Describe the procedure for analyzing the project risk.

Q5. Describe the procedure for analyzing the project risk.

Ans.  It is a well established fact that every project involves risk. Moreover, it is a practice to include a short summary of project risks in the project appraisal report. There are certain projects for which economic benefits can be quantified while for others, such quantification is not possible. Firm risk stem from technological change in production process, managerial inefficiency, availability of raw material, labour problems and changes in consumer preferences. The financial risk considers the difference between EBIT and EBT while business risk causes the

variations between revenue and EBIT. These are ways and means to reduce the project risks.

Analysis of project risks

It is the normal practice to include a short summary of project risks in each appraisal report. The purpose of this chapter is to provide a summary of project risks in order to help ensure uniformity and consistency in appraisal reports. Section-1 relates to projects for which economic benefits can be quantified and section-2 deals with projects for which such quantification is not possible.

 Projects with quantified benefits

The economic internal rate of return (EIRR) is the measure most often used to indicate the economic viability of financed projects. Calculation of the EIRR requires a set of assumptions regarding the conditions faced by the project which in the judgement of the appraisal mission are most likely to prevail during its life. However, since bank financed projects normally have a very long life, the conditions faced by the project may change for a variety of reasons. Sensitivity analysis is, therefore, carried out to determine the effects of possible changes in the values of key variables (costs, yields, and price of inputs and outputs) on the project's EIRR.The number of risks facing a project could be large, and it is neither possible nor desirable to identify all possible risks associated with a project. The risks discussed in the appraisal report should essentially be those which entail major economic consequences. These should be identified from the sensitivity analysis and described in descending order of importance with regard to their impact on the EIRR.Particular attention should be paid to risks that would substantiallyreduce the project's EIRR or render the project uneconomic by reducing its EIRR below the opportunity cost of capital. In this context, both the base-case EIRR and the sensitivity indicators are relevant. If the basecase EIRR is high, the discussion of project risks should generally include risks to which the project is highly sensitive. For example, the EIRR of most projects is highly sensitive to changes in project output, which may in turn depend on a number of factors. A discussion of the safeguards employed to minimize the risk of the outputs falling substantially below the level expected should therefore be included. For example, in an irrigation project, apart from the availability of water, output may depend on the supply of other inputs, provision of extension services, effectiveness of water management by farmer's groups, and availability of adequate infrastructure and storage facilities. Measures taken to ensure adequate and timely availability of each should be briefly explained. Risks are obviously greater in projects for which the base-case EIRR is only marginally higher than the opportunity cost of capital. These larger risks are even greater if the EIRR is highly sensitive to changes in key variables since even a small reduction in the EIRR would render the project unviable. Even when the EIRR is relatively insensitive to changes in key variables, combinations of adverse changes might easily affect the project's viability. Thus, in such cases, the remedial action proposed or adopted should be fully explained.

If the project output is traded internationally, one risk may be future changes in the price of the output, particularly if the share of a project or the country's output is small relative to the world market. In such cases, a review of world demand and supply forecasts for the good in question

should be included.By their very nature, certain types of projects such as gas and oil exploration involve very high risks. For such projects, it is necessary to supplement the sensitivity analysis with a probability analysis. The latter provides a range of possible outcomes in terms of a probability distribution and based on that project related decision could be made more intelligently. But the analysis is more complex and requires more information about events affecting the project. Due to the considerable work involved,, probability analysis of risks is usually undertaken only for project carrying a high degree of risk or for large projects where miscalculations could lead to a major loss to the economy. For such projects, the nature of the risks involved and the measures taken or recommended to minimize the risks, together with the results of the analyses, should be discussed in the appraisal report.

Projects for which benefits are not quantifiable

For projects in certain sectors or sub-sectors such as education, health, sanitation and family planning, project benefits cannot be quantified and the risks cannot be measured by sensitivity analysis. In such cases, the relationship of project risks to the project's objectives should be explained. The eventualities that might impede the realization of the objectives should be discussed in relation to the project cost and output, and also in relation to the socio-economic objectives sought by the project. In such projects, the risks are greater on the benefit side than on the cost side. For instance, in education projects, school buildings and equipment are provided to help achieve a prescribed annual output of graduates with a certain skill level. However, provision of the facilities alone may not ensure achievement of the project objectives. Their achievement may depend more upon the availability of trained teachers, provision of sufficient funds for the recurring expenditures of the institutions, curriculum and admission standards, and motivation of the students. While it is not possible to eliminate all such risks, it is essential to minimize them. Major risks of this type should be identified and explained along with the remedial measures proposed in the section in which project risks are discussed.The real benefits of this type of project relate to broad socio-economic goals. For education projects, these may include increased income level for the trainees and a higher level of industrial and agricultural productive. For family planning projects, the broad goals may be an

increased number of acceptors and a consequent reduction in the rate of population growth. The success of these projects depends not merely on the facilities provided, but also on the continued favourable conditions assumed by the appraisal mission. For such projects, the assumptions made regarding the relationship between the facilities provided and project's long-term objectives should be clearly explained. The conditions or facilities necessary but external to the project should also be identified, together with relevant assurances received from the government. For projects such as these, this is one of the most important aspects to be discussed in the section dealing with project risks.

