Managing Construction Risk

INFRASTRUCTURE AND GOVERNMENT

Managing Construction Risk A white paper on industry perspectives and some recommendations March 2009

ADVISORY

Major Projects in India – Preparing for tomorrow now! Construction is a key economic activity in India and accounts for almost 15 percent of the nation’s GDP. The India growth story has been dotted with large scale expansion plans encompassing infrastructure, energy and natural resources and private building programs. With the impetus to bridge the large infrastructure gap, we saw large number of projects being rolled over the past few years across almost all industry sectors. This construction boom was also fueled by the convenient availability of capital and at a relatively lower cost. Amidst this construction boom, the sector continued to face challenges around shortage of talent, limited contractor capacity and rapidly rising material and labor costs. The current economic slow down and difficulties in raising funds is putting further strain on the capital project owners, who are now operating in a very demanding environment with increased scrutiny from both internal and external stakeholders. The ‘growth story’ is now subject to a new set of challenges and the need to understand the complexities and risks along this path is more now. Capital project owners need to adopt a long

term view for realizing practical project completions; a flexible and agile mid term strategy and an immediate focus on the short term for managing the crisis.

Time to act...now The Government is consciously endeavoring to revive liquidity. Fiscal infusion by the Reserve Bank of India is definitely a booster shot; but for the economy to come back on its feet and its impact to be felt, capital needs to trickle down to the customer – which may easily take a couple of months. So should you wait for the end of the tunnel – absolutely NOT. The time is right to revisit your portfolio, re-jig the existing framework and shake out all the non value adding activities spanning strategy to daily operations. The need for a leaner, agile and simpler business model is evident. Outlined in the next few paragraphs are some steps that you should review and reflect upon to arrest the fall and prepare yourself to hit the ground running when the whistle blows.

© 2009 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

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Costs - ‘optimize’ v/s ‘minimize’

Inflation and spiraling commodity costs have significantly affected margins. Rapid, but sustainable cost reduction through progressive financial planning is the need of the hour. With the shift in the balance of power, the project owners are managing a far greater share of contracting risk. Accordingly, the project owners are tapping into the power of partnerships. Today’s relationships between project owners and contractors are becoming far more collaborative than in the past, with integrated project teams often housed in the same office, sharing reports that track project progress. Each party’s costs are effectively transparent, creating an atmosphere of mutual trust and dependence.

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We believe that those project owners that respond positively to the new market conditions can manage the cost risk more effectively by developing greater planning and project management expertise and monitoring contractor performance more closely. It will take time to develop such expertise in-house so there may be a need for independent assistance, especially on project planning, design, engineering and pricing. This would ultimately help in managing expectations and preserve a reputation for completing projects within budget, which will ultimately help in securing further business.

Managing uncertainty: Understand, embrace and control your RISKS

Despite improvements in the project risk management practices across the industry, many contractors appear to be short of a ‘holistic’ approach where risk is fully integrated into every aspect of the construction life cycle. This is evident from the fact that we still notice construction projects suffering from ill defined scope, design and constructability issues and mismanaged vendors. As a consequence there are clear time-costquality gaps, add to that a considerable tying up of valuable resources when you shift to fire fighting mode.

With the ever changing risks, especially in the current economic scenario, the need for a more formalized enterprise wide risk management can not be over emphasized. There is a need for the involvement of the highest level in an organization in the strategic risk management at the portfolio and the project level. The companies need to reconsider the effectiveness of their checks and balances at the project level. These could include special task groups for monitoring critical projects, environmental management systems, improved quality assurance and customer satisfaction monitoring. The

bidding process could be enhanced through a stronger approval framework that offers greater commercial oversight on the attractiveness of opportunities. Construction companies require an independent and objective risk management team that conducts risk reviews periodically and can put in place a mitigation plan that is actionable with defined timelines.

© 2009 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

3

Effective Project Integration

Increased pressure on timelines accentuates the need to bring about a seamless co-ordination between various functional areas in a project. Project integration management comprises the activities that integrate, coordinate and bring together the various functions. With multiple stakeholders from the investor to the builder, consultants to the contractors, vendors to the customers; and each with their own vested interests, the project often ends up as no-one’s baby. Industry sentiment reflects that functional integration is a key concern which has not been addressed effectively.

hand-over phases) need to be well defined. It should clearly spell out the objective, activities and respective outcomes for every process. Currently although feasibility studies are undertaken, post feasibility study review is not done to assess if study has achieved its objective. Finance department should also be actively involved in the development of project execution plan(s). Although execution plans do exist in some instances, but its relevance is limited as project schedules are subject to frequent changes and timely updates to the schedule with communication to the stakeholders is lacking.

Organization’s project development processes (initial scoping study, prefeasibility, feasibility, execution and

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Successful execution & ‘effective’ monitoring

Today there are projects dotted with a poor scope description and more often than not a non existent change control mechanism. Seldom do you see a project execution plan formulated and instances where there may be such a document, its communication and implementation are major areas of concern. The planning process needs to start well in advance of the date you mobilize site works. To aid successful execution and monitoring, it is imperative to have an independent project monitoring and reporting mechanism in place.

