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FMI Quarterly/September 2014/September 1, 2014

Bridging the Gap

getty_sharks_imageCommunication and process execution is the cornerstone of any risk management program.

Because of their experience in recent years, contractors face the reality that though the work seems to be coming back, margins may not rebound as quickly. Contractors accept that risk is an inherent part of the business; however, some are more risk-prone than others, often without intent. An unfortunate byproduct of this approach is that some contractors become numb to the risk they assume.

Tougher markets and tighter margins have many contractors rethinking the role of risk management in their organizations. Every organization approaches risk management in a slightly different manner, and, currently, there is inconsistency in the industry for a variety of reasons. Firms must more holistically manage the risks they face in today’s market to ensure the longevity of the organization. Increased exposure may lead some firms to designate a risk manager. However, holistic risk management means that risk management is embedded throughout the organization.

Who is Responsible for Managing Risk?

Larger, more sophisticated contractors have understood that a risk manager who sits at the executive level generally leads a “best-in-class” risk management program. This individual has input on management decisions ranging from strategy to operations and project delivery. Not every contractor has the luxury of being able to hire a dedicated risk manager, but that does not infer the risk is nonexistent or that the responsibility should not be assigned more broadly.

The manner in which organizations approach risk management will vary. In organizations that lack a dedicated risk manager, for example, the risk management function is often disaggregated between financial and operational silos. At a macro level, this segregation is natural. However, in many organizations these two silos often fail to communicate at a meaningful level, potentially allowing issues to fall through the cracks and leaving possible gaps in the risk management program.

Let us consider the disaggregated approach and how the risk management function operates in many organizations with this model. In the financial silo, the burden of risk management most commonly falls on the CFO, with the knowledge that buying insurance and paying claims is only part of his or her laundry list of duties. This person must also compare coverage and set the internal and external rates that the company will charge for insurance costs. In many organizations, the CFO’s job description has changed dramatically over the years, so many tend to rely on relationships with insurance brokers as trusted advisors to help with these decisions.

Once insurance is procured and internal rates are set, the operations team is responsible for the heavy lifting and for a significant share of the risk management function. We can all agree that, in its simplest terms, risk management is not only the identification of risk but also the avoidance of loss through proper management. Since risk is evident throughout the construction process, operations is responsible for identifying potential areas for loss and communicating those issues accordingly. Keep in mind, risk is not limited just to physical hazards, but also includes contractual, subcontractor and customer issues.

It is easy to imagine a situation where the financial silo purchases insurance coverage for a project with the expectation that in the event of any claim, operations will handle the claim effectively and efficiently. At this point, the financial silo considers that particular risk managed and effectively handed off from one silo to another. In reality, the operations silo may not completely understand the coverage or even know that it has coverage for a particular issue when and if a problem arises. Without proper communication and coordination, this has the potential to increase costs, thereby eroding potential profit on the project and, in the worst-case scenario, eroding a firm’s balance sheet.

We use the silo analogy to illustrate the reality of the situation in many organizations. However, in best-in-class organizations, regardless of the presence or lack of a dedicated risk manager, these silos have no hindering effect on the risk management process. Although these two silos are responsible for managing certain areas of risk, best-in-class firms have the support mechanisms and processes in place to communicate potential problems, and the tools in place to analyze and manage them accordingly.

Bridging the Gap

While traditional silos don’t necessarily need to be broken down, the responsibilities of the individuals within those silos should be tweaked to allow for regular communication. Best-in-class construction firms consider risk management more holistically and give the following functions consideration when building their risk management program. Doing so positions them to manage risks that might have otherwise fallen outside of the operational and financial silos. To simplify how contractors need to view risk more holistically, the following four areas should be addressed in a risk management program:

Strategy: An important part of your overall strategic plan is a discussion around the collective identification, assessment and management of risks. Firms should consider direct, more obvious risks that may be significant at a local level, such as staffing and job procurement. They should also think about global risk that may affect a firm more indirectly and that may not necessarily have an obvious correlation with the business. The all-to-recent mortgage crisis is a perfect example of a macroeconomic event that resulted in numerous downstream and indirect effects for the construction industry.

Business Development and Preconstruction: Owners may think of most contractors as a commodity. Developing a solid risk management program for clients and then promoting it to them will separate you from your competition and, at the same time, help improve your profit margins.

Operations: Getting “buy-in” at all levels of the operation is key. The message of managing risk must be communicated to everyone in the organization. Employees need to be shown the value and benefits of a risk management program. Employees generally need lots of examples as to how they can assist in the risk management process because to many employees, risk management is an abstract term. Great communication involves turning the abstract into real-world, practical actions that can be envisioned, remembered and implemented frequently. Best-in-class contractors put their subcontractor management and safety program (key parts of their risk management program) on display during the procurement process and have found that these strengths resonate with owners.

Finance: Being able to quantify risk and explain it to the company will go a long way in helping to promote a good risk environment. As the insurance landscape changes, the available options for determining insurance program architecture will also change. Contractors that embrace and manage risk effectively will be able to assume as much appropriate risk as their balance sheets will allow.

Whether your firm is positioned to hire a dedicated risk manager or not, the need for organizational risk management is the same. Contractors can no longer afford to let conversations affecting risk happen in a vacuum without the principal players in the room.
Risk management discussions should be more frequent in the C-suite and take up a larger portion of the CEO’s desk. Companies must provide a forum and a structure for these conversations to take place so that roles and responsibilities can be effectively defined and communicated. By committing the time and effort, risk identification and mitigation strategies can be outlined and a message sent to your organization that risk management is a now an integral part of your process and culture. Education and compliance measures should be part of the risk management process.

Done correctly, your risk management program can be integrated into your organization with little disruption of day-to-day operations or overall performance. In fact, addressing risk in a holistic manner and increasing the level of communication can give the entire organization an incremental business lift.

While we may have seen the high-water mark in the industry as far as margins are concerned, contractors are a resilient bunch. Forced to find alternative revenue streams while protecting their balance sheets, many have seen the benefit of a solid risk management plan as a way to address both issues. These plans are only as good as the processes that are in place and the knowledge and motivation of the people who are using them. Communication and process execution is the cornerstone of any risk management program. Firms that recognize the usefulness of a more formal program will increase their chances of thriving in an ever-shifting construction landscape.


Joe Poliafico is a senior consultant with FMI Corporation’s risk management practice. He can be reached at 303.398.7230 or via email at jpoliafico@fminet.com. David Madison is a consultant with FMI Corporation’s risk management practice. He can be reached at 919.785.9213 or via email at dmadison@fminet.com.

 

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