Case Study …
… and Enhancement Perspectives
„A Risk-Based Life Cycle Model
for a large PPP Project“
March 29th, 2011, Palisade EMEA Conference, West-India House, Amsterdam
Dr. Wilhelm K. Kross, Dipl.-Ing., MBA, Eur. Ing.
(Tel. : +49 176 40170603, Wilhelm.Kross@t-online.de)
Recent and new Issues in structuring larger PPP projects
Naïve and flawed approaches, and dysfunctional financing mechanisms
•
Public private partnership projects seen as an alternative financing and operating structure, mostly
seen in the fields of communal services
• Schools, community halls, buildings, roads, IT infrastructure, hospitals, waste facilities, bridges,
tunnels, army barracks, etc.
• Many similarities when compared to earlier design – build – operate – transfer project structures
• A political topic, with differing trends in differing countries
• Risk management approaches often a little naïve, particularly in forfaiting contract structures
•
Recent financial crisis triggered additional impediments
• Bank consortiums unable or not willing to enter customized project financing structures
• Fundamental prerequisites to entering negotiations with private equity investors unaddressed
• “Soft factors” still playing a major role
• Larger projects either impeded, or initiated with inadequate contracts and poor risk management
•
Entirely new approaches required to “enable” larger initiatives as prospective PPP projects
• Structuring of a front-to-end, “life-cycle” understanding of the respective initiative
• Employing certifiable management systems for each phase, and smooth transitions
• Employing structured technical insurance products
• Optimizing the PSC on the basis of risk-based life cycle models, with quantified residual risk
• Specifying features in contractual SLAs that, from a risk and cost perspective, are truly sensitive
• Enabling investor / operator consortiums to approach the financial market with a new quality of
information on the true risk, and opportunities
• Considering an up-front minority investment on behalf of the public partner, with buy-out options
© 2011 Dr. Wilhelm K. Kross
1
Historical evolution and trends in risk management
Risk management in strategy optimisation is not a reality yet
?
Regression Analytics
Swamps
= Malaria
ca. 3000 B.C.
Provisions,
Interest
Risk in
Contracts
Life
Expectancy
ca. 1750
Selective Management
Medical Field,
Toxicology
Insurance,
Risk Pricing
Statistics
Probabilistic
Approaches
Regulatory
Approaches
Economics
Systems /
Processes
Decision
Analyses
Start Computerization
Market Risk,
Credit Risk
Project
Risk
Portfolio
Management
Integrative Approaches
Social Risk,
Reputation
Option Pricing
Real Options
Risk in
Psychology
Risk
Communication
Operational
Risk
Management
Processes
Maturity and Excellence
Strategy
Optimization
© 2011 Dr. Wilhelm K. Kross
Today ...
Organization
Designs
Supply
Chains
2
Known distortions in the understanding and perception of risk
Empirical research in managerial risk controlling and management
Source : Hillson (2005). „Describing Probability :
The Limitations of Natural Language“.
PMI Global Congress 2005 EMEA Proceedings
Risk Tendency
Source : Shapira (1995). „Risk Taking :
A Managerial Perspective“.
Russel Sage, NY, NY
I would ...
Others
would ...
I should ...
