28 Aug Compare and contrast opportunities for risk prevention in light of current best practices. Discuss communication practices that are necessary for prevention of risks. Identif

TITLE: A Revised Interpretation of Risk in Project Management Sebestyén, Zoltán; Tóth, Tamás.  Periodica Polytechnica. Social and Management Sciences; Budapest Vol. 22, Iss. 2, (2014): 119-128. DOI:10.3311/PPso.7740 Abstract Both project management and finance have their own advanced risk concept, but developing a correct and complete integration of them has not been resolved so far. The novelty of the paper is a general framework for risk management in which the goals of a project are approached by the interests of owners rather than by the regular object-oriented ways. The framework resolves the following contradictions. 1) The traditional risk management approach distributes the total risk of a project among risk classes; as a consequence, the fact that only a fraction of the project risks are assumed by the owners is ignored. 2) Traditional project risk management cannot deal with the phenomenon that higher risks are found in the risk categories during the later periods of a project. 3) The positive deviation from the project goals is not interpretable in the traditional approach. In the new framework risk analysis becomes a more effective tool for all the participants of a project. 1 Introduction A contradistinction of project risk management is that the owners’ value-making approach in its full complexity is often lost on the level of operative management. The phenomena that managers tend to identify the owners’ expectations as finishing the object of the project is obvious, as the purpose of their existence in the project company is tied to the object delivering process itself. The main problem is then that the ‘harmful events’ in operative risk management also tend to reflect to the events impeding the implementation goals of the project delivery, but not necessarily to the barriers of the value creating processes. In contrast, the owners may realize added value with significant delays and cost overruns, or even without finishing the project. According to this contradistinction there is a pressing need for the development of an integrated risk management method. The novelty of this paper is a more general project definition for the field of project management where the well-known concepts of finance and the traditional concepts of project management are integrated into one framework. In this new framework, the minimum expectation (i.e. the project goal) of each stakeholder can be determined. This goal is financially connected to the interests of the participant’s owners rather than to the object of the project itself. On the other hand, in the integrated framework a revised risk analysis is introduced as an effective tool to enable participants to structure their contracts during the conceptual phase to take only favorable risks and eliminate disadvantageous risks. The application of some well-known risk analysis techniques is also illustrated in the integrated framework. After reviewing the relevant literature the paper follows a threefold structure. First, the paper provides a revised integrated project risk assessment framework enhancing the conventional risk category-based methods. Second, the minimum requirements of the owners are clarified to acquire the main goal of project risk assessment and to identify the harmful events jeopardizing this goal. Finally, the widely known risk assessment procedures are revised, and a methodology for taking and selecting proper risks is provided 2 Literature Review The general definition of risk in the project management context has undergone significant changes since the 1950s. At that time, risks were only regarded as the possible negative consequences of events or tasks (Rowe, 1977) and were analyzed in a quantitative and formal way (Nemeslaki, 2009). The project management literature concentrated on specifying the risk classes; thus, such research investigated how to manage risks based on those classes. Subsequently, the two-sided nature of risk was emphasized: positive consequences were also considered (Flanagan and Norman, 1993). To address this bilaterality, project management standards included the objective of maximizing the results of positive events and minimizing the consequences of adverse events. In accordance with these standards, many resources suggested methods for risk analysis that accounted for the probability and consequences of risks (PMI, 2013). Turner (2009) summarized the most relevant generic risk management processes and standards. Consequently, numerous industry-specific applications and research projects were established to enable the efficient management of risks (Bevilacqua et al., 2009; Chan et al., 2011; Kwan and Leung, 2011). Zhang (2011) provided an extensive literature review of two schools of project risk analysis based on their objectivity, taking the different risk definitions and methods into consideration. Eventually, risk in project management became increasingly understood conceptually as the likelihood of an event occurring within a project (Baloi and Price, 2003; Purnus and Bodea, 2013); however, an “event” continued to cover a wide range of meanings. The principal methods of risk measurement have gradually spread from other scientific fields to project management applications. (E.g. for a summary of the most frequently used methods in the construction industry, see KarimiAzari et al., 2011). The literature on project management typically divides the risk management process into steps: risk identification (and classification), risk analysis (including qualitative, and, if it is necessary and possible, quantitative ranking) and response (reaction). Because the steps of risk management must be monitored in the course of the realization phase, some authors regard controlling or tracking as an additional risk management step (see, e.g., AlBahar and Crandall, 1990). PMI (2013) states that risk management planning should be done as an additional early step, even if most of the literature does not include and mention it. This paper gives a brief survey on the risk classification methods, because the suggested model integrates and complements this point of the risk management process. There is a rather significant presence of the risk classification development phase of risk management in the literature. According to Flanagan and Norman (1993), risks should be classified based on their consequences, types and effects. From their perspective, risks can be separated into these three categories if the tool is the full-scale general system approach combined with the framework of the work breakdown structure (WBS). Chapman (2001) suggested that risks ought to be classified based on a different aspect: the place of occurrence. In this case, the classes are the environment, industry, client and project. Nevertheless, in the case of construction projects, Klemetti (2006) recommended the formation of external and internal risk source sets. The most widespread methods name the following risk