We all have come across, one way or the other, to the dillemma of how much risk we should take anticipating a reward. In more technical terms what is our risk appetite or aversion which in turn defines our risk profile. Typically, the higher the risk is, the higher the reward may be, which is a common approach in investements and financial services. But what about construction?
Before we dive deeper into this consideration, let’s approach risk in a project finance or PPP project. The project sponsors are willing to be part and invest in a vehicle when the business case can demonstrate high return on invest. Given that during the construction period of the project, all the available funds are fully directed towards the project execution, the viability of the business case depends on the construction being completed on time, on budget and as per the quality standards. In other words, the financial viability of a project initiative depends to a significant degree on the successful construction of the project, during which all the idientified risks have been identified and adequately managed and mitigated to ALARP.
So let’s return to the set question above. Is the notion ‘higher risk, hgher return’ applicable to construction projects? In a recent very interesting article published by KcKinsey & Company entitled ‘The next normal in construction’, the authors quote that ‘Historically, the construcion industry has underperfomred..and…Profitability is low at around 5% EBIT, despite high risk and many insolvencies’. Do the authors argue that profitability should be higher given the high risk profile of many construction projects? I tend to believe that no given the well established and evidence based approach in the construction industry that successful projects are those that minimise the identified risks and are left with residual risks that can be managed and for which appropriate risk mitigation measures and contingencies have been planned and are in place.