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A Risk Management Framework for Selling a Mega Power Plant Project in a New Market

Abstract

The origin of most risks of a mega project usually takes place in the phases before closing the contract. As a practical point of view, using project risk management techniques for preparing a proposal is not a total solution for managing the risks of a contract. The objective of this paper is to cover all those activities associated with risk management of a mega power plant project sale’s processes; from entrance to a new market to awarding activities and the review of contract performance. In this study, the risk management happens in six consecutive steps that are divided into three distinct but interdependent phases upstream of the award of the contract: pre-tendering, tendering and closing. In the first step, by preparing standard market risk report, risks of the new market are identified. The next step is the bid or no bid decision making based on the previous gathered data. During the next three steps in tendering phase, project risk management techniques are applied for determining how much contingency reserve must be added or reduced to the estimated cost in order to put the residual risk to an acceptable level. Finally, the last step which happens in closing phase would be an overview of the project risks and final clarification of residual risks. The sales experience of more than 20,000 MW power plant projects alongside this framework, are used to develop a software that assists the sales team to have a better project risk management.

Keywords: Project Marketing; Risk management; Tendering; Power Plant;

1. Introduction

The time required for selling a project is much shorter than the total life of the project and commissioning period; however, every decision made in this short phase could result in opportunities and threats that affect the health of the project and consequently, the organization. Existence of these threats and opportunities alongside uncertain nature of the selling phase, make the implementation of risk management a very vital step in the sales processes of a mega project. The better implementation of risk management would lead to a better quality for the product of the selling phase, which is indeed the contract.

In this study, a framework for risk management in selling phase is developed. This framework is based on the experience of selling more than 20,000 MW power plant projects. Obviously, during the pre-tendering, tendering and closing of these projects, different challenges have been faced and different decisions are made accordingly. The proposed framework employs the result of these decisions and occurred challenges to provide a guideline for project managers and risk managers. Since a comprehensive risk identification during tendering phase only is not achievable, this study identifies the project risks in a progressive elaboration manner.

For risk identification and management process a software is developed that do this job in 6 consecutive tasks that happens in 3 steps of pre tendering, tendering, and closing in which risks are identified, analyzed, and a response plan is assigned to each risk. In the final step, residual risks are put to an acceptable level and accordingly the project contract is prepared. The output of this whole process is to put all identified risks in a watch list which would be monitored by the project team and the feedbacks are documented to be used for the future projects.

2. Pre-Tendering

Mega projects pose challenges at the pre tender stages of a contract that if not managed properly the scheduling, budgeting and financing can be significantly and negatively impacted. The pre tendering risk management process suggested in this study includes two main steps. The first step is the market risk report preparation and is independent of any project. The objective is to have relational and functional development to better known owners, contractors, and competitors of the new market and also by understanding the customers\' needs be able to customize the solutions accordingly. Following these objectives, the company would be in a

position to detect the projects far upstream and be able to prepare a better tender package. The second step is the bid no bid decision making which is dependent on the project and will be discussed later. [1]

2.1. Market Risk Report

When the organization decides to enter a new market, the marketing team starts to study the characteristics of that market. In the first step, opportunities and threats of the market should be investigated and linked to the strengths and weaknesses of the organization in a competitive atmosphere. The output of this endeavor is a report, called Market Risk Report (MRR), which is in fact a standard report with different categories that establishes the potential risks of the future projects that may stem from the features of the new market. As it was mentioned earlier, MRR is prepared in the pre tendering phase when there is no defined project yet. The goal is to be in a position to detect market risks well in advance and make more inclusive decisions in the short and critical tendering phase. Using a checklist, the software asks the user to answer some questions and by comparing the answers with other markets’ characteristics and organization accepted thresholds, a watch list of opportunities and threads would be provided.  Figure 1 shows the flowchart of this process that will be discussed in the next paragraph.

Market Data Collection: The goal of a data collection is to determine the attractiveness of a market, both now and in the future. Organizations evaluate the future attractiveness of a market by gaining an understanding of evolving opportunities and threats as they relate to that organization\'s own strengths and weaknesses. Data collection is generally undertaken to develop an initial understanding of the market. Business intelligence is enhanced while marketing strategies are optimized with the help of the data collection process. Data Collection in marketing research is a detailed process in which a planned search for all relevant data is made by researcher. The required data are collected and grouped into appropriate meaningful categories. The findings of a market analysis may motivate an organization to change various aspects of its investment strategy. The most important elements that should be considered during data collection are market size, market trends, market growth rate, market opportunity, market profitability, industry cost structure, distribution channels, and success factors.