classes, among others (Shen et al., 2001). The economic and political environment in which a project is realized provides the country risk. In some cases, political risk constitutes a separate category. Construction and scheduling risks involve time and cost overruns; problems related to technical, quality, design and environmental questions; permits; licenses; and acts of God. Technical risks often form an independent category. Exchange rate, inflation and interest rate risks belong to the class of financial risks. Changes in the environment and the accuracy of forecasts are regarded as business risks or market risks. The regulatory environment determines the legal risks. In addition, the team executing a project and the management methods could also involve risks that are referred to as management risks. Another branch of the research examines the human components of risk management and their effects. For example, Thevendran and Mawdesley (2004) divided the human factors that affect construction project risks into three groups. The individual level of human factors includes elements related to abilities, skills, knowledge, stress, motivation, and emotional and cultural characteristics. On the project team level, there are management, communication, and coordination tasks and control. The organizational level contains systems and procedures, organizational politics and norms. The field of risk management has found its place and role in the project management processes, however, certain targeted empirical tests signal the possibility of serious fundamental problems. For instance, Uher and Toakley (1999) studied the implementation of risk management applications and tools and found that although most experts were familiar with the current concepts of risk management, they did not apply them in the initial phase of projects. Moreover, the authors found that risk identification is the best-known component of risk management, and the respondents showed a preference for using qualitative methods in risk analysis techniques. These authors also found that although information technology is widely used in the conceptual phase of a project life cycle, it is used primarily for cost estimating, scheduling and forecasting. They also observed a distinct lack of integration between information systems on average. These results show that although the most updated risk engineering techniques are available, their application and operation is still far from smooth. The root of this phenomenon is that the picture remains incomplete: the ultimate motivations behind risk management processes must be clarified. The literature often implicitly assumes that risk management can be interpreted as an engineering tool with processes that are bounded to the tangible product of a project (e.g., finding and managing causes which jeopardize completing the planned object). In most cases, even the more sophisticated risk management frameworks focus on engineering methods (Dikmen et al., 2008; Tserng et al., 2009) and fail to define the comprehensive goal of risk assessment. For example, it is irrational to discuss the well-known time overrun risk from the project owners’ point of view if such risk does not involve a change in value for them, because e.g. lost money will be regained from a contractor in the form of a penalty payment. Certainly, time overrun would not be an important risk for the owners of contractors either if insurance covers the additional costs. In this case, the owners of the insurance company bear the risk. Although Zavadskas, Turskis and Tamosaitiene (2010) already have identified a multi-attribute decision-making method taking the interests and goals of the stakeholders into consideration, the ranking of these goals, and the context among them, the risk analysis consequences expressed as functions have been left undefined. 3 Integrated Risk Assessment Framework The problem with the conventional approach for project risks is that a manager may conclude with certainty that the ultimate aim of his or her company is to create the object of the project. However, in a carefully designed contract, the compensation that is paid in the case of the client’s cancellation of the contract is often comparable to the profit that is made if the object of the project is created successfully. In such a case, the owners of the contracting company may not perceive the interrupted project as a failure. According to a generally accepted definition by Project Management Institute (2013), “a project is a temporary endeavor undertaken to create a unique product, service, or result.” This definition implies that someone wants to accomplish something. In fact it would be more appropriate to assume that someone wants to accomplish something, as long as it is in his or her interest. In the paper, therefore, a more general project definition is introduced which is related to the interests of the participant’s owners. All notations used in the paper are summarized in Table 1. First, let us define value-driving parameter (xn,t) as an arbitrary variable that can have any effect on the financial position of the owners of a business idea. The business idea is either to deliver a complete unique product, service, or result; or only to participate in creating it partially. n = (1,…,N) refers to the physical indicators (see below), and t = (1,…,T) refers to the time period under study (typically in years). Based on these two variables, the CFt = s(x1,t ,…,xN,t) annual cash flow in year t can be determined, showing the expected change in the value of the owners’ equity related to the business idea for that period of time Value-driving parameters can be typically the following: • parameters that are necessary for the calculation of the cost of capital: long-term nominal risk-free return, market risk premium, unlevered or levered industrial sector beta, and debt beta (the beta of a stock, portfolio or debt is a number describing the correlated volatility of an asset in relation to the volatility of the market as a whole); • taxes: corporate income tax, business tax, land tax, building tax, VAT, and other taxes; • parameters of a potential loan: amount of the loan, base interest rate (often bound to a reference index), interest surcharge, other costs, spot exchange rates and expected inflation rates of relevant currencies); • project-specific parameters (e.g., investment costs, components of expected operation costs and revenues, expected terminal value); • parameters of unusual and acts of god situations (e.g. possible damage in environment, potential occupational safety and health damages, and unexpected penalties). Now, the project can be defined as the series of expected values of cash flows calculated from the value-driving parameters of a business idea. Annual cash flows are uncertain expectations regarding the future, and can be specified only from the perspective of the owners of the actual business idea. Fig. 1 shows the expected cash flows of the genuine business idea owners. As Fig. 1 shows, the later cash flows have a higher forecasting uncertainty that is illustrated by higher standard deviations.