Thought leadership

<h4>The larger and more complex the programme of works, the greater the likelihood that the forecasting will be inaccurate – and the greater the downside impact will be of that inaccuracy.</h4>
<p>There are certainly examples in our experience of the health sector of organisations undertaking initiatives with insufficient attention paid to forecasting and risk management. In a sector that is all about prevention and treatment of, often, life threatening conditions, risk should always be at the heart of every initiative. </p>
<p>Cost overruns are caused primarily by cost underestimation, not scope changes. Design errors, change orders, poor site management and not hiring the right team can all be factors, but they are factors that we see occurring time and again – and therefore can be factored into any forecasting.<br /></p>
<p>Research suggests that there are typically three explanations for underestimation of risk:</p><h4><strong>Technical</strong></h4>
<p>The issue here is about insufficient data and poor modelling techniques. The quality and capability of risk management software has increased exponentially over recent years. Yet these improvements appear not to have been matched by a corresponding improvement in forecasting accuracy. </p>
<p>Software capacity is constantly improving, but the outputs of the software rely, ultimately, on human input.</p><h4><strong>Optimism bias </strong></h4>
<p>The HM Treasury Green Book defines optimism bias as “the proven tendency for appraisers to be optimistically biased about key project parameters, including capital costs and operating costs, project duration, and resulting benefits delivery.” </p>
<p>Essentially, optimism bias is the psychological phenomenon where we have a tendency to look on the bright side of life. It is a natural human phenomenon. And although there does appear to be variation in different cultures, research suggests that we all have this bias.</p>
<p><a href="https://www.lexica.co.uk/people/zen-marolia" target="_blank" rel="noreferrer noopener">Zen Marolia</a>, Risk Consultant at Lexica, adds: “We manage optimism bias by trying to quantify the risk utilising Monte Carlo simulations, hence reducing the need to hold large quantities of contingency under the optimism bias umbrella.” </p>
<p>Bias can be addressed in several ways, such as:</p><ul><li>Reviewing forecasts for over optimism</li><li>Applying quality control on a proposal</li><li>Soliciting dissenting views during the estimating process</li><li>Developing a culture of openness around conversations related to risk </li></ul><h4>Strategic misrepresentation</h4>
<p>Strategic misrepresentation is “the tendency to deliberately and systematically distort or misstate information for strategic purposes”, essentially telling untruths in response to incentives. </p>
<p>The idea is beautifully illustrated by this revealing quote from the Mayor of San Francisco, Willie Brown, discussing a large cost overrun on the San Francisco Transbay Terminal megaproject in his San Francisco Chronicle column (from 2013): “<em>News that the Transbay Terminal is something like $300m over budget should not come as a shock to anyone. We always knew the initial estimate was way under the real cost. Just like we never had a real cost for the [San Francisco] Central Subway or the [San Francisco–Oakland] Bay Bridge or any other massive construction project. So, get off it. In the world of civic projects, the first budget is really just a down payment. If people knew the real cost from the start, nothing would ever be approved. The idea is to get going. Start digging a hole and make it so big, there’s no alternative to coming up with the money to fill it in</em>.”</p>
<p>Strategic misrepresentation, to some degree, might be addressed through the use of reference class forecasting, as a structured way of trying to predict the future of a project by analysing previous similar projects and their outcomes. </p>
<p>In the final analysis, there needs to be an understanding and agreement around how much risk an organisation is prepared to live with, and how much contingency.</p>
<p>Most important project decisions involve risk taking, and we need to be able to answer questions starting with “how”. These questions include:</p><ul><li>How much risk do we want to take? What is the risk appetite in the organisation?</li><li>How much risk are we taking right now?</li><li>How much risk will we eventually take?</li><li>How do we manage risk?</li><li>How can we maximise gains without incurring losses?</li><li>How much contingency should we maintain?</li></ul><p>One of the key aims of any organisation is to maximise stakeholder value. The way in which risk is managed is always going to be a critical part of that critical conversation. </p>
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