• Data Standardization: Data standardization is the first step to ensure that your data is able to be shared across the enterprise. This establishes trustworthy data for use by other applications in the organization. Ideally, such standardization should be performed during data entry. If, for some reason this is not possible, a comprehensive back end process is necessary to eliminate any inconsistencies in the data. All collected data would be categorized in the software. The number of these categories depends on the industry; however, some categories like stakeholders, infrastructure, resources, and technological advancement are common for all fields.

• Market Evaluation: This step involves the examination of various aspects and measures of a market segment in comparison to the firm’s goals and resources. Typically, the firm assesses whether this particular target market logically fits with the firm’s strategic direction, whether it is the best use of its resources (opportunity cost), and to what degree the firm would be able to successfully compete in the segment.

• Market Risk Identification: The objective of risk identification is to identify and categorize risks that could affect the project and document these risks. The outcome of risk identification is a list of risks that may come from within the project or from external sources. What is done with the list of risks depends on the nature of the risks and the project. On complex, high-cost projects that are by nature uncertain, the risks can feed the rigorous process of assessment, analysis, mitigation and planning, allocation, and monitoring and updating described in this document.

The identification process will vary, depending on the nature of the project and the risk management skills of the team members; however, it generally begins with an examination of issues and concerns created by the market

risk management team. As an instance, for a company in power plant industry, this watch list would be in categories like stakeholders, general power sector information, resources, infrastructures and etc. In the stakeholder\'s category, for example, owners, competitors, contractors, and potential joint ventures would be studied in respect of financial and technological abilities and their market power. In Other categories, type and availability of fuel, energy prices, technological advancement and efficiency of current power plants, and energy loss of equipment are investigated to reach a market entrance strategy and prepare the technical and commercial proposal.

2.2. Bid no bid decision making

Depending on the project’s owner and the nature of the project, there are two major methods to arrive at the contract award, competitive bidding and negotiation. In the competitive bidding method, which is the focus of this study, the client puts an advertisement for tendering or invites major contractors to participate in the tender. This step is a critical decision point for other side, the general contractor (G.C.), whether to bid or not. If no, G.C. may lose an opportunity and if yes, then the next step is to purchase the bid documents, allocate recourses for preparing requested documents, estimate the cost and submit the bid.

As the process of preparing and finalizing bid packages has a considerable non-refundable cost for the general contractor, this decision should be taken carefully. There are many studies devoted to this challenge and many decision support systems using artificial intelligence is developed. However; these solutions are not realistic enough and has not yet been accompanied by application in practice. [2], [3], [4]

In this study we propose a methodology that commences with analyzing the overall bidding procedure by investigating the important factors that affect the bid or no bid decision. The most important factors influencing this decision is categorized and investigated by three points of view; technical and project management point of view, marketing point of view and portfolio management point of view. These aspects are investigated in following paragraphs and also shown in figure 2 in the next page.

2.2.1. Portfolio management point of view:

Top managements may make different decisions in competitive bidding procedure base on the purpose of participating in the bidding. In a typical situation, the G.C. participates to win the job in order to maximize its overall long-term profit. In some other situation, barely for a strategic purpose, the G.C. may enter the bidding game just to lower the winning bid price and thus minimize its competitors’ profit. Sometimes, the G.C. submits a bid in order just to show its interest and existence in the market. There are some other influential factors on the decision making of the portfolio manager such as nature of the project and overall economic condition.

2.2.2. Marketing point of view:

Beside technical and project management investigation, marketing expectations of a G.C. should be satisfied by the bid. For example, marketing manager by employing his developed relations in the new market could gather more data about the market competitiveness and have a better estimate of the chance of winning.

Moreover, MRR that have been prepared by marketing team in pre tendering phase could be a good reference for evaluating the risks of project and competitive bidding climate during the period of decision making.

2.2.3. : Project management point of view:

The bid-no-bid decision is made not only on the probability of winning the tender, but also on the need to consider the possibility that the company can finish the project successfully following the contract agreement. Therefore, when the company wants to respond to a bid invitation asks the technical staff, proposal team and project management team to take element of technical points, complexity and uncertainty of the project into consideration.

Finally having the software output verified by the experts, uncertainties are minimized and G.C can ensure that decision is made with least possible risks through competitive bidding.

