The global economic crisis of late 2000's has hit the global economy extremely hard and no industry has been left unscathed. The construction industry has also been hurt by the economic downturn rather badly. This report will look at the causes of the recent economic downturn and its impact on the construction industry.
The recession has caused many firms to look at avenues for corporate risk management as most of the insurance companies are now under severe financial pressure. This report will look at corporate risk management for construction companies by analyzing the risk management approach used by Balfour Beatty.
The latest global recession has been termed as the worst to hit the planet since the Great Depression of the 1930's. The downturn was triggered in the United States by sub-prime mortgage crisis, rise in commodity and oil prices and a steep decline in the US's economy (Nistorescu & Ploscaru n.d.). The effect of the United States economy has a global impact because it is the biggest economy in the world.
The key ingredient of the economic collapse was the sub-prime mortgages that were given out to borrowers. When the borrowers were unable to repay the mortgage it led to the collapse of major financial institution. The global economy was affected once Lehman Brothers, one of the world's largest financial institutions bankrupted in 2008. This led to the global economy facing severe recessions; the construction industry was also a victim of the collapse (Frei 2010).
According to Frei (2010), in 2008 bank lending was close to impossible, and there was also no inter bank borrowing, there was no rescheduling of loan repayments, as a result, many construction projects were laid to rest even before they were started. Property prices fell to extreme low, which were on a rise during the early 2000's. This led to a collapse in investor confidence.
The economic downturn brought about significant changes in demand and supply in the construction business. Many contractors were forced to lower their bids for construction below their variable costs in order to stay in business. Many times projects were left unfinished due to shortage in funds from investors, as a result many construction companies went out of business or ventured into other fields (Mukucha, Mphethi & Maluleke 2010).
The economic downturn in the construction sector was also felt by the laborers as construction is one industry where labor is heavily invested and required. The cancellation of construction projects and requirement of cost cutting in these companies led to heavy unemployment in the sector. The less the labor, the lower the profits and hence many companies had to face loss in profitability. Governments all over the world attempted to stipulate their respective economies by investing heavily in different projects themselves as the private sector lay stagnant for quite some time now which led to slight recovery by these economies (Frei 2010).
The construction industry in the United Kingdom was hit quite badly with the global downturn. The sector facing most problems was house building whose rate fell faster than the GDP. The UK construction industry is led by the private sector which outpaced the public sector by multiple of three in 2007. After the recession in the country, the public sector contract orders were halved in 2009. In 2007, 2.34 million people were employed in the construction sector which fell to 2.07 million in 2011 (Maer 2012).
Individuals and corporations are constantly facing numerous risks at all time which can be altered through effective and systematic risk management. According to Crawford (2002), risk management functions in four tiers; identifying, analyzing, responding and lastly, controlling risk. Loosemore, et al (cited in Ongel 2009) states that the traditional approach used by construction companies were to mitigate their risks using insurance companies, however, with time many companies have realized the importance of risk management in-house and have decreased their reliance on insurance companies and other financial institutions. Risk Management has hence become an integral part of the organization ever since the economic downturn.
According to Adnan, Jussof and Salim (2008), the objective of effective risk management is to protect the continuous flow of the business even if some risk realizes itself. In order for it to work, firstly, all the relevant risks are identified and then quantified to ensure that policy measures are taken to protect the organization from the adverse effect of the risks.
Executives in organizations are responsible to control the risks that arise in their midst. These executives have separate and defined role in corporate risk management. Enterprise risk management is a systematic way to identify and then reduce the risks that corporations face. Most of the corporations follow different approaches to Enterprise Risk Management (ERM), all of these approaches are stemmed from four process steps; identifying, analyzing, responding and controlling (Opolot, Buys & Slabber 2009).
Effective ERM involves working in close coordination among the senior executives specially the CEO and the Risk Managers. ERM allows for an increase in risk control, better corporate governance, increased sense of accountability and improved ability to pin point and administer risks (Harvard Business Review Analytic Services 2011).
The global economy is facing extreme contractions, and no industry has been left unhurt. It is also necessary for the construction industry to look at avenues for corporate risk management at the time when even the insurance companies are forced to withdraw.
Extensive research has been done in risk management of the construction sector specially the construction projects. Chen et al. (cited in Zou, Zhang & Wang n.d.) has pointed out several risks associated with construction projects. Rise in prices of materials, discrepancies in budgeting and supplier default is the major risk concerns faced by the construction sector projects. Tam et al. (cited in Zou, Zhang & Wang n.d.) analyzed the safety performance of the construction sector in China and came to the conclusion that lack of awareness of higher management, lack of awareness of project related individuals, lack of training and unwillingness to invest in safety measures are the most significant risks associated with the construction industry's safety performance.
Individuals in the construction sector are aware of the importance of risk management; however, its application is mostly based on concepts, and the analysis methods are qualitative rather than quantitative. The risk management approaches used by many organizations are based on little knowledge base, and there is a lack of interest to implement the policies put forth by the risk management team or committee Uher and Toakley (cited in Zou, Zhang & Wang n.d.).
