Risky business

The recent recession has proven that economic cycles, and the dangers coupled with them, are very much alive.

Financial difficulties however, are just one of the risks that construction and real estate businesses have to address.
According to our report on risk management, A New Risk Equation, based on a study of 465 British and Irish senior executives including those from construction and real estate businesses, risk management practices prepared companies poorly for the downturn. British and Irish construction and real estate businesses saw widespread failure of their risk systems designed to help them foresee or address the recession.

Risk management within a company, whether embedded in dedicated departments and formal processes, or simply a set of considerations for executives when making decisions, should at the very least do what the name suggests: prepare companies for the possibility of things going badly wrong. This may not have rung true in the case of many in the construction and real estate sectors. Indeed, the risk management procedures adopted by management minimised the impact the recession had on companies, at less than 40 percent of the British and Irish construction and real estate businesses, according to our survey.

This begs the question as to whether the risk management lessons of the economic crisis have been learned and suggests that when stability returns, many construction companies will revert to the compliance-based approach that left them so vulnerable to the downturn in the first place.

The survey states that over half (53 percent) of the construction and real estate executives interviewed said that their review of strategic financial and operational risks undertaken before the crisis adequately captured the impact of the downturn, against 42 percent who believe that it did not. However, just 37 percent thought that risk management helped to minimise the impact of the recession. The problem may have been that executives were keeping an eye on the wrong potential dangers.  Too many leaders and managers of UK construction and real estate companies may not have been alert to balance sheet and financing risks as the extended period of low inflation, low interest rates and increasing sources and availability of capital had left them principally paying attention to company operational risks that remained more consistently present in front of them.

Another issue is that quite a lot of risk management practice is essentially compliance-based, following rules that are often dictated by regulation. This may be letting many construction and real estate businesses down because it creates an illusion of things being under control. Certainly, risk processes were not going to enable companies to sail through such troubled waters unscathed, but they might have done better at preparing them for the eventual storm.

On the upside, the crisis appears to have changed how construction and real estate businesses review risk and the recession has pushed companies to become more active risk managers. According to the survey, 80 percent of construction and real estate executives say that they have changed how they perceive risk as a result of the downturn, and 81 percent say they review risk more often. Construction businesses will no doubt be more familiar with risks that were not thought about before, the difficulty however, is knowing how much of this is simply a temporary reaction to a traumatic experience, and how much is a considered improvement based on a learning experience. Business leaders may have learned from the crisis, but whether that will be embedded into the company remains to be seen.

It is encouraging that construction and real estate companies have spent more time addressing possible risks but on the downside, management interest in risk typically increases after a large shock, but usually lessens as conditions improve. As it might be expected, the focus today is more on the financial dangers just suffered rather than on addressing risk more broadly.

To get real value from the risk management process, construction and real estate businesses need to ensure a balance between identification of the risks, and a response to them. Scenario planning has an important role to play in helping companies improve how they respond to an event but businesses also need to remain flexible enough to deal with situations that aren’t on their risk register. An appreciation of risk management needs to become part and parcel of everyday language at every level of business. For risk management to go beyond simple compliance and play such an integrated role, it may help for the business to have a champion – be it a chief executive or CRO (chief risk officer) – who can ensure that risk considerations are brought into decisions and strategy making early on, rather than being a box to tick prior to completion. Companies need some way, whether through risk officers or other executives, to more effectively challenge ideas.

Overall the survey paints a rather disappointing picture of the effectiveness of risk management. Risk processes appear to have a genuine influence in decision making at only 53 percent of construction and real estate companies, and only 37 percent of businesses claimed that risk is managed at all levels. Risk procedures have created a common awareness from top to bottom at just 49 percent of businesses surveyed. Only 31 percent of executives in construction and real estate feel that the risk management process adds value to the business. Interviewees say that to improve these figures, risk management must go beyond the mechanistic calculation of risk based on specific metrics in order to produce compliance with regulation or best practice procedures.

Rather, risk managers should consider using scenario building, stress testing or other techniques which incorporate a diverse range of relevant information – not merely hard data – about the surrounding risk environment.  The risk function will then be in better shape to help companies with the variety of strategic issues they face. Also, by helping the leadership decide on, and understand, the implications of an appropriate risk appetite, risk management can also help with the identification of opportunities to improve operations. Even what might seem on the surface like a simple compliance exercise can greatly improve processes.

Construction and real estate businesses may now be paying more attention to key risks but it is imperative that their approach to risk management does not become lax as economic conditions improve. Companies have definitely learned some quite specific lessons about the ways they got hurt. It is probably making them more risk averse in those areas. On other aspects of risk, they might have the same attitudes as before the downturn. The evidence is that the current heightened risk management activity adopted by construction and real estate businesses is part of the traditional cycle associated with economic downturns rather than a fundamental rethink. Ultimately, it’s concerning that businesses may not have necessarily learned from the harsh lessons they suffered.