3. Tendering

Performing risk management is most vital in the tendering process since the project uncertainty is at its peak during this phase. Generally, the level of risk increases in the beginning of a project and reaches its highest level through the tendering phase. [5] Contractors could have better conditions in both tendering process and executing phase should get involved in the risk management earlier. In fact, there is a strong relation between an early risk management and the success of a project. However, there is a misconception that by getting engaged in the risk management early, the legal costs would increase. In real world this is not true; in practice the sooner engagement, the less expensive it is to do a corrective job, and more importantly the more effective jobs could be done. The main hinder for organizations to apply risk management in tendering phase is the idea that identifying project risks early, will lead to a higher and uncompetitive price. These organizations underestimate the advantages of early risk management which are most beneficial for themselves.

In this part, the risk management process in tendering phase is presented. The first step is to identify as much as possible tender related risks and then do the quantitative and qualitative risk analysis. In the final step, a response plan would be allocated for identified risks.

3.1. Tender risk report (TRR)

Tender documents issued by the client for a mega project consist of different parts including legal, financial, and technical divisions. The sales team distributes every part of the tender documents to the associated expert team. Each part would be studied and analyzed by the experts and all the vague aspects of the documents would be highlighted. In this step all uncertainties and risks of the tender should be identified to be analyzed in the next step in order to have a better risk identification, it is essential to understand the organization’s objectives. Events that are supposed to potentially impede the achievement of objectives are considered to be risks and should be investigated and monitored. It is better to first evaluate these risks without consideration of possible risk responses. These risks should be then evaluated based on the likelihood of occurrence and the significance of their impact on the organization’s objectives, which is discussed in the next part. The output of this part is a report that contains tender related risks and would be updated in the next parts.

3.2. Risk Analysis

In risk analysis, the objective is to understand how and when the identified risk arises and estimate their impact. A better risk analysis is the foundation of a more effective risk management program. The risk analysis is often enriched by various modeling techniques which could be mainly categorized in quantitative and qualitative analysis. In most methods the goal is to calculate the probability and impact of the identified risks. However, in practice and in the short period of tendering phase, this method is not applicable. In real world, most risks are discussed and clarified by parties and then categorized as facts, risks, or watch list. The main difference of proposed risk analysis method of this paper with other existing methods is that risks should be clarified by discussion here and get either transferred or accepted, which means that the probability of occurrence of them get close to one or zero. The remaining risks would be analyzed by common quantitative and qualitative methods.

Qualitative analysis is the most basic form of risk analysis and is used more often. This method categorizes potential risks based on either nominal or ordinal scales and does not involve numerical probabilities. On the other hand, quantitative risk analysis numerically determines the probabilities of events and the likely extend of their impacts. The result of this analysis alongside the clarification and discussion with client results should be added to the tender risk report to have an updated report for the risk response planning and mark up decision making step.

3.3. Risk response planning and mark up decision making

One of the most important steps of participating in a tender is to estimate the cost and decide on the markup to finalize the bid price. The estimated cost is sum of cost of material, equipment, labor, financial interest, insurance, tax, contingency, overhead and etc. Adding desired profit to the estimated cost, the bid price is calculated. The estimated cost has to be low enough to win a project but at the same time high enough to get the required profit. [6] A major part of the cost estimation is to quantify the identified risks and increase or decrease the cost accordingly. In order to achieve the required profit, all organizations need to take on a certain level of risk. Based on the risk tolerance of the organization and the results of risk analysis, the ways to address identified risks could be determined. The organization risk tolerance together with risks’ expected impact and likelihood of occurrence are the basis for risk response planning.

As it was mentioned in the previous part, based on the discussions and clarifications, all risks are tried to be categorized as facts, risks, and watch list. The most important goal of the tendering team is to come up with a price that includes all identified and unidentified risks. As it is shown in figure 3, risks in the facts group are added or reduced to the estimated cost as cost impact. Risks in the second group are considered in the final price as contingency reserve. Risks in the watch list have very low impact or probability of occurrence but they should be monitored since their impact or probability may vary in time. Beside these identified risks or known-unknowns, there is another group of risks that are not identified but may happen in future. This group is called unknown- unknown and is added to the estimated cost as management reserve. Management reserve is specified by the portfolio manager with consideration of market risk report, tender risk report and his or her experience. Figure 3 shows the whole tendering process.

4. closing

The stage after the announcement of the winner proposal is post-tender discussions and negotiations which is called closing phase. In closing phase both sides try to meet their own expectations by specifying price, quantity, quality requirements, conditions associated with a product or service, and arranging for contract signing. Preparing and managing the contract is the last part of sales process and another critical element from the risk management point of view.