Risk is the exposure to the consequence of uncertainty. Project risk is the chance of something happening that will have an impact on achieving project objective Risk management: is the culture, processes and structure directed towards the effective management of potential opportunities and adverse effects Risk management process: it involves the systematic application of management processes and procedures to the tasks of establishing the context, identifying, and analysing, assessing, treating, monitoring and communicating risk .Risk identification is the process of determining what, how, why and where things may happen. Risk analysis is the systematic use of available information to determine how often specified events may occur and the magnitude of their consequences . Risk evaluation determines whether the risk is tolerable or not and identifies the risk that should be accorded the highest priority in developing responses for treatment . Risk treatment establishes and implement management responses for dealing with the risks, in ways appropriate to the significance of the risk and the importance of the project. Managing of project risk is an integral part of quality project management system, and fundamental to achieving good project outcomes. That is, systematic identification and assessment of risk and  effectively dealing with the results is significant to the success of the project. Risk management in projects is one of the major areas of interest in the area of  project management. Risk management is designated as one of the main project management knowledge areas in the project management . It is described as a process that accompanies all the phases in project life cycle – from project definition phase through to the project closure phase. The concept of risk management is therefore central to all aspect of a project.  A number of researchers have proposed various project management processes for  risk management in projects. Boehm (1991) proposed a two phase process of risk  management consisting of risk assessment  phase which is made up of three steps; identification, analysis and prioritization;  and risk control phase made up of risk management planning, risk resolution  and monitoring, and risk tracking and corrective actions. Klien and Ludin (1996) proposed a four step process – risk identification, analysis, control and reporting. Their proposal parallel Deming’s four steps of quality management – plan, do, check and act. Fairley (1994), suggested seven steps of project risk management – (1) risk identification; (2) risk probabilities and effect assessment; (3) creation of strategy to mitigate identified risks; (4) monitoring risk elements; (5) invoking a contingency risk plan; (6) treatment of the risk; and (7) recovering from the risk. Chapman and Ward (1997) proposed a nine phase generic process – definition of the key aspect of the project, focusing on a  strategic approach to risk management; identifying elements of risks; structuring the data about risk assumptions and relationships; assigning risk ownership and responses. The Association for Project Management defines PRM as the process and techniques which enables effective management of risk associated with a project (APM, 2000). Because every project is unique, dealing with risk in project may therefore be different from situations. However, a general simple framework for risk management involve four (4) steps which many different PRM tools and processes have revolve around. The four steps are:

1. Identification of risks

2. Quantification of risks

3. Planning for risks

4. Monitoring and control of risks

To manage project risk effectively requires all four steps and it is a continuous iterative process of management. It is therefore carried out from time to time at each phase of the project and whenever there is a deviation from the project plan. Risk management is perhaps the most difficult side of project management. The project team must be able to recognise risks faced and identify the root causes and trace these through the project to their consequences. In the context of construction project, the use of risk management from the early stage of the project, where major decisions are such as design and selection of construction method can be influenced, is very essential. . The main elements of risk management process are:

a. Commination and consultation: it is a continuous process throughout the risk management process. Communication and consultation with both external and internal stakeholders appropriately at stage of the risk management process;

b. Establishing the context: internal, external and risk management context in which the rest of the process will take place is establish. The risk evaluation criteria and definition of the analysis structure is established; 

c. Risk identification: the  identification process should indicate where, when, why and how and occurrence of an event could delay, prevent, degrade or enhance the achievement of the objectives;

Risk Identification

There are many tools and techniques for Risk identification. Documentation Reviews

Information gathering techniques

Brainstorming

Delphi technique – here a facilitator distributes a questionnaire to experts, responses are summarized (anonymously) & re-circulated among the experts for comments. This technique is used to achieve a consensus of experts and helps to receive unbiased data, ensuring  that no one person will have undue influence on the outcome

• Interviewing

·         Root cause analysis – for identifying a problem, discovering the causes that led to it and developing preventive action

·         Checklist analysis

·         Assumption analysis -this technique may reveal an inconsistency of assumptions, or uncover problematic assumptions.

