Introduction
The construction industry is one of the largest and most stable industries in the world, with the overall value of the industry ranging between 2.27 and 7.5 billion USD, or around 13.6% of total global output. The construction industry experiences continued growth even in times such as the economic crisis of 2009, and is expected to increase 1% by 2020 (Kerur and Marshall 2). As such, construction is a highly lucrative and profitable venture.
The abundance of professional construction companies has been key to the highly developed infrastructures of Western Europe and the United States. However, as it stands, the demand for large-scale construction projects has diminished in first-world countries due to various budgetary constraints and a lack of government support.
At the same time, developing countries offer significant opportunities for construction ventures, since they are interested in developing their own infrastructure to support tourism, sports events, and other activities. Some examples include FIFA- and Formula One-related projects, which both require significant investments by the host countries. Every host is required to provide airports, hotels, roads, stadiums, and entertainment facilities in order for the events to be successful.
Despite its size and success, the construction industry has always faced risks. Even in domestic projects, a contractor must deal with issues ranging from project delivery demands to jurisdictional risks. Performing construction outside of one’s country of origin adds to these by including greater transportation, political, cultural, and socio-economic difficulties as well. Risk management is therefore critical to the success or failure of any given construction venture. The purpose of this paper is to analyze the risks existing in international construction, provide mitigation strategies, and offer information regarding construction risk mitigation in the scope of UAE regulations.
Risks Faced by International Construction Companies Across the Globe
Construction is a complex and dangerous process that involves the efforts of hundreds of people. In order for a construction company to succeed, rigorous planning and execution are required. Due to the inherent danger posed by construction, it is one of the most highly regulated industries in the world. Some of the risks in construction projects include prolonged contract periods, complications with the process, environmental factors, funding issues, and organizational dynamics (Kerur and Marshall 4). Of course, there are many other risks, which will be further elaborated on in the scope of this paper. However, all risks can be split into two large subgroups based on their nature: jurisdictional risks and construction delivery risks (Kerur and Marshall 5).
Modern construction risk management generally concerns itself with construction delivery risks, as these issues constitute the majority of situations that can threaten the project. Mechanical failures, supply non-deliveries, lack of coordination, project design flaws, weather, and force majeure situations are detrimental to most projects (Kerur and Marshall 5). Jurisdictional risks, however, are typically considered to be the same as generic business risks and are expected to be solved at corporate policy levels.
While this approach may work in domestic markets, following the same course of action in foreign countries would likely be ruinous to construction ventures by not accounting for various jurisdictional risks caused by unfamiliar legal systems. It must be noted that construction delivery risks and jurisdictional risks are interconnected, as a construction delivery risk can effectively trigger the process of legal action. Some examples would include neglect of various safety regulations and protocols and the potential consequence; loss of human life. Jurisdictional action, in turn, can cause the project to stop and thus impose additional project delivery risks.
International jurisdictional risks include economic barriers to entering the market (such as extensive competition or government actions), higher taxes and tariffs set up for foreign business ventures, currency exchange risks, insurance risks, political and social instability risks (including wars, rebellions, demonstrations, and government expropriation), and the economic agendas of changing governments (Kerur and Marshall 5). Other risks include differences in traditions and customs between the market country and the country of origin, significant differences in legal systems, lack of proper infrastructure to manage jurisdictional risks, importation and customs issues, and, finally, international labor issues (Kerur and Marshall 5).
Risk analysis for international construction projects requires the separation and analysis of both project delivery risks and jurisdictional risks. Simply writing off jurisdictional risks for common business risks in a globalized venture will not be enough, as the number of unique instances within the construction industry is significant. Handling all of them within the framework of corporate policies is impossible, as that framework is primarily geared towards the domestic market. While project delivery skills are universal and can be analyzed by the company’s engineers and construction specialists without the need for specific knowledge and adaptation, dealing with jurisdictional risks would require assistance from local legal advisors.
Risk Identification
Types of Risks
The article by Kerur and Marshall is useful in identifying the various types of risks inherent in an international construction venture. The following list offers the most likely issues that might be encountered in the scope of the project as well as explanations into what these risks represent (Kerur and Marshall 7):
- Economic feasibility. Every project is conducted with the goal of paying off the expenses and bringing substantial profits in order to make the effort worthwhile. Before a construction project is initiated, a business plan and financial estimations are necessary. The risks lie in inaccurate predictions of the project’s current and future worth.
