Recognizing and assessing financial risks before you sign a construction contract is not an exercise you can ignore. Let’s take a quick look at how a regional contractor uses last week’s Probability and Impact Matrix in everyday business.
Risk Factors Recognized
XYZ Construction is an $80 million family-owned general contractor that has built schools in the Atlanta region for 25 years. While browsing through the Dodge Reports, the marketing department was attracted to a private hospital out for bid in Orlando, Florida. It was a $70 million job outside their operating region, but the marketing department felt it was close enough to be considered. XYZ had always worked for local school boards in Georgia and South Carolina. The firm had never worked for the nonprofit planning to build this modern hospital and no one at XYZ had even heard of the design team from Miami that would be supervising.
Most of XYZ’s school jobs were in the $25 to $40 million dollar range. They had never built a hospital, and their subcontractors were mostly local who might not be able to tackle a big job in Orlando. The company currently has two large high schools under construction. One nearing completion in a year while the second wouldn’t finish for two years. Each of the current projects requires about $5 million in working capital to keep payables and payroll current. It was estimated that the new project would require $20 million in working capital.
Probability and Severity
The CEO, CFO, and VP Ops were the risk committee at XYZ. They each rated the probability and severity of eight risk factors embedded in the potential job from 1 to 5. Their assessment scorings are listed below:
#1. CEO Probability 3 / Severity 2 Combined Average
CFO Probability 3 / Severity 2
VPO Probability 4 / Severity 3 Probability 3.33 Severity 2.33
#2. CEO Probability 2 / Severity 2 Combined Average
CFO Probability 4 / Severity 3
VPO Probability 2 / Severity 2 Probability 2.66 Severity 2.33
#3. CEO Probability 3 / Severity 2 Combined Average
CFO Probability 4 / Severity 4
VPO Probability 4 / Severity 4 Probability 3.66 Severity 3.33
#4. CEO Probability 3 / Severity 3 Combined Average
CFO Probability 5 / Severity 4
VPO Probability 3 / Severity 3 Probability 3.66 Severity 3.33
#5. CEO Probability 3 / Severity 2 Combined Average
CFO Probability 3 / Severity 4
VPO Probability5 / Severity 5 Probability 3.66 Severity 3.66
#6. CEO Probability 2 / Severity 2 Combined Average
CFO Probability 3 / Severity 3
VPO Probability 5 / Severity 5 Probability 3.33 Severity 3.33
#7. CEO Probability 2 / Severity 2 Combined Average
CFO Probability 4 / Severity 5
VPO Probability 4 / Severity 4 Probability 3.33 Severity 3.66
#8. CEO Probability 4 / Severity 4 Combined Average
CFO Probability 5 / Severity 5
VPO Probability 4 / Severity 4 Probability 4.33 Severity 4.33
Plot The Risk Profile
Hand-draw a Probability and Impact Matrix using the example in last week’s blog and plot the risk committee’s combined average assessments of each risk factor. This is a serious learning exercise, and you may be surprised at the result. What’s more important, however, is that you will experience hands-on how to reduce complex statistical risk factors into a clear and simple risk profile.
Manage Your Risk
For years I have been preaching that the failure rate in our industry will never change if we don’t change our behavior and start taking risk management seriously. If you make this simple exercise part of your everyday project selection process, you will manage the risk in your book of business as efficiently as a Las Vegas oddsmaker. (Remember they never lose.) Unrecognized risks cause project losses. With this process, you will adjust the odds against ever taking a losing job strongly in your favor. This is not rocket-science. It is common sense. The complexity of the transactions in our business makes it risky. Avoiding too much risk is just good business.
Next week we’ll interpret the matrix you created this week.
For more information on the Probability and Impact Matrix read more at: MATRIX
For a broader view of risk committees, read more at: COMMITTEE
To receive the free weekly Construction Messages, ask questions, or make comments contact me at research@simplarfoundation.org.
Please circulate this widely. It will benefit your constituents. This research is continuous and includes new information weekly as it becomes available. Thank you.