·         Diagramming techniques

·         Cause and effect diagrams

·         System or process flow charts

·         Influence diagrams – graphical representation of situations, showing the casual influences or relationships among variables and outcomes

·         SWOT analysis

Expert judgment – individuals who have experience with similar project in the not too distant past may use their judgment  through interviews or risk facilitation workshops

Risk probability and impact assessment – investigating the likelihood that each specific risk will occur and the potential effect on a project objective such as schedule, cost, quality or performance (negative effects for threats and positive effects for opportunities), defining it in levels, through interview or meeting with relevant stakeholders and documenting the results.

Probability and impact matrix – rating risks for further quantitative analysis using a probability and impact matrix, rating rules should be specified by the organization in advance. See example in appendix B.

Risk categorization – in order to determine the areas of the project most exposed to the effects of uncertainty. Grouping risks by common root causes can help us to develop effective risk responses.

Risk urgency assessment - In some qualitative analyses the assessment of risk urgency can be combined with the risk ranking determined from the probability and impact matrix to give a final risk sensitivity rating. Example- a risk requiring a near-term responses may be considered more urgent to address.

Data gathering & representation techniques

Interviewing–You can carry out interviews in order to gather an optimistic (low), pessimistic (high), and most likely scenarios.

 Probability distributions– Continuous probability distributions are used extensively in modeling and simulations and represent the uncertainty in values such as tasks durations or cost of project components\ work packages. These distributions may help us perform quantitative analysis. Discrete distributions can be used to represent uncertain events (an outcome of a test or  possible scenario in a decision tree)

Quantitative risk analysis & modeling techniques- commonly used for event-oriented as well as project-oriented analysis:

Sensitivity analysis – For determining which risks may have the most potential impact on the project. In sensitivity analysis one looks at the effect of varying the inputs of a mathematical model on the output of the model itself. Examining the effect of the uncertainty of each project element to a specific project objective, when all other uncertain elements are held at their baseline values. There may be presented through a tornado diagram.

Expected Monetary Value analysis (EMV) – A statistical concept that calculates the average outcome when the future includes scenarios that may or may not happen (generally: opportunities are positive values, risks are negative values). These are commonly used in a decision tree analysis.

Modeling & simulation – A project simulation, which uses a model that translates the specific detailed uncertainties of the project into their potential impact on project objectives, usually iterative. Monte Carlo  is an example for a iterative simulation.

Cost risk analysis - cost estimates are used as input values, chosen randomly for each iteration (according to probability distributions of these values), total cost will be calculated.

Schedule risk analysis - duration estimates & network diagrams are used as input values, chosen at random for each iteration (according to probability distributions of these values), completion date will be calculated. One can check the probability of completing the project by a certain date or within a certain cost constraint.

Expert judgment – used for identifying potential cost & schedule impacts, evaluate probabilities, interpretation of data, identify weaknesses of the tools, as well as their strengths, defining when is a specific tool more appropriate, considering organization’s capabilities & structure, and more. Risk Response Planning 

Risk reassessment – project risk reassessments should be regularly scheduled for reassessment of current risks and closing of risks. Monitoring and controlling Risks may also result in identification of new risks.

Risk audits – examining and documenting the effectiveness of risk responses in dealing with identified risks and their root causes, as well as the effectiveness of the risk management process. Project Manager’s responsibility is to ensure the risk audits are performed at an appropriate frequency, as defined in the risk management plan. The format for the audit and its objectives should be clearly defined before the audit is conducted.

Variance and trend analysis – using performance information for comparing planned results to the actual results, in order to control and monitor risk events and to identify trends in the project’s execution. Outcomes from this analysis may forecast potential deviation (at completion) from cost and schedule targets.

Technical performance measurement – Comparing technical accomplishments during project execution to the project management plan’s schedule. It is required that objectives will be defined through quantifiable measures of technical performance, in order to compare actual results against targets.

a.Reserve analysis – compares the amount of remaining contingency reserves (time and cost) to the amount of remaining risks in order to determine if the amount of remaining reserves is enough.

b.Status meetings – Project risk management should be an agenda item at periodic status meetings, as frequent discussion about risk makes it more likely that people will identify risks and opportunities or advice regarding responses.

c. Risk analysis: this comprise identification and evaluation of existing controls. It also includes determination and evaluation of likelihood, consequences and the level of risk. It is vital that range of potential consequences and how they could occur are taken into consideration;

d. Risk evaluation: this consist of comparison of estimated risk levels against pre-established criteria. The balance between adverse outcomes and potential benefits is considered to enables decisions to be made about the nature and extent of treatment required and priorities;

e. Risk treatment: it involves development and application of specific cost effective strategies and action plans  to reduce potential adverse cost and increase potential benefits;

f. Monitoring and review: the risk management process is an iteration process. It is therefore important to continuously monitor and review the effectiveness of all the steps in the whole risk management process. This is vital for continuous improvement and ensures changing circumstances do not alter priorities.