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A SPECIALLY COMMISSIONED REPORT
PROJECT RISK
MANAGEMENT
THE COMMERCIAL DIMENSION
Tim Boyce
THOROGOOD
PROFESSIONAL
INSIGHTS
THOROGOOD
PROFESSIONAL
INSIGHTS
A SPECIALLY COMMISSIONED REPORT
PROJECT RISK
MANAGEMENT
THE COMMERCIAL DIMENSION
Tim Boyce
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The author
Tim Boyce began his career in the Ministry of Defence holding executive positions
in contracts, contracts policy and finance. His industrial career began at Plessey
in 1980 after which he enjoyed appointments with Siemens, British Aerospace
and more recently as commercial director at BAE SYSTEMS. His functional
responsibilities have included contracts, commercial, procurement, estimating,
legal, project accounting and the implementation of the European Business Excel-
lence Model.
His committee work includes the Chartered Institute of Purchasing and Supply
National Contracts Management Committee, the CBI Contracts Panel, the CBI
Defence Procurement Panel and the CBI/MoD working groups on partnering
and incentive contracting. He was the CBI observer at the HM Treasury Central
Unit on Purchasing working group on incentivising industry. In 1997 he was
invited by the Director General of the CBI to join the CBI Public Private Partner-
ship Forum. He has lectured widely in the UK and in the US on business, contract
and commercial management.
THOROGOOD PROFESSIONAL INSIGHTS
Contents
1 TOTAL RISK MANAGEMENT 1
2 GETTING TO CONTRACT 8
1. The risk – risk scenario 9
2. The bid/no bid decision 9
3. Bidding 16
4. Pricing for risk 19
5. Risk review board 23
6. Making an offer 25
7. The priced list of risks 29
8. The caveats register 30
9. An effective contract 31
10. Negotiation 34
11. Contract launch 35
12. Pointers for project risk management 36
Checklist 36
3 FINANCIAL RISK 38
1. Prime contract financial risk 39
2. The nature of price and the sharing of cost risk 39
3. The client will not pay 43
4. The client cannot pay 46
5. Inflationary cost increases 46
6. Foreign currency fluctuations 48
7. Contract termination 51
8. Financial claims against the prime contractor 53
9. Pointers for project risk management 54
Checklist 55
4 TECHNICAL RISK 58
1. Do we want to take this risk? 59
2. Analysing the requirement 60
3. Options 60
4. Sharing the risk 61
5. The commercial engineer 62
6. Setting the baseline 63
7. Requirement creep 64
8. The changing requirement 65
9. The work takes longer than expected 66
10. The never-ending contract 68
11. Failure of performance 69
12. Buyer initiated problems 70
13. Pointers for project risk management 71
Checklist 72
5 TIMEFRAME RISK 74
1. Bidding compliant delivery 75
2. The timeframe obligation 78
3. Time is of the essence 79
4. Consequences of delay 79
5. Liquidated damages 81
6. Force majeure 81
7. Delivery incentives 83
8. Client delay 84
9. Subcontractor delay 86
10. Prime contractor delay 86
11. The threat of termination 88
12. The threat of damages 89
13. Pointers for project risk management 91
Checklist 92
THOROGOOD PROFESSIONAL INSIGHTS
6 SUBCONTRACTOR RISK 95
1. For the want of a nail 96
2. Subcontracting: Benefit, risk and strategy 97
3. Subcontractor lateness 104
4. Subcontractor failure 105
5. Subcontractor work unfit 106
6. Monitoring subcontractors 106
7. Pointers for project risk management 107
Checklist 108
7 PROJECT COMPLETION AND BEYOND 113
1. Life after completion 114
2. Key contractual milestones 114
3. Residual obligations and risks 117
5. Acceptance 118
6. Products rejected 120
7. Title does not pass 121
8. Products lost or damaged in transit 122
9. Failure after delivery/acceptance 122
10. Warranty 123
11. The hand over of technical data to the client 125
12. Third party intellectual property rights 127
13. Account management 129
14. Pointers for project risk management 130
Checklist 131
THOROGOOD PROFESSIONAL INSIGHTS
Section 1
Total risk management
THOROGOOD
PROFESSIONAL
INSIGHTS
Section 1
Total risk management
The basis of all business is buying and selling goods or services or a combina-
tion of the two. The word product is these days used for both goods and services.
