Question

You are the project manager for a new multimillion-dollar building renovation for your organization. The company needs to maximize the space that it has, and the best approach is to do a staggered build-out in order to better maximize the space in the existing building. You feel that the best approach was to negotiate with multiple contractors on a fixed-price contract. Different contractors discussed other contracts with you, particularly ones to address the current market fluctuations in the raw materials market. You ignore those other companies and settle on an agreement with a local company that is willing to accept your terms for a fixed-price contract. You find out a few weeks into a 4-month project that raw materials have increased by 250%. The contractor meets with you to discuss a price increase for the project. You have already committed a fixed price to the company and there is no contingency in the budget. The contractor advises that he will go bankrupt if he is forced to finish the project at this price and so the contractor sends you notification that he is stopping work on the project. Word of the work stoppage flies through your company and your boss calls you to his office for an update. You explain what has happened, but he feels that you are responsible for allowing this to get to this point. You are told by your boss to work something out with the contractor and to go into the negotiation with a good plan on how to mitigate the costs. Upon reflection of this situation, consider the below questions and how this situation might have been different with a different contract approach. • Why was putting too much risk on another company a negative thing? • If one is paying for risk mitigation, then why not outsource all risk? • In the big picture, what is the role of insurance in risk mitigation?

Answer 1

Answer: It is not wise to mitigate risk by putting more risk on another company as it will ultimately harm the interests of the company itself. Illogical burden on any company may cause the company to take a negative approach for solving the problem. In this case itself it is evident that by completely transferring the risk of raw material fluctuation on the contractor company ultimately resulted in the stoppage of the project. So if a company is working in cooperation with another company it is important that risk is mitigated by a rational sharing of risks. When total risk is transferred to any one partner it is both irrational as well as unethical decision. Thus putting too much risk to another company is a negative thing. Even if one is paying for risk mitigation, one should understand that entire risk cannot be mitigated by outsourcing. Therefore a rational approach it required in risk mitigation. The tools like insurance can definitely help in risk mitigation as it helps in sharing of the risk. But at the same time it cannot be ignored that even insurance has its limitations and it only reduces risks but does not eliminates it completely.