Risk management strategy is effectively deployed when resources are efficiently put to use to minimize the risk which is of major concern to the organization. Effective risk management as explained by The Committee of Sponsoring Organizations of the Treadway Commission (2004) is done thorough a proper channel. Firstly, risks are identified, and objectives are created to manage the risks and then policies are implemented to either reduce the risk or avoid it.
The studies related to risk management of the construction sector have divided risks into different categories and then formed decisions on how to manage them. Turner (cited in Klemetti 2006) has divided project risks into four categories; business risks, external risks, internal risks and insurable risks. External risks are risks arising from external factors that the organization has no control over. Business risks are general financial risks that every organization takes which can also produce favorable results.
For large construction projects risk categorization can be done in three categories as explained by Miller and Lessard (cited in Klemetti, 2006). The three risk categories are Market risk, completion risks and institutional risks. Market risk arises when the organization is unsure about their demand for large projects. Technical risks related to construction completion is categorized as completion risks and lastly, institutional risks are related to political situations that may arise during the phase of the project. The risk management approach suggested is once again a systematic way to identify and then transfer or diversify the risks.
Construction sector is a very vast sector and the construction projects are usually huge in terms of financial and time requirements. Every construction company faces unique risks, and it is their job to identify the risks that may harm the operations of the organization. These risks can then be managed by decision making by the higher management and the individuals involved in a particular project.
Balfour Beatty is one of the largest construction companies in the world, present in almost 80 countries across the globe. Their approach to effective risk management is to identify the risks at an early stage and then take actions to reduce or mitigate the risks. The stakeholders involved in risk management are the Board of directors, Auditors, Divisional management and operating company management (Balfour Beatty 2011).
Balfour Beatty operates in many countries due to which it has to face with many risks and uncertainties. There are three external risks that Balfour Beatty faces. Most important is the risks arising due to the current economic downturn which may cause customers to cancel or delay different projects, which may affect the company’s profitability. Balfour Beatty has managed that risk through diversification and broad customer base with which they have an extremely effective relationship. The second external risk is the probability of customer solvency. The company manages the risk by carefully examining the credit details and history of the customer before they are signing contracts. The third external risk that Balfour Beatty faces is the legal and regulatory risk; Expansion into different regions also exposes the group to several risks if they fail to correctly identify the costs and benefits. Legal and regulatory risks also arise because every region's government has its own set of rules for the group to follow and they have to be careful in their operations. The group lay down a legal framework for operations in different regions and carefully follows the rules which are laid down by them to mitigate the risks Balfour Beatty plc n.d.).
The strategic risks of Balfour Beatty are risks related to acquisitions and investments. These risks are mitigated through carefully valuing the acquisitions and investments which are done by experienced and professional personnel. Some of the financial risks related to Balfour Beatty are liquidity, currency and interest rates. These risks are managed by effectively maintaining the cash reserves and investments to reduce the liquidity risks, dealing in foreign exchange forwards and derivates to reduce the exchange rate risks and using interest rate swaps that swap floating rate debt for fixed rate debt to manage the interest rate risks. The operation risks that Balfour Beatty faces are mostly related to health and safety and sustainability. These risks are managed through proper policy implementation. This ensures that safety and health standards are maintained as well as following a sustainability plan that covers the company’s operations until 2020 (Balfour Beatty plc, n.d.).
The risk management policy at Balfour Beatty involves a keeping of the risk register where the identification, causes and consequences are documented. The documented risks are then analyzed through their possible impact on the business of the company. The risks are put in according to their impacts, and then actions are developed to eliminate or reduce the risks. Responsibilities are divided among the concerned people who monitor and evaluate the progress of the risk mitigation process. The risk registers are once again used to document the whole process, and new risks are identified; thus, the cycle continues (Balfour Beatty plc n.d.).
The risk management process at Balfour Beatty is segregated into four steps; identification of risks, analysis and evaluation of risks, reporting and monitoring risks and mitigation. In the identification stage, the risks are identified at all levels; group, divisional and project. The risks are than quantified. In the analysis and evaluation stage, the risks that are identified and quantified are analyzed based on the likelihood of the given risk realized and the impact the risk would have at all levels. In the reporting and monitoring stage, the risks are subjected to intense reviews by the management who lay out a plan for its mitigation. In the mitigation stage, actions are developed and then implemented to eliminate the risks (Balfour Beatty 2011).
Effective corporate risk management is a step wise process through with the risks is identified, analyzed and then steps are taken to mitigate the risks. A similar approach is used by Balfour Beatty plc, one of the largest construction companies in UK. They have effectively managed to use enterprise risk management approach to mitigate or reduce their risks that arise from their operations. All the other construction companies also need to take the example from Balfour Beatty’s case to manage their risk in-house so that the risks may not be realized in the future or at least every company is prepared beforehand to tackle the risks.
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