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Risk and ValueTwo Sides of the Same Coin

John K. Hollmann PE CCE CEP

Value and Risk 2

Introduction

John K. Hollmann, PE CCE CEP

Owner/Consultant, Validation Estimating LLC• I help owner companies improve their Cost

Engineering practices• 30 years experience in engineering, project control,

cost estimating, consulting, benchmarkingAACE International Roles:

• Fellow• Technical Board Director of Recommended Practices• Editor/Lead Author of AACE International’s Total Cost

Management (TCM) Framework• Co-Chair of task force to develop a Decision and Risk

Management Professional (DRMP) Certification

Value and Risk 3

The Challenge of Dealing WithValue and Risk

Value and Risk jargon is multiplying;

Is there a way to make sense of it all?

Value Engineering

Value-at-RiskValue Management

Risk ManagementThreat

Opportunity

Value Improving Practice

RiskAnalysis

Value Analysis

Certified Value Specialist

Certified Risk Manager

Added Value

Value and Risk 4

Addressing the Value and RiskChallenge

How does your project system addressRisks?...Value?....Is it in an integrated way?

This presentation will…

define basic concepts and terms,show parallels between Value and Risk,describe some best practices in industry,show how to integrate the practices

…and ensure a balanced approach

Value and Risk 5

Value(as defined in AACE’s TCM Framework)

Value

...measure of the worth of a thing in terms of usefulness,desirability, importance, money, etc.

Value Management

…what an enterprise does to ensure that its assets andprojects provide or maintain the usefulness (i.e.,value) that the various stakeholders require

Value and Risk 6

Risk(as defined in AACE’s TCM Framework)

Risk

…take your pick:

same as uncertainty (i.e., threats + opportunities), negative impacts of uncertainty (i.e., threats) net impact of uncertainty (i.e., threats – opportunities)

Risk Management

…a process for addressing uncertainty in projectoutcomes in a way that increases the probability thata planned outcome will occur without decreasing thevalue of the asset or project

< hint: pick this one

Value and Risk 7

Value and Risk…Attributes of an Asset or Project

Value (worth) is something we try to increase

…without increasing, and possibly decreasingrisk

Risk (uncertainty) is something we try to reduce

…without decreasing, and possibly increasingvalue

Value and Risk 8

Value and Risk…Both Involve Opportunity and Threat

Value (worth) is something we try to increase

…without increasing, and possibly decreasingrisk

Risk (uncertainty) is something we try to reduce

…without decreasing, and possibly increasingvalue

Opportunity

Opportunity

Threat

Threat

Desirable

Undesirable

You cannot manage one without managing the other

Value and Risk 9

Agenda

Define basic concepts and terms

Show parallels between Value and Risk

Describe some best practices in industry

Show how to integrate the practices

Value and Risk 10

Risk Management Process

Establishing the context

Risk identification

Risk analysis

Risk evaluation

Risk treatment

Monitoring andreview

Communicationand

consultation

Derived from draft of ISO 31000 “Risk Management”

Risk assessment

Value and Risk 11

Is This Process Generic to BothValue and Risk?

Establishing the context

Risk identification

Risk analysis

Risk evaluation

Risk treatment

Monitoring andreview

Communicationand

consultation

Risk assessmentValue

Value

Value

Value

Value

Value and Risk 12

Value and Risk Management ProcessSimplified

Identify Ideas/Risks

Scope

Assess/Analyze

Take Action?

Look Out For More

Value and Risk 13

Value and Risk Management ProcessSimplified

Value Improving Practice/Opportunity

PlannedValue

AddedValue

ReducedValue

Risk/UncertaintyTre

atment/

Oppor

tunity

Uncert a in ty

VI P

/Opp

ortu

nity

Value and Risk 14

Understanding How Value and Risk areRelated Does Not Mean Practices Should beCombined (But Do Integrate the Processes)

Use of practices to improve Value have lagged the useof Risk Management practices

Because Value was being short-changed, some “Risk”practitioners attempt to cram everything into their riskassessment methods

My experience is that this generally diminishes thefocus on each

Companies need to…

Implement Value Improving Practices Integrate them with the Risk Management Process

