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|Federal Highway Administration > Publications > Public Roads > Vol. 68 · No. 1 > Reducing Uncertainty|
by Chris Allen
Managing risk from the outset can ensure smoother delivery over the life of a transportation megaproject.
Risk is inherent in nearly every decision a person makes, even minor ones like deciding when and where to cross the street. A pedestrian, for example, may consider crossing midblock, rather than walking down to the corner to wait for the light. Although a midblock crossing is unsafe, if the street is empty, the pedestrian may determine that the risk level is low and choose to cross anyway. During rush hour, however, the risks are much higher. This basic decisionmaking process is at the heart of risk management.
Risks arise because of limited information and uncertainty about the future. In transportation construction projects, project managers face the risk of cost overruns, scope and schedule creep, and even waste, fraud, or abuse. Environmental, quality, and safety factors also represent sources of risk. And with megaprojects, managers run the risk of generating political controversy at the Federal, State, or local level. An unrealistic assessment of risk, for example, could lead to overly optimistic estimates, resulting in unachievable goals and unmet expectations.
Managing risk effectively, especially with major transportation projects, requires implementing a structured, well-thought-out risk management plan. Although managers cannot eliminate risk entirely, they can minimize uncertainties by monitoring a project's risks, developing strategies to mitigate them, and establishing fallback positions and contingencies. Risk management also can lead to more creative and efficient management techniques, such as innovative financing, new methods of accountability and control, and increased options for contractual arrangements.
To maximize the investment of taxpayer dollars in transportation services, the Federal Highway Administration (FHWA) identified risk assessment and management as important tools for deploying limited resources and identifying uncertainties. Risk assessments would enable agency managers to focus on, manage, and direct limited resources to mitigate the potential for adverse events.
The Project Management Institute's Risk Management Specific Interest Group describes the process of risk identification and assessment as turning "'unknown unknowns' (uncertainty) into known risks for the purpose of better managing the project." One widely used risk model uses the severity and frequency approach to assess risk, which helps map and sort out the high- and low-risk areas. In the risk assessment model, severity is the magnitude of a given risk and frequency is the likelihood of the risk occurring. "Shifting resources toward high-risk areas and away from low-risk areas is crucial," says Tom Sorel, group leader with FHWA's Major Projects Team.
Agencies can manage risk at the strategic, operational, and project levels. The strategic approach looks at risk from an agency perspective. At the operational level, risk management entails developing best practices to achieve the goals outlined in the strategic approach and implementing them agencywide.
Project-level risk hones in on specific project details such as processes that ensure accurate contractor billing, verify changes, and check on potential scope creep. During a project, risk assessments can be reevaluated continuously as additional information and feedback come in. Because a project manager would track the risks through the project life cycle, a red flag would occur if a specific timeline was not being met or an invoice submission was higher than normal. The project level is where it is crucial for agencies to make decisions about how to allocate their human resources for particular projects and the types of activities that must be executed. Implementing internal control procedures helps ensure that stakeholders at all levels and functions adhere to directives, such as policies and procedures for authorizations, approvals, performance reviews, verifications, and reconciliations.
A risk assessment might take into account such things as funding; design complexity; interdependence of individual contracts; time and workplace restrictions; staffing levels, abilities, and experience; scheduling; potential for waste, fraud, and abuse; and the amount of third-party involvement and coordination required. (See "Areas to Consider in Risk Assessments".)
Risk and Megaprojects
Megaprojects offer unique challenges for risk management. For example, risk analysis plays an important role in developing estimates for the project costs and schedules that are essential throughout the project life cycle. (See "Accounting for Megaproject Dollars".) Because of the size and impact of megaprojects, numerous activities aside from engineering and construction can affect the management and outcome of a megaproject, such as new laws, negative publicity, market fluctuations, catastrophic events, and other variables.
Risks commonly fall into two broad categories: (1) those that can be identified by the project team (sometimes termed "known unknowns") and (2) those that are beyond the grasp of the project team at a particular point in time, such as an unanticipated budget cut (sometimes called "unknown unknowns"). According to Dr. Edmund H. Conrow, a project risk management consultant from Redondo Beach, CA, "Although risk management is commonly applied to the first type of risks—the known unknowns—a good, properly implemented risk management process can help to quantify the risk impact and develop sound plans for alleviating the effect of unanticipated risks—the unknown unknowns." To manage a megaproject effectively, the project management team must account for and be prepared to manage both anticipated and unanticipated risks.
Use of Contingencies
Contingencies have been effectively used to budget for uncertainty, despite the belief by some pundits that contingencies create a self-fulfilling prophecy with the project cost automatically growing to consume all contingencies. This may be based on the concern that a "cushion" may result in a more relaxed management approach to cost containment, inevitably leading to unnecessary cost increases.
However, in the application of risk management, contingencies recognize that unspecified but legitimate additional costs will arise during the life of a project. The additional costs must be covered by the project's budget.
"It is preferable from a management perspective to have the funds readily available to resolve issues in a timely fashion," says FHWA's Deputy Administrator J. Richard Capka. "It is also important that those who manage the State [department of transportation] budget be freed from the nuisance of having to make frequent and numerous but minor budget adjustments to cover clearly legitimate costs. Management is accountable for the expenditure of contingencies and must ensure that the project management team remains focused upon adequate cost control."