Very Successful
© 2011 Dr. Wilhelm K. Kross
Successful
A Little Success A Little Failure
Failure
Considerable Failure
3
Strategic enhancement of traditional risk management focus
Components of an organizational risk and opportunity management
Time
Benefits
e.g. Capital cost assessment and optimization, taking risk into account
Benefits from
opportunities
Risk adjusted process- / project optimization
“Right-sizing“ of risk-reduction initiatives
Support of strategic decision making
Efficient risk management as competitive advantage
Supporting
investment
decisions
Evaluation of planning accurateness
Securing the
business
operations
Avoidance of
deviations
Support of gap / sensitivity analyses
(risk adjusted prognoses for
organization, division, and projects)
Avoidance of surprises through
timely intervention
Compliance to regulatory minimal requirements
Avoidance of
losses
Compliance with
regulations
IdW-Standard, IFRS, SEC and stock exchange rules, 8th EU Directive
KonTraG, SOX, Corporate Governance Codex
Austria Norm, ISO Standards, TÜV and DIN Standards
SolvV, MaRisk, MiFID, FRUG
Environmental and human health laws and regulations
… etc. …
Level of development of risk management
© 2011 Dr. Wilhelm K. Kross
4
Critical success factors also include „project management“
Projects are the prevailing structure for strategy implementation
To be handled with care though:
•
Project structure is used for accounting approaches, also as an implied line function, year end
reporting determines the project end, incomplete project life cycles, resultant costs within the
framework of project- management / optimization is largely ignored
•
Operational risk is not explicitly reported, unclear degrees of conservatism
•
Small crises are rolled into large projects and have the potential of jeopardizing the entire project
•
No clear delineation between project / line functions, historical liabilities are delegated into the
project, project manager is confronted with conflicting goals and objectives
•
Projects are set up in a too large scale, then implied line structures in stead of project structures,
operational work-arounds and poor compromises later dominate the order of the day
•
Complexity of individual activities and work packages is not reviewed explicitly, resulting in roll-over
management, many activities 97% complete
•
Project financing models overall only consider the development phase, not the life-cycle
•
Transition from development to resultant operational phases are structured inadequately
•
Project manager not holding down the required authority for large initiatives, mega-projects are set up
to fail, undesired results not tracked in knowledge base
•
Inadequate project manager qualification approaches, inconsistence competence and process
models instead of management sills, soft factors are partially neglected
•
Risk ownership in projects all too often not related to true structural power and competences
© 2011 Dr. Wilhelm K. Kross
5
Lessons learnt in so-called IT mega-projects
Real-life initiatives requiring new focus of PM and change management
From the beginning…
Project
Objective
Projects are set up too large, structured too rigidly and executed in an
overly decentralized manner
(Quasi-business line function instead of project management)
Failure
Planned Project
Progress
Budget Consumption
Professional restrictions are not identified and prioritized right from
the project start
(Vague maximum objectives as “basis for negotiation“)
Work packages are not managed in respect of cost-benefit
considerations - and risk consciousness as well as trade-offs
Achievement of Objectives
(Project progress = budget consumption ≠ residual complexity)
Project
Initiation
Complexity
Business
Concept
Implementation
and Interfaces
…to the end
IT Architecture Concept
Integration Concept
Process Improvement
Decision / Performance Analyses
Project Failure
70% Residual
Complexity
in Interfaces
Increasing deviation from the original project scope, subprojects are developing a life of their own
Increasing complexity through reactive detection of project issues
and problems
Ad-hoc problem solving replaces project management
180%
Professional
Requirements
120% Residual
Professional +
150%
Technical
Requirements
Project Initiation
Business Concept
© 2011 Dr. Wilhelm K. Kross
Project ends with a hard compromise or with a “termination by
decision“, overdue change is poorly or not implemented
Implementation and Interfaces
6
Project planning and project management in Germany
Particular risks of projects in the public sector
•
Auxilary requirements: small and medium size company tendering, setting an example, constructional
art, no official „black listing“, hardly any pre-qualification criteria
•
Further risk factors inherent in the EU tendering and budgeting laws and regulations
– Lead time for tender documentation, tender procedure complaints, litigation, budget reallocation,
susceptibility to blackmail by service providers due to the long lead time in tendering processes
– No explicit risk provision, unreliable reference data, critical path is intransparent, no optimsation of
insurance concepts
– Reverse-engineering of the cost estimates to the level of „ES-Bau“
•
Pre-programmed failure: delayed start, documentation becomes more important than true performance,
inappropriate monitoring of external project management, service providers assume an independent
reality, bold letters, increased formalism, formalism in the process of tallying the contract specifications,
mobilisation of an army of lawyers, ….