- Taxation. Different countries have different regulations regarding taxation of domestic and foreign companies. Not accounting for these differences involves a risk of miscalculating the feasibility and profitability of the project.
- Currency risks. In order to conduct operations in a foreign country, a company requires foreign currency. Profits are also derived from foreign currency and must be transferred to domestic currency in order to be utilized elsewhere. Thus, changes in currency rates pose a potential risk for the profitability of the project.
- Market conditions and practices. Market analysis is an essential part of any business plan. Some of the risks associated with entry into foreign markets include competition, relations with suppliers, and general views towards foreign companies within the population.
- Insurance. It is necessary for construction ventures to secure the company from any anticipated risks as well as to ensure the protection of customers by purchasing insurance. However, some domestic insurance companies may be reluctant to make deals with companies who are planning to conduct construction abroad.
- Legal entity establishment. While some countries allow companies to establish foreign offices, others do not. Instead, they require legal entities to be present and fully responsible for the construction under regional laws and customs. This may pose additional risks and difficulties for the construction company.
- Expropriation. In some countries, where the rule of law is not as certain as in the majority of western states, expropriations for criminal or political reasons is a significant risk.
- National employment. In most scenarios, companies are required to hire a certain number of national workers to perform labor. This may be an economic necessity or a legal requirement. It also poses certain risks, such as finding workers and adding them to the project.
- Political stability. This is a prominent risk in certain countries in Africa and the Middle East. Political instability can result in expropriation, nationalization of assets, withdrawal of permits, or even war.
- Government relationships. Depending on the company’s relationship with government officials, construction may or may not face additional scrutiny or even purposeful sabotage from various legal entities.
- Regional traditions and religious practices. Although this rarely becomes a problem, sometimes a failure in understanding regional practices may undermine a construction venue by alienating customers and investors.
- Governing law. In some areas, governments prefer that regional laws outweigh international laws and customs. This must be accounted for during risk analysis.
- Dispute resolution and enforcement. Disputes are an inevitable part of a construction process, as there are many risks of legal action initiated by or against the company. Depending on the country, laws and regulations pertaining to disputes may be different.
- Regional forms of contract. Many nations implement their own variations of construction contracts. Knowing the differences between these is necessary to avoid any contractual pitfalls.
- Health and safety regulations. The construction industry is inherently dangerous to human life, so safety precautions must be taken to avoid injury and the loss of life. Any major incident has the potential of shutting down the project.
- Subcontractors and supply chains. In many instances, construction companies have to rely on either internal or external chains of suppliers and subcontractors to conduct certain operations and deliver materials. Both are associated with their own risks.
- Imports, customs, and visa issues. Not all technologies are readily available on foreign markets. Specialists, instruments, and materials may need to be imported. Risks associated with transportation across borders may cause delays in project times.
- Climate. Materials, instruments, and people are sensitive to the environment. Depending on the severity of the climate, these risks may cause additional expenses necessary to protect personnel and ensure the stability of the structure. In addition, situations of force majeure are frequently related to extreme weather or climate changes.
Some or all of these factors must be accounted for during the process of risk assessment, which will be discussed in the following section.
Risk Identification Matrix
Kerur and Marshall (6) state that the process of risk management typically starts with the identification and assessment of risks pertaining to each particular international construction project. Many risks are unique to a particular project, most especially regarding the region where construction is being held, but some are relatively universal as well. Kerur and Marshall (7) provide a list of twenty potential risks that need to be covered in a standard risk analysis matrix:
This matrix presents an approximation of risks for a typical developing country located in a relatively stable economic and socio-political environment. The majority of the risks for such locations are in the medium range and are manageable. However, depending on the project and the precise location of construction, these risks can change from low to very high. Construction ventures in war zones, countries with serious political instabilities, or dangerous environments are much riskier. Typically, there are specialized companies that undertake these high-risk/high-reward projects. They usually demand payment up-front in order to cover some of the risks associated with unstable economic and political situations.
Strategies for Risk Mitigation in Construction
All of the risks mentioned in the risk identification matrix above require a solid strategy in order to minimize their potential impact on the success of the venture. It must be noted that no risk can be completely eliminated, as it is impossible to predict the outcomes of the thousands of variables that are at play during construction. Therefore, all mitigation strategies revolve around the idea of acceptable risks. Risks that can be feasibly avoided through proper planning and deliberate preparation can be dealt with within the scope of a mitigation strategy.