This management will depend on a deliberate process and set of rules governing the use and surveillance of contingencies.
Although some projects develop contingencies as a percentage of total project cost, contingency planning would be more accurate if based on a risk analysis, which is a more focused and rational approach. This approach also enables project managers to track the accuracy of the assumptions that went into the assignment of risk-based contingencies more closely.
The following four projects help illustrate best practices for managing risks associated with megaprojects.
Woodrow Wilson Bridge
The Woodrow Wilson Bridge connects Maryland and Virginia, spanning the Potomac River just south of Washington, DC. The $2.43 billion project will replace the existing bridge and upgrade four interchanges along a 12-kilometer (7.5-mile) corridor of Interstate 95.
Since construction began in 2000, the FHWA team has developed annual oversight plans to manage risk on a case-by-case basis throughout the life of the project. But in February 2004, the team began a formal risk assessment for the entire project.
The team identified several critical program elements for risk assessment, including project-wide security, fabrication and availability of materials, incident management, claims, project schedule, environmental commitments, errors and omissions, utility construction conflicts and delays, design management review and oversight, change orders, maintenance of traffic, work zone safety, and acceptance process. The team classified these elements as low, medium, and high risk.
According to Jitesh Parikh, megaproject oversight manager in the FHWA Maryland Division, examples in the low-risk category include the acceptance procedure and staffing. The medium-risk category includes change orders, utility construction conflicts and delays, and environmental commitments. The projectwide security, fabrication and availability of materials, incident management, claims, and project schedule fall into the category of moderate-high risk.
"In building the superstructure, one risk was not having enough bidders to reap the benefit of competition," says Bob Douglass, project director with the Maryland State Highway Administration. "Breaking [the project] into three smaller contracts increased the number of potential bidders."
On a broader level, the team took several other actions to minimize risks, such as scheduling weekly teleconferences to discuss projectwide issues, holding monthly meetings for project managers from FHWA and the States, and adhering to the construction management plans developed by the Virginia DOT and the Maryland State Highway Administration.
"From a risk management standpoint, our job is to look after a number of separate contracts," Douglass says. "And one of the primary risks we're concerned with is one contractor delaying another contractor by not finishing in time, driving up overall costs. From that standpoint we'd assess the interface between contracts and make sure that every contractor recognizes what the key points are and then set ground rules to minimize the risk of one contractor delaying another."
And, by requiring a financial plan to be updated annually, Parikh explains, the team can monitor the cost and revenue structure during the project continuum and provide a reasonable assurance that sufficient financial resources will be available to implement and complete the project as planned. In addition, both Maryland and Virginia have processes in place to ensure that agencies receive invoices in the correct amounts.
Central Artery/Tunnel Project
Boston's Central Artery/Tunnel Project, also known as the "Big Dig," entails extending Interstate 90 to run under Boston Harbor to Logan Airport and replacing the existing elevated Interstate 93 through downtown with a tunnel. The 14-year project consists of 12.5 kilometers (7.8 miles) of highways, about half of which run through tunnels. With nearly 95 percent of the project complete, managers expect to stay within the current $14.625 billion budget.
As with the Wilson Bridge, the main risks associated with the Central Artery/Tunnel Project involve costs, schedule, and safety, according to Daniel C. Wood, with the FHWA Massachusetts Division. Wood says that during the course of the project, risk assessments have been carried out more and more frequently. "There are 110 individual construction contracts," he says. "If one contract slips, it has a domino effect that affects multiple contracts. So [project managers have] learned to manage and coordinate these contracts very carefully not only with contractors but also with third-party agencies."
"Time is money," says William Edwards, the budget manager for Bechtel/Parsons Brinkerhoff, the management consultant for the project. "If you break down scopes of work into finer scopes, you do have additional complexity among contractors. And if the contracts are dependent on one another, a delay on one contract could impact another contractor. That risk may be with the owner in this case the Massachusetts Turnpike Authority dependent on the reason for the delay."
"On the other hand," he adds, "if you make the contracts too big and limit the number of bidders, the competition is less. So there should be an educated balance between the two approaches."
Wood notes that the management team incorporated a pool of contingency funds into the project's finance plan to cope with cost overruns or unforeseen scope changes.
Considering the timeframe, the biggest cost-related risk is how to handle the U.S. inflation rate over the life of the project, he says. Built-in safeguards help handle the risk more effectively. The management team reduced scope creep from 18 percent to 11 percent, Wood adds, thanks to new specifications for design consultants. "That may not sound like much, but with a $14.625 billion project, it is."
The Central Artery/Tunnel Project Office within the Massachusetts Turnpike Authority incorporates known costs and contingency costs into its annual budget assessment. "History in the industry tells us that we need to have money available for unforeseen events," says Edwards, from Bechtel/Parsons Brinkerhoff. Putting a value on this unknown factor results in a future allowance, he says. For every contract, a type of risk assessment is carried out.