€
€
Risk loading
Risk adjusted
costs to
receive
budget approval
© 2011 Dr. Wilhelm K. Kross
Risk and
assumption
stripped
costs of ES Bau
stripped
costs advanced
Risk adjusted
costs advanced
for budgeting of
AöR
Refrence base for
risk loading of
EW-Bau
7
PPP project planing and PPP project management in Germany
Many opportunities are systematically destroyed for PPP-Projects
•
Narrow minded set for business case, partially using incorrect risk allocation
– Minimum requirement of proof of significant cost savings
– Thereby not taking into account explicit consideration of the risk factors of EU tendering law and
German budgeting laws and regulations in a comparison model
– Time-to-market is not an official decision criterion
– Distrust on the part of the public sector “possible loss of control” to the private sector (?)
•
Mostly forfaiting combined with limited intervention clauses, very little project financing models
– Many risk factors remain in the public sector; lowest risk model for bankers, investors, developers
and operators; sensible for small standardized projects based on attractive transaction costs
– For financing arrangements, many risk factors remain unnoticed, hardly any explicit risk analysis,
risk aggregation is often incorrect, management quality is largely negligible, rating prognoses of
project implementation companies tend to be arbitrary
•
Insurance concepts are integrated unsatisfactorily, suboptimal overall direction
•
Transitions from development to operational phase are mostly suboptimal, also cost allocation between
development and operational phases are not always sensible
•
Too many steps are not standardized, thus in turn creating unnecessary transaction costs
© 2011 Dr. Wilhelm K. Kross
8
Employing appropriate risk and opportunity management focuses
Framework to integrate and evaluate cause / consequence relationships
Factory
Supplier
Warehouse
Wholesaler /
Retailer /
Retailer
Customer
Target Structure and Work Flows
Enterprise modelling
Extent of Damage
Production Factors and Resources
1
catastrophic
2
Risk analysis
negligible
3
4
high
5
8
6
9
low
7
medium high
1 day
Financial Key Indicators
1
Fire: production hall
2
…
4
Interruption: power supply
5
…
8
Burglary: canteen
9
…
Probability of
Occurrence
1 week
1 month
6 months
Product development
Procurement
Balance
Sheet
P&L
Controlling
Data
© 2011 Dr. Wilhelm K. Kross
Business impact analysis
Production
Distribution
No impact
Significant impact
Negligible impact
Catastrophic impact
9
Risk and cost reduction in the planning of a project
Traditional approach to project planning (simplified example: building construction)
Preparation
Kick-Off
Project structuring
Concept / methodology
Tender
Detailed planning
Tender award
Excavation
Foundations, building
Installations, adjustment
Application approvals
Permitting process
Escalation of approvals
Compensation negotiations
Completion, Review
Sub-optimal approach, inevitable suboptimal results, some hidden problem areas:
Unclear degree of consertativeness, hidden buffers, all individual estimations are probably too high or low
Inconsistent degree of detail, no overview of the complexity hubs or the influence of risk factors
Sensitivity analysis and scenario optimisation require signifinant additional time, and in all likelyhood are rather complex
© 2011 Dr. Wilhelm K. Kross
10
Risk and cost reduction in the planning of a project
Probabilistic enhancement of project planning
70%
30%
Marginal additional effort, however, robust and comprehensible results, fewer hiddel problem areas:
Use of available data as well as moderated three point estimates to bridge inherent data gaps
Explicit reflection of the influence of risk or future decisions, dependencies and correlations are explicitly reflected
Monte-Carlo simulation in standard software, sensitivity analyses and scenario optimization at the press of a button
© 2011 Dr. Wilhelm K. Kross
11
Risk and cost reduction in the planning of a PPP project
Probabilistic analysis, iterative optimization of life cycle costs
Probabilistic project model incl. uncertainties and
variability in duration and resource utilization per activity
Simulation and regression analyses to identify cost and time drivers,
impact of core risk factors, interdependencies, optimization potentials
Extension toward a risk-based life cycle cach flow model
Risk adjustied optimization of life cycle costs
Costs
risk adjusted
Budget
PSC
Time
© 2011 Dr. Wilhelm K. Kross
Quality
12
Fundamental new insights from risk-based life-cycle model
Entirely new sets of information, enabling informed decisions
•
Major risk and cost drivers identified, as well as their inter-relationships throughout the life-cycle
• Quantitative data and information base, with an appreciation of its true quality
• Multi-scenario decision base, including an appreciation of risks and issues
• Early insights into the likely impact of good and poor decisions, and assumptions
• Energy efficiency aspects appropriately integrated in design specifications
• Valuable insights for the design of intelligent risk transfer mechanisms in contract designs, e.g.
