Reducing the Cost of "Risk"

Risk is never eliminated, at best it is managed and at worst it negatively impacts the project outcome. Our industry talks a lot about Risk Allocation, but allocating risk does not, in and of itself, manage the impact of risk. To manage risk is to mitigate its impact on (among other things) the project cost. Stated differently: risk is never eliminated, it's impact can only be mitigated through proper management. I believe the first step toward its proper management is "communication".

YouTube Video "Risk Profiles"

Reducing the cost impact from risk through "communication" is a simple concept. If I understand exactly what you need as a consumer, I'm in a better position to know what to delivery, know its delivery will satisfy you, I can deliver it at a lower cost, and I can possibly exceed your base-line expectations. To directly relate this to Project Delivery, let's consider what "communicate", "need", "satisfy", and "expectations" really mean to the owner, designer, and builder.

By "communicate" I mean using a 'method' that places into the design-builder's mind exactly what is in the owner's mind. The owner's "needs" and "expectations" (as they are understood in the owner's mind and documented in a RFP) are clearly transferred to the design-builder (and are equally understood by all designers and builders). As a result, if the owner and design-builder have a complete and mutual understanding of the project needs and expectations, then mutual satisfaction (project outcome) has the opportunity to be achieved.

If, if, if this 'mutual understanding' can be achieved, interesting things begin to happen. The most exciting (at least to me) is the likelihood the design-builder exceeds the owner's expectations. Why, the cost (money) available to meet and exceed the owner's expectation becomes more abundant. This is largely due to one thing; risk, or more specifically the perception and planning for the negative impact of risk.

The following diagrams graphically explain this concept. The first diagram represents the owner's 'budget' available for a given project. The size of the 4 collective boxes represent the dollars available to spent on each of the four categories of cost: General Conditions (cost for management and misc. items consumed to produce the project), Sticks & Bricks (cost of material that creates the project), Design & Specialty (costs for architectural, engineering, and special design services), and risk (the cost associated with "something going wrong", "misunderstanding", "unforeseen requirements", etc.).

Since the overall size of the box (the budget) is set, by reducing the cost attributed to any of the boxes within the overall will free-up funds to be used elsewhere (for the purposes of improving the outcome). For the most part General Conditions fall into a some-what consistent range in a given market, as does design services. I know they vary depending on the details of the project, but stick with me for a minute. That leaves "Brick & Sticks" and "Risk" to consume the balance of funds. What happens if the "Risk" the design-builder "perceives" (for what ever reason) is reduced as shown in this diagram.

By reducing the Risk box, more funds are available for Bricks & Sticks; for space, better finishes, longer warranties, higher quality. If you are a Project Owner, think about the easiest way to reduce the Risk box...communicate your expectations such that what exists in your mind is exactly what exists in the design-builder's mind at the time of Proposal (before the contract is signed). If we (the project stakeholders) can communicate at this high-level of mutual understanding, the design-builder does not 'guess' at his response to your RFP.

How many bucks are we talking about? I've heard (milling about the industry for the last 35 years) that as much as 30% of the cost of a project is to cover the cost if "something likely goes wrong". What exactly, can probably be imagined by you, through your own experience. The threat of 'risk' causes us to 'tighten' our 'restrictions' on each other...we try to control the impact of risk by making it the other guy's fault. We don't know what will happen, so builders throw dollars at it, owners throw 'contract clauses' at it, and designers add notes to drawings.

Having written dozens and dozens of design-build RFPs over the last 12 years I can tell everyone this, risk and how it is controlled is the keystone of High Performance Outcome. If owners clearly communicate achievable project expectations (the RFP) and allow design-builders to manage design and construction decision-making (with the owner substantiating those decisions), the Risk-Box shrinks...guaranteed.

By the way...when the project is complete the only 'box' left behind with the owner is the "Bricks & Sticks", so maximize your outcome.  Proven methods and strategies to achieve Risk-Reduction are at the heart of the 3PQ Process. The results of "clearly communicating" a "mutually understood" scope-of-work within the RFP results in a High Performance Outcome. 

Read more about the 3PQ Strategy