Risk Management, 1992 Engineering Conference Proceedings

A new paper machine project was appropriated in the spring of 1987 with a capital budget of $270 million and projected rate of return of 24 percent. The capital cost estimate supporting this budget was based on pricing factors influenced by the preceding few years of relatively low capital spending. During the latter part of 1987, a pulp and paper capital spending boom began, vendor capacity was quickly oversold, and a hyper-escalation of capital equipment pricing occurred. As result, the project capital cost overran seriously, was 2 months late in completion and, consequently, failed to achieve the financial objectives. This project did not employ any formal risk management procedures. A similar, comparably budgeted project was initiated later that same year but employed from Day 1 an aggressive risk management system. It was completed within budget and ahead of schedule. Both projects were exposed to similar situations and events but, through formal risk management, one was able to avoid the detrimental consequences and became successful.

This and other case histories cause us to believe that project failures are more often caused by risk negligence than risk itself. The objective of this paper is to increase awareness of risk and identify some proven risk management techniques.

Risk management is also a capital optimizing tool. Contingencies are rarely available to cover post start-up changes or add-ons often required to fulfill or enhance a project’s intent. Because of this, scopes and capital budgets are often conservatively defined to provide the security of achieving the project objectives without going back to the investors for more money. This results in overexpenditure, which equates to lower return on investment. It is better to define and install the minimum possible scope that may achieve the desired performance, but identify any potential performance risks and what may have to be added later to remedy. Plans can be made for early identification of problems during the learning curve, and fast track remedies. Thus, capital is not invested unnecessarily, or before it is absolutely required, thereby maximizing potential return on investment.