Value and Risk 15

Agenda

Define basic concepts and terms

Show parallels between Value and Risk

Describe some best practices in industry

Show how to integrate the practices

Value and Risk 16

Best or Recommended Practices

Construction Industry Institute (CII) definesthese as “practices that can lead to enhancedproject performance”

i.e., practices that increase value

AACE International uses the termRecommended Practices because it is rare thatanyone can really say what is “Best”

For a high performing company, “best”practices should be “business as usual”; i.e.,part and parcel of their everyday activities

Value and Risk 17

Example: CII Best Practices

From: The Use and Impact of Value Improving Practices and Best PracticesJim Lozon, P.Eng. and Dr. George Jergeas, P.Eng.AACE Cost Engineering Journal, Vol. 50/No. 6 JUNE 2008

Value and Risk 18

Example: AACE RecommendedPractices (RPs)

From: www.aacei.org/technical

10S-90: Cost Engineering Terminology

11R-88: Required Skills and Knowledge of Cost Engineering

12R-89: Model Master's Degree Program with Emphasis in CostEngineering

13S-90: Recommended Method for Determining Building Area

14R-90: Responsibility and Required Skills for a Project Planning andScheduling Professional

15R-81: Profitability Methods

16R-90: Conducting Technical and Economic Evaluations: As Appliedfor the Process and Util ity Industries

17R-97: Cost Estimate Classification System

18R-97: Cost Estimate Classification System: As Applied inEngineering, Procurement, and Construction for the ProcessIndustries

19R-97: Estimate Preparation Costs: As Applied for the ProcessIndustries

20R-98: Project Code of Accounts

21R-98: Project Code of Accounts: As Applied in Engineering,Procurement, and Construction for the Process Industries

22R-01: Direct Labor Productivity Measurement: As Applied inConstruction and Major Maintenance Projects

23R-02: Identification of Activities

24R-03: Developing Activity Logic

25R-03: Estimating Lost Labor Productivity in Construction Claims

28R-03: Developing Location Factors by Factoring: As Applied inArchitecture & Engineering, and Engineering, Procurement &Construction

29R-03: Forensic Schedule Analysis

30R-03: Implementing Project Constructability

34R-05: Basis of Estimate

40R-08: Contingency Estimating: General Principles

41R-08: Risk Analysis and Contingency Determination Using RangeEstimating

42R-08: Risk Analysis and Contingency Determination UsingParametric Estimating

43R-08: Risk Analysis and Contingency Determination UsingParametric Estimating – Example Models as Applied for the ProcessIndustries

44R-08: Risk Analysis and Contingency Determination Using ExpectedValue

52R-06: Time Impact Analysis: As Applied in Construction

53R-06: Schedule Update Review: As Applied in Engineering,Procurement, and Construction

Value and Risk 19

Value Improving Practices (VIPs)

The term “VIP” originated from IPA, Inc. and its clients VIPs are more than “business as usual”. They are:

a formal, planned process with assigned responsibilities facilitated efforts led by an independent experts done in a way that involves all the key stakeholders done in a way that documents, communicates, and follows

up on the results Unlike most of what are often labeled “Best Practices”,

IPA’s “VIPs” have been shown by empirical research toactually improve project outcomes Big Caveat: VIPs do not “add value” until you have

solid “basics” such as good project scope definition,project control, etc., etc.

Value and Risk 20

Example: IPA VIPs

From: The Use and Impact of Value Improving Practices and Best PracticesJim Lozon, P.Eng. and Dr. George Jergeas, P.Eng.AACE Cost Engineering Journal, Vol. 50/No. 6 JUNE 2008

Most Used

Most Used

Value and Risk 21

Value Analysis and Engineering

VA/VE is “the systematic application of recognizedtechniques which identify the functions of the productor service, establish the worth of those functions, andprovide the necessary functions to meet the requiredperformance at the lowest overall cost.” (per SAVEInternational)

Given that functions are attributes of an asset orproject that give it a purpose and make it useful ordesirable (i.e., anything that provides what a customerwants or needs), VA/VE is arguably the most importantVIP; i.e., it is directed straight at the issue of value

Note: Many mistakenly think Value Engineering is anysession where they search for savings of any type