In completing risk assessments for the Central Artery/Tunnel Project, the project team surveys various stakeholders, including the construction team, the design team, and stakeholders, asking a series of questions related to unforeseen changes in designs, schedules, or field conditions (especially for work underground). "There are claim contingencies, schedule contingencies, scope contingencies, and rights-of-way settlement contingencies," Edwards says. "So we go to the people who are closest to that expertise and get their feedback as to the probability that a risk-related event is going to happen, and, if it is probable, what that means in terms of a dollar value for future allowance."
The collected information is reflected in the budget assessment and subsequently in the annual finance plan for the project. "It's a rigorous process," he says. "I'm not going to say the plan captures all risks, but when we put one of these estimates together, we probably have a hundred inputs from different sources on our projects. So the methodology is a way of standardizing how they go through and develop their risk allocations."
Central Texas Turnpike Project
To cope with growing highway congestion in the Austin area, the 105-kilometer (65-mile) Central Texas Turnpike Project includes a 79-kilometer (49-mile) eastern bypass around Austin. The final phase of the project is expected to open in December 2007. The current project estimate is $2.6 billion, which is $200 million below the original finance plan. According to Timothy J. Weight, director of turnpike construction for the Austin district of TxDOT, thanks in part to prudent risk management strategies, the project is on time and under budget.
To ensure that sufficient money would be available to cover the expected costs, the Texas DOT (TxDOT) planners established a risk matrix that modeled different scenarios so that additional costs could be anticipated given the budget constraints. The matrix included contingencies for such things as change orders, scheduling delays, and increased right-of-way costs. It also helped planners identify who was responsible for the risk the contractor or the State.
"Right-of-way costs were our biggest financial risk," Weight says. "It's hard to predict how much the real estate is going to cost you 2 years out." The project required buying up around 650 parcels of land and working with as many property owners.
Other risks taken into account included environmental concerns, such as acquiring land with endangered species or archaeological sites. Planners mitigated these risks by securing rights-of-entry on parcels prior to making deals for the right-of-way costs, and then studying the alignment in as much detail as possible. "The more you know what it looks like on the ground, the better you mitigate that risk," Weight says.
"It always benefits you when you can identify what the potential risk would be and come up with a contingency plan," he adds. "I think the size of the project and the more unknowns there are define the sphere of that matrix."
Hiawatha Light Rail Transit Project
Construction began in January 2001 on the $715 million Hiawatha Light Rail Transit Project, on schedule to open in phases this year. The 19.3-kilometer (12-mile) line will connect three of Minneapolis/St. Paul's most popular destinations— downtown Minneapolis, the airport, and the Mall of America.
According to Mark Fuhrmann, chief of staff for the Hiawatha Project Office at Metro Transit, the project has gone smoothly—on time and on budget. Partial credit goes to the innovative techniques the project managers adopted to manage risk, such as establishing a $5.5 million shared-risk contingency fund with the contractor, based on 19 risk items. At the end of the project, the contractor will keep 91 percent of whatever is left in the fund. Such an incentive encourages the contractor to manage risks wisely, ensuring that adverse events are kept to a minimum. Consequently, to date the contractor has charged against the fund for only a couple of minor instances.
"The contractor has been very diligent in working through the risk items, identifying work-arounds or creative solutions to maintain schedule and minimize cost," Fuhrmann says. "So we feel that's been a successful technique for Hiawatha [Light Rail Transit] to employ with our design-build contractor to stay on schedule and within budget."
In the event that any of the 19 risk items come into play, the contractor can choose to do one of two things. If the contractor elects to bill against the fund, the project managers need to certify that the risk factor is eligible for the shared expense. Or the contractor can decide not to charge against the fund and keep the schedule moving without taking the time to determine what the expense against the fund would be. In the latter case, "He [the contractor] basically absorbs the cost, because at the end of the project, he's eligible to earn 91 percent of that $5.5 million," Fuhrmann says.
Risk management boils down to implementing a structured, systematic way of reducing and minimizing the impacts of uncertainties by considering what risks exist in a project, deciding what can be done about them, taking action to address the risks, reevaluating the situation, and communicating about the risks and contingencies throughout the process. Developing an effective strategy not only helps project managers identify and minimize risks and prepare fallback options, but it also leads to greater financial certainty, providing clearer insights into decisionmaking and engendering more reliable planning—all of which will affect public trust in the short and long terms.
Chris Allen serves on the stewardship/oversight team in the FHWA Office of Infrastructure in Washington, DC. His responsibilities include risk assessment and management, and the identification of stewardship best practices. Prior to joining the Office of Infrastructure, he served as a technology transfer specialist in FHWA's Resource Center. He has worked with FHWA for 14 years, serving in a number of positions around the United States.
For more information on the Woodrow Wilson Bridge Project, contact Jitesh Parikh at 410-962-4342, ext. 128, or email@example.com; the Central Artery/Tunnel Project, Daniel C. Wood at 617-494-2462 or firstname.lastname@example.org; the Central Texas Turnpike Project, Timothy J. Weight at 512-225-1344 or email@example.com; or the Hiawatha Light Rail Transit Project, Mark Fuhrmann via Josh Collins at 612-215-8212 or firstname.lastname@example.org.
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