transferred risks and SLAs as a function of contract duration
• Optimizable approach to designing insurance programs
• Early appreciation of early detection mechanisms for likely risks and potential issues
• Residual risk and opportunity profiles demonstrable to private equity sector participants
• Valuable know-how upgrade in actually developing and operating the probabilistic models
•
And more … for this project, and others to come
© 2011 Dr. Wilhelm K. Kross
13
Next steps: integration of certifiable (?) management systems
Generic framework for the introduction of risk controlling & management
1.
Definition of unacceptable risks, available
budgets, risk management and corporate
communication strategy
2.
Internal and external loss database
Software selection and system solution
Risk reporting requirements
3.
Possible events, gap and hazard analyses
Consequence chains
Cause / effect relationships
4.
1. Corporate Policy
2. Operational Risk Indicators
3. Processes and Workflow
4. Approaches to Proactive / Reactive Risk Management
Performance assessment models
Responsibilities, skills and training
5. Risk Transfer Scenarios
5.
Cost comparisons
Comparison of cost effectiveness
Scenario optimzation
6.
Conditional probabilities
Consequence chains
Total cost of risk optimization
7.
(Un) acceptable residual risk
Cost effectiveness and budget availability
Provisions for expected cost
8.
Scenario analysis and prioritization
Planned reduction and / or insurance and / or outsourcing of exposure scenarios
9.
Decision support and communication tools
Comparison of scenarios / description of processes / residual risk per scenario
6. Gradually Refine Quantification Approaches
10.
Integration into a holistic internal model
Integration into continuous improvement cycles
Integrated management, aligned risk culture
© 2011 Dr. Wilhelm K. Kross
7. Derive Conclusions for Scenarios
8. Planning and Implementing
9. Results / Priority List
10. Subsequent Iterations, Continuous Improvement, Interfacing
Certifiable Frameworks (PMBOK, BS25999, ON 49000, CObIT, etc.)
14
Challenges in future-oriented corporate risk management
Adjustments to a dynamic environment inclusive of strategy changes
© 2011 Dr. Wilhelm K. Kross
15
Overdue enhancements of financial risk management framework
Simulation of future performance, not extrapolated historic performance
DVaR
Absatzmenge
Absatzpreise
Materialpreise
Personalkosten
Sonstige
Kosten
R1
R2
R3
R4
R5
Free
Free
Cash
Cash
Flows
Flows
5.000 Trials
Plan-GuV
Gesamtleistung
56.040 T€
Materialaufw and
12.952 T€
Personalauf w and
21.146 T€
sonst. betr. Aufw and
15.683 T€
+/-15%
+/-4%
,034
+/-4%
Abschreibungen
2.140 T€
Betriebsergebnis (EBIT)
4.119 T€
Finanzergebnis
RAC
+/-4%
,026
1
+/-4%
z.B.
Betriebsunterbrechung
R6
356 T€
Forderungsausfall
R7
Produkthaftung
,017
R8
,009
%
-5‘000 T€
a.o. Ergebnis
0 T€
Gew inn vor Steuern
4.475 T€
Gew inn nach Steuern
2.569 T€
,000
-200,00
-100,00
0
56,00 100,00
200,00
250,00
Careful: Non-quantification of risk = quantification with zero
!
