1995), Practical risk management in the construction industry, Thomas Telford, London. 5. Equitable Risk Allocation, Research Summary 210 1, Construction Industry Institute, The University of Texas at Austin, Austin, September Flanagan R., Norman G. (1993), Risk management in construction, Blackwell Publishing, Oxford. 7. Koniunktura gospodarcza budownictwo, Wrzesień 2011 r. Webpage of GUS: two_09m_2011.pdf 8. Marcinek K., Foltyn Zarychta M., Pera K., Saługa P., Tworek P. (2010), Ryzyko w finansowej ocenie projektów inwestycyjnych. Wybrane zagadnienia, Uniwersytet Ekonomiczny w Katowicach, Katowice.

9 Excerpts from the scientific research on risk conducted among Tworek P. (2009), The all risks insurance in Polish construction industry. International Scientific Conference on Insurance Industry Trends III, Ekonomická Univerzita v Bratislave, 22 nd October 2009, Bratislava. 10. Tworek P. (2010), Methods of risk identification in companies investment projects, 5 th International Scientific Conference Managing and Modelling of Financial Risks, VŠB Technická Univerzita Ostrava, 8 th 9 th September, Ostrava. 11. Tworek P. (2010), Ryzyko wykonawców przedsięwzięć inwestycyjnych. Akademia Ekonomiczna im. K. Adamieckiego, Katowice. 12. Tworek P., Valouch P. (2011), The condition of construction industry in Poland and the Czech Republic under the financial crisis. Selected issues, [in:] Studia Ekonomiczne, Edited by Marcinek K., Uniwersytet Ekonomiczny w Katowicach, Katowice. Summary The paper is empirical in its character. In particular, it presents the excerpts from the scientific research conducted by the author among the selected group of the largest construction and assembly companies in Poland. The key aim of the paper is to outline and discuss the results of the empirical research into risk in business activities carried out by the surveyed companies. The research has covered only the largest contractors as large and very large construction and assembly companies tend to act as general contractors and carry out the biggest investment projects which, by definition, involve the highest risk. The execution of such projects requires the identification of risks, which occur at all stages of the investment and construction process. Key words Risk, risk management, construction enterprises Z badań naukowych nad ryzykiem wśród największych polskich wykonawców budowlanych (Streszczenie) Artykuł posiada charakter empiryczny. W szczególności przedstawia fragment wyników badań przeprowadzonych przez autora wśród wybranych największych przedsiębiorstw budowlano montażowych w Polsce. Zasadniczym celem artykułu jest prezentacja i omówienie wyników badań empirycznych dotyczących problematyki występowania ryzyka w działalności badanych przedsiębiorstw. Badaniom objęto tylko największych wykonawców, ponieważ w praktyce to duże i bardzo duże przedsiębiorstwa budowlano montażowe występują w roli generalnych wykonawców i realizują największe projekty inwestycyjne, które z definicji obarczone są największym ryzykiem. Ich realizacja pociąga za sobą konieczność identyfikacji ryzyka we wszystkich etapach procesu inwestycyjno budowlanego. Słowa kluczowe Ryzyko, zarządzanie ryzykiem, przedsiębiorstwa budowlane