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FMI Quarterly/December 2013/December 1, 2013

Converting Risk Into Financial Reward

getty_tightrope_imageToday’s construction industry is a dynamic and global business, with opportunities for innovation and thought leadership taking place throughout the world. For years, the industry’s risk management philosophy has been to react to risk rather than to be proactive and embrace it.

Reacting to risks means to identify and place controls in an effort to minimize the severity when an incident occurs. Companies defined successful risk management as perfecting safety, health and environmental programs; transferring risk by contractual language; and procuring insurance. These strategies provided limited success based solely on reducing frequency or severity of loss.

A more comprehensive enterprise risk management program focuses on reducing loss cost as well as improving productivity and profitability. This means identifying the risk, measuring the potential occurrence and severity, evaluating your risk tolerance and either accepting or changing the scope of the risk. This type of strategy relies on commitment to a well-established corporate culture and a strong philosophy of continuous improvement targeted at operational excellence. When a company has successfully embraced these philosophies, the true power of turning risk into reward is increased.

While there are many aspects to a strategic risk management philosophy, this article focuses on three emerging issues: people, globalization and business partnerships through joint ventures.

PEOPLE

People are the No. 1 risk associated with construction; they are responsible for the ideas, actions and eventual outcomes on every construction project. Success or failure is dependent on people’s ability to evaluate and make correct decisions. This applies across all levels of the organization.

Risks related to people include items such as knowledge and skills, availability, recruiting, health and welfare as well as retention. As an example, in the next three to five years, we expect a shortage of more than 2 million skilled workers in the U.S. domestic construction market alone. Our industry needs recruiting and training techniques that will enable business to grow while at the same time retaining the experiential knowledge from the existing workforce.

The industry has made minimal strides to attract young talent, but organizations such as the ACE Mentor program and the AGC Mentor/Protégé program are steps in the right direction. Training programs, technical schools and university degrees tailored to the construction industry have also expanded, but participation is still lagging. If your organization is not actively involved in recruiting and development in your local communities, you need to take the initiative to get involved and actively inspire and train potential candidates.

Regardless of the innovation and technical advances the industry achieves, people are still our primary asset, and we must continue to protect, train and advance their knowledge and skill levels. The risks associated with an untrained, unqualified workforce are significant, ranging from loss of life, injured employees, projects losses and reputational and financial loss to you and your stakeholders.

GLOBALIZATION

Rapid market globalization has created new opportunities and challenges in virtually every industry in recent decades, and the global expansion of the construction market has been particularly pronounced. As domestic contractors go abroad and increased numbers of foreign contractors come to North America, the challenges of culture and communication increase exponentially.

Successful best practices established in the U.S. will often be challenged when deployed abroad. You must be prepared for differences in political climate, regulations, customs, currency fluctuations, and environmental and geographical issues that will increase the risks to your project and your people.

Foreign companies entering the U.S. market can experience even more challenges due to the increased litigious and regulatory environments of federal and state entities that do not exist in many foreign countries. Many companies are partnering with in-country organizations as a means to help mitigate these risks.

JOINT VENTURES

Although not new to construction, joint ventures (JVs) have been increasing between foreign and domestic construction companies. The risks being magnified by entry into foreign countries precipitate the opportunity to share both financial and operational risk and potential rewards. One partner typically brings either financial or technical resources while the other partner usually contributes cultural, communication and political insight to the JV.

When assessing the potential risks and rewards of a JV, whether domestic or foreign, you should consider the following:

  • Does this bring value to my organization?
  • Is this JV necessary or simply desired?
  • Can we broaden our opportunities and create additional market demand for our product by taking on this JV?
  • Will this be mutually profitable for the shareholders?
  • Does this provide an edge to our business platform for dynamic growth and strategic alliances?
  • Will our reputational risk be enhanced or potentially suffer because of the JV?

The JV must provide the best opportunity to capitalize on the risk and reward for any project. Several risks must be considered and addressed before entering into the JV agreement.

Consider the arrangement and financial impact. Many projects range in the billions of dollars and extend over several years, which can have a considerable impact on your financial status. Your JV agreement must be clearly understood by both parties and thoroughly documented by contract.

Choose partners that align with your corporate culture. This is a long-term commitment, and cultural clashes in beliefs and practices can increase both financial and reputational risk.

Assess whether your partner is capable of meeting the project needs. Often, if losses take place and quality suffers, a project will not come in on schedule or within budget. It is important to have a full understanding and contract language for who is responsible for each aspect of the risks associated with the project.

Consider the long-tail nature of construction risk. Your exposure does not end when the project is complete; it extends into the future based on the laws and regulations of the governing body where the project exists. Construction defect claims can sit on your balance sheet for years and dip into profits on projects considered complete. Detailed commissioning, warranties and service plans are keys to managing these risks.

Evaluate the complexity of new requirements to construction mean and methods. Market dynamics continue to evolve with issues related to LEED, LEAN, project delivery methods and innovative products and materials. JV partners must be nimble, knowledgeable and proactive with risk management approaches that can deliver required risk solutions as needs change.

CONCLUSION

While there are numerous other considerations that need to be vetted in the risk management arena, this article focused on the three emerging issues of people, globalization and joint ventures. Part of the business of construction is converting risk into financial reward; failure to manage the entire risk process adequately can equal financial ruin. All companies desiring to be successful should consider a more comprehensive enterprise risk management program that focuses on reducing loss cost while improving productivity and profitability.


Angela Skow is vice president of Controlled Insurance Programs for Zurich in North America’s Construction Segment. She can be reached at angela.skow@zurichna.com. Deron Cowan is Global Construction Technical Center lead for Zurich Services Corporation. He can be reached at deron.cowan@zurichna.com.

 

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