Recognizing, identifying, and measuring risk is a critical pre-bid task. A Las Vegas sports book doesn’t wait to set the line until after the game. A handicapper who failed to take a key player’s injured wrist into account or the weather forecast before setting the line would fail. The same is true for the construction professionals who bets their company's survival on the next project they want to bid without recognizing, identifying, and measuring the financial risk inherent in every new project.
Never Book a Loser
Every bettor wants to know how bookies can measure risk so accurately that they seldom lose. Construction professionals who learn to act like handicapper by analyzing risks before they bid, give themselves the best chance of making a profit on every project. This recently developed pre-bid construction risk handicapping tool has three steps: recognize, analyze, and mitigate risks.
Recognize
There are nine profit impact areas in which most project financial risks are hidden. We recommend forming a risk management team to begin handicapping the potential profit on each project under consideration by taking a close look at these nine areas and recognizing the risks that each might contain.
Analyze
The next step for the construction professionals (like the bookie) is to analyze each risk factor recognized. Start by estimating the probability that the risk will occur and the potential severity of its impact on profitability. At this point, any steps to mitigate the impact of each risk must be considered and evaluated. The net final impact of these two factors (probability and severity) can then be measured on a scale of 1 to 5 that we discussed last week. Placed on a probability and impact matrix enables you to clearly picture the overall risk on every potential project.
I will walk through how to use a Probability and Impact Matrix to avoid risk. This step-by-step handicapping process gives you a significant edge over your competitors: The risk team should:
- Identify the risks in each of the nine profit impact areas from last week.
- Estimate the probability and severity of each risk factor.
- Chart each risk factor from 1 to 5 on the vertical axis labeled "Probability“ and on the horizontal axis labeled "Severity" 1 to 5.
- Plot the assigned values for each risk factor on its own (or a combined) chart.
- Create a combined chart and plot the values of each risk factor. The chart has four quadrants: top right quadrant-NO GO; top left-CONDITIONAL; bottom right-CONDITIONAL; bottom left-GO.
Your combined Probability and Impact Matrix should look like this:
In this example nine risk factors were identified; the probability of occurrence and severity of impact estimated; and the values plotted on the combined chart. This puts a complex analysis into a simple graphic pictorial. The accuracy of the tool is dependent on the team’s knowledge and experience estimating the likelihood and severity of the risk, and their ability to effectively mitigate.
Beware of Bias
The first rule of sports handicapping is "do not act like a fan." If you want something to happen, for a million unconscious reasons you will decide in its favor. There can be no bias in the GO/NO-GO decision on a construction project. There is too much at stake. Always default to common sense. Contractors must be risk takers. But we need to be professional risk takers.