Value and Risk 22

Constructability Reviews

“The use of construction knowledge and experience inplanning, design, procurement, and field operations toachieve overall project objectives (per CII)

The purpose of the constructability review is to identify thefollowing five items:

Design errors, in either material selection or dimensions Ambiguous specifications Project features that will be difficult or exceedingly costly

to construct as designed Project features that exceed the capability of industry to

properly build Project features that are difficult to interpret and will be

hard to accurately bid Project “features” include both physical characteristics and

planning attributes

Value and Risk 23

Other VIPs (*abilities)

There are a group of VIP methodologies that involveanalyzing “…abilities,”; i.e., how “executable” a projector work process is and how “operable” or usable theresultant asset, product, or service is

Common examples include: Constructability; focused on execution Reliability, availability, and maintainability (RAM)

which is focused on operations. The are many others. Their common goal is to find the

best value alternative approach They are similar to VA/VE except the focus is on the

relation between design and how a process isperformed (an ability), rather than functions of the endproduct or service

Value and Risk 24

Apply VIPs Early and Often Enough toInfluence Design, Planning & Decisions

Pote

ntia

lto

Infl

uenc

eV

alue

Asset Planning Asset Implementation Project Control

Asset OptionSelected

AssetOpportunityIdentified

Project Fully Authorized

Asset Planning and Implementation Phase

VIPs

VIPs

Value and Risk 25

Risk Management

Risk Management is is covered by ISO,PMIBOK, AACE’s TCM etc.

Processes are all pretty much the same However, what is lacking in most

processes is the step to incorporate riskcost and time into project plans (e.g.,contingency)

AACE’s TCM and RPs address these gaps

Value and Risk 26

AACE’s TCMChapter 7.6 Risk Management

QuantifyRisk Factor

Impacts

AnalyzeContingency

Identify andAssess

Risk Factors

Screen RiskFactors

ControlRisk Factors and

Impacts

Develop RiskManagement Plan

Plan for RiskManagement

Develop andMaintain Methods

and Tools

HistoricalInformation

(6.3 and 10.4)

Asset orProjectScope

(3.2, 7.1)Project

ImplementationBasis(4.1)

StrategicAsset

Requirements(3.1)

PlanningInformation

(7.1,7.2, 7.3,7.4,

7.5, 7.7)

MitigateRisk Factor

Impacts

Cost, Schedule,and Resource

Information(7.2, 7.3, 7.4)

SelectedAlternative

Planning BasisInformation

(3.2, 7.1, 7.2,7.3, 7.4, 7.5, 7.7)

ChangeInformation

(6.2 and 10.3)

ProjectImplementation

Bas is(4.1)

RiskManagement

Plan(3.2 and 8.1)

Riskacceptance

criteria

Risk Analysis Risk Mitigation

Alternativesfor furtheranalysis

Risk Assessment

AssessChanges and

Trends

ManageContingency

(10.3)

RiskPerformanceAssessment

(6.1 and 10.1)

HistoricalInformation

(6.3 and 10.4)

Process takes a “second pass” through assessment

Value and Risk 27

AACE ContingencyRecommended Practices

AACE is developing Contingency-related RPs inreadiness for its Decision and Risk ManagementProfessional (DRMP) Certification

40R-08: Contingency Estimating: General Principles 41R-08: Risk Analysis and Contingency Determination Using

Range Estimating 42R-08: Risk Analysis and Contingency Determination Using

Parametric Estimating 43R-08: Risk Analysis and Contingency Determination Using

Parametric Estimating – Example Models as Applied for theProcess Industries

44R-08: Risk Analysis and Contingency Determination UsingExpected Value

Value and Risk 28

What is Not An AACE ContingencyRecommended Practice?