A television is a product and a particular type of insurance scheme may be
described by the provider as a product. For the purposes of this Report the word
product will be used in the former sense. Products are designed and produced
and sold to customers as end items in themselves. The characteristics of a product
might include: it is available off-the-shelf; it is produced (hardware) or replicated
(software) in quantity with each unit being identical to every other; the design
is driven by the supplier (albeit aimed at specific markets) rather than by an
individual customer; the performance characteristics are well known prior to
the product being made available to customers; its constituent parts are readily
available as materials or components.
On the other hand there is a particular type of service which is called a project.
It commonly comprises the bringing together of many disparate products into
an overall solution. The characteristics might include that it is bespoke; it is unique;
the design is driven by one customer; performance characteristics can be designed
and modelled but not known until the project is complete; its constituent parts
may comprise products which themselves must be specially designed. Projects
tend to be of large financial size and long timescale. Whilst no business enter-
prise is without risk, it can be seen quite readily that projects are by their very
nature of considerably greater risk than products. Management of risk in a projects
environment is therefore of considerable importance.
Project Risk Management is a well established doctrine supported by many tools
and techniques. Risk analysis, risk registers, risk models and active risk manage-
ment are all important in seeking that ultimate goal of project management –
completion on time, to specification and within budget. There is, however,
another key distinction between products and projects, the significance of which
is perhaps sometimes overlooked. Products tend to be bought or sold subject
to standard terms of contract. The buyer or seller, usually whichever is in the
stronger position, subjects the transaction to his standard terms. In a percentage
of cases there may be some negotiation of these terms, but frequently not.
Conversely the prime contract terms for a project are invariably negotiated,
specially drafted and often of significant contention before the parties come to
agreement. Each side may come to the negotiation armed with a preferred set
2
THOROGOOD PROFESSIONAL INSIGHTS
of terms, some or all of which may be based upon standard terms. Each will
try to exploit the strength of its bargaining position to secure its terms but
ultimately the agreed terms will always be of a bespoke nature, reflecting not
only the outcome of commercial negotiations but in many instances reflecting
the fact that individual standard terms may simply not exist or may be inade-
quate for the unique situation of the particular project.
Interestingly the choice between buyer and seller standard terms in a routine
product transaction is fraught with danger for the side that concedes, for the
simple reason that standard terms are never generated with fairness or balance
in mind. The reason that every transacting organisation has different standard
terms for sale and for purchase is that each organisation expects to purchase
from its suppliers on terms which it would ideally never confer on its customers
and vice versa. The central reason is that each organisation likes to both buy and
sell at zero or minimum risk to itself. Standard terms are a means of pushing
risk ‘down’ to suppliers and ‘up’ to customers. Everyone in the supply chain has
the same motive. Of course in simple product transactions little attention is given
because nobody expects anything to go wrong. The product is identified by part
number or catalogue number, specifications exist, and price and payment are
straightforward. The client gets what he is expecting and the supplier gets his
money. The allocation of risk under the contract terms is of no practical interest
other than in the very small percentage of cases where things do go wrong.
Projects are different. It is not so much that the parties expect things to go wrong
(if they did, they have no business in proceeding) but that they are aware that
the risk of difficulty is inherently much higher. Not only are there usually more
risks but several of the risks may have a significant probability of arising and
the impact of a risk that materialises may be catastrophic. This results in two
things. Firstly, each side (preferably jointly) will consider how best to manage
the project so that risks do not materialise at all or, if they do, that the impact
is minimised. Secondly great attention is given to the negotiation of bespoke
contract terms. The contract is ultimately the single vehicle by which risks are
allocated (or shared) between the parties. It is essential that each party knows
where it stands both before a final decision is made to enter into the contract
and afterwards, if risks materialise.