Contract risks that can negatively affect the value of the contract include poor incentives, bad planning, ill-informed buying, deliberate contract manipulation, embedded options, elaborate pricing structures, miscommunication, and poorly managed knowledge transfer leading to loss of intellectual property, and repeated efforts. Closing phase consist of three main stages, contract drafting, final negotiations and contract signing. risk management tasks including identification, Assessment, and response planning should be done during this life cycle. Finally, identified risks will be stored, administrated and reviewed. [7]

Contract Drafting: The draft contract is usually prepared by typical clauses appropriate for the specific contract and should be approved by both legal and business specialists. Since every single word in the contract could be used as a reference for future claims, it is very important to investigate the contract draft as much as possible. In this phase, after the preparation of the draft, all potential risks and uncertainties should be identified.

Contract negotiation: The contract negotiation phase involves back and forth between the parties to reach acceptable terms which facilitate taking decisions and actions to control risk. The draft contract would be submitted to the counterpart for comments, clarifications and feedbacks. All identified risks from previous stage would be discussed to reach an agreement on how to be transferred, mitigated, or accepted. In the software, there is a checklist that keeps getting updated based on the experience of the organization and the user is required to evaluate the uncertainties and risks of the project listed there. If the risks are not in the acceptable level, there would be a warning for the user to look for appropriate response plans.

Contract Approval: this stage is the last stage of sales process and the output is the product of sales and marketing efforts which is the contract.  The objective is to have a contract with least possible risks and

uncertainties. Beside the contract, there would be a contract risk report (CRR) which contains all identified risks that are accepted or their probability of occurrence and impact are at the acceptance level and should be monitored during the execution of the project. Moreover, CRR include the secondary risks that may stem from the risk management plans from previous phases. The CRR would be submitted to the project team in the kick off meeting and can help the execution team to have a more comprehensive overview and ability to manage project risks, downstream of award of the contract. It should be mentioned that CRR only contains major project risks that affect the health of the project. The project management and execution team should identify and manage the project related risks after the kick off meeting separately.

As a review, the whole risk management during the sales and marketing processes is shown in the following graph (figure 5). As shown in the figure, at first, in the pre tendering phase, by preparing the market risk report uncertainties and risks decrease. In the bid-no bid decision point, based on the made decision and the selected approach, there would be a fall in the uncertainties and risks graph. Having decided to bid, all relevant divisions in the organization would cooperate to identify, analyze and prepare a response plan in the tendering phase which results in a rapid decrease of uncertainties. At the end of this phase the cost is estimated and all cost impacts, contingency and management reserves are considered in the price based on the identified risks. There is another critical point in this phase, in which by deciding about the bidding price, more risks and unknown unknowns are covered. Selected as the winner contractor, the contract team starts to make a draft of the contract and by negotiating tries to reduce the uncertainties and manage identified risks as shown in the graph until the approval of the contract. Despite all these efforts, some risks would still remain which are in fact the residual and secondary risks that should be monitored by executive team during the project life cycle.

Conclusion

The origin of most risks of a mega project usually takes place in the phases before closing the contract. As a practical point of view, using project risk management techniques for preparing a proposal is not a total solution for managing the risks of a contract. In this study, the whole sales processes of a mega project from entering a new market to the submission of the contract to the executive team is investigated. In order to have a more effective risk management, the whole process is divided into three main parts of pre tendering, tendering, and closing that cover the whole process and include 6 tasks. The output of every main part is a report, called MRR, CRR, TRR for pre- tendering, tendering and closing phase. These reports alongside the organization’s experience and the developed software are sources to have a contract that is as much as possible risk free. This contract and the report of residual risks are submitted to the executive team for further analysis and monitoring during the life cycle of the project.

References

 [1] Cova, B., Maze, F. and Salle, R. (1994) \'From Competitive Tendering to Strategic Marketing: An Inductive Approach for Theory-Building\', Journal of Strategic Marketing.

[2] Shahs, A. A. (1993). Factors considered in tendering decisions by top UK contractors. Construction Management & Economics, 11(2), p111-118. Retrieved from.

[3] Element, M., & Mohamed, A. (2008). SCBMD: A knowledge-based system software for strategically correct bid/no bid and mark-up size decisions. Automation in Construction, 17(7), 864-872. doe: DOI: 10.1016/j.autcon.2008.02.013

[4] Chua, D. K. H., & Li, D. (2000). Key factors in bid reasoning model. Journal of Construction Engineering & Management, 126(5), p349-

357. Retrieved from.

[5] Smith, N.J., Merina, T. and Jobbing, P. (2006): Managing risk in construction projects. Blackwell, Oxford.

[6] Park, W. B., & Chapin, W. (1992). Construction Bidding: Strategic Pricing for Profit. New York: John Wiley & Sons, Inc.

[7] Aberdeen Group. (2004), Best Practices in Contract Management –Strategies for Optimizing Business Relationships

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