© 2011 Dr. Wilhelm K. Kross
16
Required enhancements of financial risk management framework
Demonstration of future performance (e.g. of a large medical facility)
Defensible risk analysis and
robust business concept
Negotiate and implement
financing vehicle
Implementation project and
pilot operation
Fully trained initiation,
optimized work flow
(„bankable business plan“)
(„structured solution“)
(„robust & transparent“)
(„efficient & effective“)
Overall concept
Updated business plan
Final work flows, rooms,
2-3 months of pilot
Cooperation contracts
Proof of multi-fold
architectural plan, etc.
operation (one shift),
(pre-negotiated)
securitization
Project structuring,
„trouble-shooting“
Tenders, cost proposals
Seed finance
Work breakdown,
Start of research programs
Detailed negotiations
Include public support
Project schedule,
Transfer to double shift
Purchase of property
funds and guarantees
Management structure,
operation considering
Detailed risk analytics
Optionalities, SLAs &
Communication,
applied learning / efficiency
Process optimization
guaranteed capacity of
Project office, etc.
Take up full operation
Project optimization
supplier/insurance
Permitting processes
Fast-tracked downpayment
Proof of estimates, e.g.
Insurance concept
Site preparation
Actives management of
Operational capacity,
Detailed negotiation
Raw building, finishes
SLAs, co-operations
Robust project plan,
with investors
Pilot installations
Systematic realization of
Robust work flows,
Structuring of special
Technical equipment
any synergy effects
Buffers, contingencies,
purpose vehicle, early
Personnel planning,
Extension to 3 shift
Risk bearing capacity
contracts with investors
employment contracts
operation depending on
Business plan with
Negotiation of
Training of staff
demand / patients
sensitivity analyses
financing packages
in test-/pilot operation
Accelerated settlement of
Contract negotiation,
Outbuildings, parking,
high-interest loans
tender documents
gardening etc.
Transfer of project at the
Formal kick-off
Acceptance, transfer
end of contract
© 2011 Dr. Wilhelm K. Kross
17
Conclusions and further recommendations
Life-cycle project risk management as a decision support process
Results
Risk Management must be set up for specific circumstances, consisting of various interlayered analysis and management levels
Significant problems already resolved, not too narrow minded approach, no reinvention of the wheel
Historic often overemphasized controlling, tail wagging the dog , probabilistic approach often sensible
Software-credibility does not solve the problem, however, software enables new forms of optimization
Risk management on the systems-, processes-, projects-, portfolio-, initiative-, enterprisewide and supply chain levels is currently experiencing a fundamental change in mindset
Cultural paradigm change, toward incentive schemes for the delegated responsibility
Creation of interface to optimization frameworks, beyond enterprise boundaries, integrated logistic networks
Truly significant is the handling of “soft“ factors
Human understanding and attempts at manipulating the initial evaluation, subsequent implementation,
delegation of responsibility, strategic stakeholder communication, throughout the entire life cycle
Entrepreneurial focus in prioritization framework, creating a transparent risk culture, enhance risk
awareness, facilitate flexibility, create risk ownership structure
Probabilistic financial modeling can become a true enabler
Lessons learnt from private equity based mega-project financing reflect that innovative project financing
approaches are a realistic perspective for larger-scale PPP projects
One can make better decisions for the right reasons !
© 2011 Dr. Wilhelm K. Kross
18
Any further questions or comments?
Dialogue is possible by e-mail too …
Building professionalism in project management®
Project Management Institute
Frankfurt Chapter
Dr. Wilhelm K. Kross, Dipl.-Ing., MBA, Eur. Ing.
Past President
Postfach 1705, D-61287 Bad Homburg, Germany
Tel. +49 (0) 176 / 4017 0603
Wilhelm.Kross@PMIFC.de
www.PMIFC.de
© 2011 Dr. Wilhelm K. Kross
19