Best practices to monitor project progress could include ‘Earned Value Analysis’ or EVA and an adequately designed change management process that is customized to the nature and scale of the project on hand. Earned Value Analysis is a method for measuring project performance. It indicates how much of the budget should have been spent, in view of the amount of work done so far and the baseline cost for the task, assignment, or resources. Additionally it provides the project owner / manager the visibility on cost to complete which is an essential input in current times of depleting cash reserves.

To arrive at a project master schedule, every discipline needs to make their detailed schedules, key interdependencies understood, project float identified and ownership assigned. Contractor and vendor milestones need to be built in to the master schedule, reviewed by the execution team and shared with all departments, post project head approval and then released for actual construction.

© 2009 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

5

Human capital: Investing in the future of the industry

There is a general consensus that shortage of talent in the construction sector is a long term problem and will continue to push up project costs and risks. The flow of talent into construction has been gradually drying up as candidates have sought alternative – and often more lucrative – career options. The Government, which is the biggest buyer of the capital projects, has also not done enough to address this challenge. The education system is often not delivering the required number of specialists across project management, engineering, estimating, surveying and contract management.

contractors and governments to attract more school leavers and graduates. Companies should also seek to stay in touch with changing employee aspirations. By encouraging diversity in its employment practices, and by offering greater flexibility in working hours, the sector can reach out to a wider potential audience that perhaps would not previously have considered such a career. Investment in existing employees is also crucial in order to offer better-defined career structures, with a greater focus on training and higher salaries where possible.

Facing a desperate game of catch up, the industry needs a genuine collaboration between project owners,

6

Embrace sustainability

While the vast majority of project owners recognize the importance of sustainable construction practices, many remain unconvinced that it is good for their business. Limited regulations around sustainability and varying implementation across the world do not contribute to the cause. Today the technology is available to create green buildings and infrastructure for as little as five percent additional costs. Good architects can make a building substantially more energy efficient at little or no extra cost. Many of those involved in construction also underestimate the energy cost savings

that accrue from ‘green’ buildings. Some organizations have made use of seminars and publications as well as setting up an internal helpdesk to spread the word. As many companies have learned, a ‘green’ reputation can bring real competitive advantage as well as longer term cost savings. By embedding sustainability firmly into both their own and their business partners’ culture and operations – and maintaining a strong independent overview – owners can stay a step ahead of both the regulators and their peers.

© 2009 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

Conclusion

The current economic environment and the increasing strain on resources do not have a precedent. Construction forms the key development activity for the real estate and infrastructure sectors; and as a result demands a significant share when it comes to any/enterprise business strategy. Interestingly enough, an activity that is at the very core of growth and development is almost primeval on its maturity curve; with a rudimentary understanding of the prevailing risks the need to understand, evolve and implement a risk management strategy was never more astounding than now. Even in these challenging times there is a growing demand for higher quality services with lower prices and tight turnaround times. Construction delivery methods that combine control and responsibility are becoming more appealing, if not standard in the industry.

First riding on the IT boom and then the thrust from the real estate sector gave the construction industry enough impetus to go from project to project and clock reasonable profits. This time around the equation is a little lop sided, yes the infrastructure gap is glaring and provides good opportunity, but the dipping investor sentiment, apparent absence of a risk management framework and instances of weak corporate governance, all put together present a herculean task. The inefficiencies that got covered up yesterday will get profiled and the cracks will begin to show. Project & program management expertise will be key, companies that optimize their costs, while integrating various construction processes would have a good chance. An integrated, tailored and dynamic risk management strategy coupled with a forward looking approach that incorporates principles of sustainability and good HR policies will be the key ingredients for successful construction companies.

Tough times call for tough measures. The onus is now on the construction project fraternity to act, take quick action to inculcate, imbibe and institutionalize key management processes in their very DNA – and in doing so they will prepare for tomorrow – now!

© 2009 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

About KPMG in India KPMG is a global network of professional firms providing Audit, Tax and Advisory services. We operate in 144 countries and have 137,000 people working in member firms around the world. The independent member firms of the KPMG network are affiliated with KPMG International, a Swiss cooperative. Each KPMG firm is a legally distinct and separate entity and describes itself as such. The Indian member firms affiliated with KPMG International were established in September 1993. As members of a cohesive business unit they respond to a client service environment by leveraging the resources of a global network of firms, providing detailed knowledge of local laws, regulations, markets and competition. We provide services to over 5,000 international and national clients, in India. KPMG has offices in India in Mumbai, Delhi, Bangalore, Chennai, Hyderabad, Kolkata and Pune. The firms in India have access to more than 3000 Indian and expatriate professionals, many of whom are internationally trained. We strive to provide rapid, performance-based, industry-focused and technology-enabled services, which reflect a shared knowledge of global and local industries and our experience of the Indian business environment.

© 2009 KPMG, an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

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