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High risk capital projects: inherent vs. imposed risk

Peter Kalish,
Many capital projects involve high risk. Peter Kalish explains an important distinction between inherent and imposed risk.

The revolution in product design that has occurred over the past three decades has been a boon to clients, but a headache for capital project teams. Systems demand tighter tolerances, use more complex advanced materials, and must meet higher performance requirements. Temperatures are higher, materials are more hazardous, ambient environments are more tightly controlled, infrastructure consistency is more vital, and automation systems have become more sophisticated. All of this has increased the risk associated with big capital projects. 

But not all risk is the same. Some risks are inherent in the process being designed and implemented, and some risks are imposed by the people executing the project. Recognizing the difference and managing each effectively is the key to successful high risk capital projects.

I’ll illustrate the difference between inherent and imposed risk through an example. A few years back, I worked in a startup business that sourced and commissioned a complex piece of custom automation. It involved thin metal components with tight tolerances. There were high temperatures, and one of the materials was highly corrosive. Automation needed to perform assembly and fine detail laser welding in an inert environment. All of this had to happen at sub-minute takt times with single piece flow. 

These conditions were necessary to meet product performance requirements and therefore, would be considered “inherent risks”. We couldn’t arbitrarily change materials or processes to de-risk this system. Our only option to reduce inherent risks would have been to continue research and development for an extended period. But the market was impatient, and we needed to go with the best available processand the risk it presented.

Before starting equipment design, we issued a performance specification that drove supplier bench tests on all of the complex process steps. Based upon those results, a design was developed by the supplier and approved by our teama design that we believed mitigated the inherent risks. The supplier began to source components and construct the assembled system. 

Midway through the build, we learned of new product requirements based upon market feedback. Those requirements demanded changes to dimensions, material properties, and automated processes. We also sourced material from new suppliersdifferent from those that provided test parts during bench testing (turns out, procurement specifications did not fully characterize the critical quality attributes of these materials). 

Since the equipment being sourced seemed to have the ability to adapt to these changes, we issued a change notice to the equipment supplier, and they modified the equipment. We came to find out later that this decision caused a significant amount of “imposed risk”. Risk was injected to an already difficult process without resetting and performing new bench tests with updated performance specifications. The result was an unqualified failure. The equipment was unable to meet quality requirements, let alone production rate.

To make the matter worse, both our company and the supplier confused the difference between inherent and imposed risk. Inherent risk is owned by the buyer. It is built into specifications and is the reason why design tollgates are built into projects. This gives the buyer the opportunity to retire inherent risk before approving a design.

Imposed risk is what contracts are designed to manage and why project management skill is so important. If a purchaser or supplier opts to impose new risks on the project by, for instance, changing a dimensional tolerance after designs have been approved, there should be a contractual instrument executed that acknowledges the new risk and establishes agreement on who is the indemnifying party in the event of failure. This didn’t happen with our complex automation. Instead, we issued a change notice that modified key assumptions backing the design and the supplier accepted the change notice without rejecting responsibility for the unproven changes (what would have been a reasonable stand).

The result was an unfounded or, at least, indefensible warranty claim on the part of our business. Frustration ensued and both parties resorted to finger pointing.  This is all too common an occurrence, especially when new, unproven capital equipment is being sourced. It is less common on proven equipment where inherent risks have been retired through design. If (imposed) risk increases in these projects, it is usually due to problems like bad project management—causing schedule delays or cost overrunson the part of either the supplier or buyer.

With the gradual gutting of critical skills within industrial business needed for capital project executionlike project management, manufacturing engineering, and experienced sourcingthe need to recognize the distinction between inherent and imposed risk falls to suppliers. And suppliers that can more fully understand the spectrum of inherent risks (technology, operations, compliance, controls, etc.) are most likely to deliver measurable impact to capital equipment buyers.

About Peter Kalish: Peter is a director of business development at OBG with more than 30 years of experience driving new product introduction and new business startups. He is an entrepreneurial business leader with a track record of building robust operations and high-performance teams in industrial and technology businesses. Peter can be reached at: Peter.Kalish@obg.com.