The contingency method used by mostcompanies is not recommended

That method is “estimate line-item ranging”

i.e., assigning high-most likely-low rangeto estimate and running Monte-Carlo

Empirical research has shown that it doesnot address systemic risks (and it violatesthe principle of linking risks-to-impact)

Value and Risk 29

Agenda

Define basic concepts and terms

Show parallels between Value and Risk

Describe some best practices in industry

Show how to integrate the practices

Value and Risk 30

TCM: An Integrated Process forApplying the Skills and Knowledgeof Cost Engineering

The world’s firstintegrated process forportfolio, program, andproject management(published 2006)

The foundation for allAACE Internationaltechnical products

Covers the entire assetlife cycle

Value and Risk 31

ProjectPerformanceAssessment

(10.1)

Project Scopeand Execution

StrategyDevelopment

(7.1)

SchedulePlanning andDevelopment

(7.2)

WBS &ExecutionStrategy

Cost Estimatingand Budgeting

(7.3)

ResourcePlanning

(7.4)

Value Analysisand Engineering

(7.5)

RiskManagement

(7.6)

AnalysisBasis &

Feedback

Analysis Basis & Feedback

Project ControlPlan

Implementation(8.1)

ScheduleBasel ine

(Activi ties)

CostBaseline(Budget)

ResourceBaseline

(Quantities)

I terative, concurrent processes

Project CostAccounting

(9.1)

Performance andPerformanceMeasurement

(9.2)

BaselinePlans

Strategic AssetManagement

Process(2.3)

Improvement Opportunities(variance from baseline plans)

ScopeChange &Forecasts

ChangeManagement

(10.3)

Project Implementation Basis(Asset Scope, Project SystemRequirements, Budget, etc.)

Cost, Progress and Performance Measures

BaselinePlans

Forecasting(10.2)

ProcurementPlanning

(7.7)

Project Historical Database Management(10.4)

All ProjectControl

Processes(7.1 to 10.3)

ActualData

HistoricalData

ActualData

HistoricalData

ContractRequirements

Status Checks& Feedback

TCM Project Control Process

Each block representsa process further

defined in the TCMFramework

PlanPlanDoDo

CheckCheck

AssessAssessIn TCM, Value and Risk Are Assumed To Be Parallel

Processes

Value and Risk 32

Integration in AACE’s TCMChapter 7.6 Risk Management

QuantifyRisk Factor

Impacts

AnalyzeContingency

Identify andAssess

Risk Factors

Screen RiskFactors

ControlRisk Factors and

Impacts

Develop RiskManagement Plan

Plan for RiskManagement

Develop andMaintain Methods

and Tools

HistoricalInformation

(6.3 and 10.4)

Asset orProjectScope

(3.2, 7.1)Project

ImplementationBasis(4.1)

StrategicAsset

Requirements(3.1)

PlanningInformation

(7.1,7.2, 7.3,7.4,

7.5, 7.7)

MitigateRisk Factor

Impacts

Cost, Schedule,and Resource

Information(7.2, 7.3, 7.4)

SelectedAlternative

Planning BasisInformation

(3.2, 7.1, 7.2,7.3, 7.4, 7.5, 7.7)

ChangeInformation

(6.2 and 10.3)

ProjectImplementation

Bas is(4.1)

RiskManagement

Plan(3.2 and 8.1)

Riskacceptance

criteria

Risk Analysis Risk Mitigation

Alternativesfor furtheranalysis

Risk Assessment

AssessChanges and

Trends

ManageContingency

(10.3)

RiskPerformanceAssessment

(6.1 and 10.1)

HistoricalInformation

(6.3 and 10.4)

The Risk (and Value) processes exchange information

e.g., findings from VIPs (uncertainties) are in input toRisk Identification, and Mitigation options

(opportunities) are inputs for VIP consideration

Value and Risk 33

Are you…- using a robust set of VIPs ANDRisk Management practices?- AND are they integrated?

Value Improving Practice/Opportunity

PlannedValue

AddedValue

ReducedValue

Risk/UncertaintyTre

atment/

Oppor

tunity

Uncert a in ty

VI P

/Opp

ortu

nity

Value and Risk 34

Questions?

Contact:

John K. Hollmann PE CCE CEP(jhollmann@validest.com) or 1-703-945-5483

Key References:

TCM and RPs• Free (.pdf format) from AACE at www.aacei.org/technical

VIPs• AACE Cost Engineering Journal, Vol. 50/No. 6 JUNE

2008; The Use and Impact of Value Improving Practicesand Best Practices, Jim Lozon, P.Eng. and Dr. GeorgeJergeas, P.Eng,