A project management plan may ascribe responsibilities between the parties.
A risk management plan may purport to allocate individual risks to one party
or the other but the contract must be clear on what these allocations mean from
a legal perspective. This is not just a point of technicality. For example, if the
client agrees to carry responsibility for a particular risk (which affects the proba-
bility of timely completion of the project) and to undertake risk mitigation activities,
1 TOTAL RISK MANAGEMENT
3
THOROGOOD PROFESSIONAL INSIGHTS
[...]... helping the project towards a successful conclusion Putting these things together we are inevitably drawn to the fact that risk identification must inform the prime contract negotiations and the prime contract must inform the management of risk during project execution Understanding between project or risk managers (doing the job) and business or commercial managers (doing the prime contract) is therefore... launch 12 Pointers for project risk management Checklist Section 2 Getting to contract 1 The risk – risk scenario Bidding for a contract involves a twin risk Firstly there is the risk of losing the competition and secondly there is the risk of winning it! As has been said before now, the good news is that we’ve won the competition, the bad news is that now we have got to perform the contract’ In any... Commenting on a risk at the bid stage is theoretically the right thing to do because it exposes the issue early on and shows the client how thoroughly the prime contractor has understood the potential prime contract and the lengths to which it has gone to respond realistically On the other hand it may count against the prime contractor when the client adjudicates all the bids To eliminate the risk of a caveat... consider when the relationship between project risk management and commercial risk management of a project really begins The two facets certainly come together at the prime contract negotiation stage, but in many ways that is already too late There are four key points when the coming together must occur: TRM STAGES THE KEY QUESTION Bid/no bid decision What is the probability of submitting the winning... to carry the risk Emerging from these considerations is the idea that the prime contractor could put forward a priced list of risks as options for the client to consider All companies are used to offering options that would have the effect of altering the cost, scale, performance and timescale of the project but the concept of offering risk options is one that should be given some thought The risk options... completely ignored but, other than in a cost -risk sharing scheme (see Section 3), there is no point covering all the risks by provision in the price Not only would this produce an uncompetitive price but some risks are not appropriate for treatment by pricing provision The risk of the prime contract being cancelled for the convenience of the client is a serious financial risk but there is little point... exposure in the review-and-approve part of the process The procedure should require the establishment of a Risk Review Board whose tasks are: • To review, modify if necessary and approve the Pre-Contract Risk Analysis; • To interrogate the bid team or the prime contractor functions listed above on the identification of risks in their respective areas and the mitigation plans; • To ensure that all risks are... fuller exploration of the commercial aspects of business the reader may refer to The Commercial Engineer’s Desktop Guide (Hawksmere) THOROGOOD PROFESSIONAL INSIGHTS 7 THOROGOOD PROFESSIONAL INSIGHTS Section 2 Getting to contract 1 The risk – risk scenario 2 The bid/no bid decision 3 Bidding 4 Pricing for risk 5 Risk review board 6 Making an offer 7 The priced list of risks 8 The caveats register 9... management Contract awarded Project completed Figure 3: Risk Management Transition In the pre-contract stage two risk management activities should be underway One looks at the problems associated with preparing an attractive bid on time and defeating the opposition The other is concerned with predicting whether or not the project can be completed successfully Naturally if the early work on the latter question... assuming that the pre-contract project risk analysis is well established then a most pressing question arises as to what allowances should be made in the price to cover perceived project risks Theoretically if the price is high enough the prime contractor will take any and all risks However, clients do not have unlimited funds, competition does not permit generous covering of risk within the price and . involves a twin risk. Firstly there is the risk of losing the
competition and secondly there is the risk of winning it! As has been said before
now, the good. combination of project risk management and commercial risk
management might be called Total Risk Management:
Figure 1: Total Risk Management
TECHNICAL RISK
MANAGEMENT
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