There are four risk mitigation strategies, each of which is based on a different set of principles. These strategies are avoidance, reduction, transfer, and retention (Bernstein et al. 27). Risk avoidance strategies seek to completely eliminate the chances of risk by avoiding situations that are associated with the potential risks (Walker 58). For example, choosing to opt for frost-resistant concrete would allow the company to avoid incidents with concrete being damaged in low temperatures, which would completely eliminate the issue of not being able to perform construction during the winter period. Although this strategy does not eliminate all the risks associated with construction, it is capable of eliminating some of them.
Risk reduction strategy, as the name suggests, purposes to keep risks at an acceptable level. When this strategy is implemented, planners accept that the elimination of risks is impossible. However, if everything is done right, potential risks can be avoided and their probability significantly reduced. All health and safety standards are risk reduction strategies. While a worker remains in danger of falling, misusing a tool, or harming themselves or others in a myriad of different ways, the presence of scaffolding, safety nets, rails, and barriers significantly reduce the chances of injury or death (Walker 59).
Risk transfer strategies are most commonly used for the legal aspects of construction. Risk transfer strategies exist to ensure that the burden of responsibility is held by organizations other than the construction company (Walker 56). All insurance operations are, in essence, risk transfer strategies. Other potential risk transfer strategies include setting up joint ventures or national entities to hold the majority of responsibility in case of an incident.
Lastly, there are risk retention strategies. These strategies assume that certain risks cannot be feasibly reduced or avoided. Instead, the company develops methods of dealing with the responsibility and prepares the necessary resources and materials in order to deal mitigate the aftermath of the risks when they happen (Walker 62). Instances of force majeure, such as earthquakes, tsunamis, tornadoes, or similar environmental upheavals, can be used as examples of risks where risk retention is the only valid strategy.
A risk mitigation strategy for a construction venture will have to borrow from all four of these concepts, as none of them is individually capable of answering the needs for risk mitigation completely. Not all risks can be effectively avoided, delegated, or reduced. Fully facing all eventualities, however, would considerably drain the resources available for the project. Providing scaffolding and safety nets is much less expensive than paying a large fine for potential loss of life and facing the country’s criminal justice system for negligence. However, every individual strategy can be applied to a particular risk. In some situations, several are used in conjunction to maximize the mitigation potential of a strategy.
Implementation of Risk Strategies
Kerur and Marshall (12) offer several examples of implementation of the aforementioned risk strategies in construction. These examples include joint venturing, learning from past mistakes, and obtaining legal counsel from entities in the target country. In the scope of this paper, these examples shall be examined, and new ones shall also be considered.
Joint Venturing
Since jurisdictional risks in international construction projects are much more potent when compared to domestic ventures, it is necessary to be able to assess and detect these risks upon entering any given foreign country (Kerur and Marshall 12). However, identifying jurisdictional risks without prior experience in the market can be complicated, and mitigation options for construction companies will be limited due to lack of knowledge. In these situations, there is the option of conducting joint ventures with companies that are already established in the region. This strategy offers plenty of risk mitigation options, as representatives of the local company will provide much-needed knowledge regarding legislation, contracts, documentation, subcontractors, and other important aspects of the construction operation.
Through a joint venture, an international company may gain access to the joint company’s full list of contacts and suppliers. In addition, managers and representatives of the construction company would be able to gain experience in the field and eventually be able to operate on their own, once their knowledge of existing risks and conditions becomes complete. However, joint ventures present their own set of risks, as the reputation and good name of the international venturing company will be tied to the practices of the local company. This could create potential complications in maintaining a unified corporate policy, as the companies would argue over whether they should adhere to international standards or operate based on local customs alone.
Personal Experiences Model
If a company does not wish to pursue a joint venture, it can attempt to enter the market by opening a smaller project in order to learn the ins and outs of the system they intend to operate in without facing the potential critical failures of large-scale venturing. This model involves completing projects and then analyzing the mistakes made and difficulties encountered during their completion, both operational and jurisdictional (Kerur and Marshall 12). Based on these lessons, the company is capable of assembling a comprehensive list of major risks that could potentially harm larger projects. In other words, operating a small firm at first would allow the company to train its employees on site and learn how to deal with risks, while at the same time avoiding any major losses.
Though this strategy is efficient and self-reliant, it does have several flaws. One of the most significant flaws is the amount of time necessary to carry out these minor projects before moving on to larger ones. Due to the competitive nature of construction, there is a chance that by the time the company moves in, all the available construction projects would be already taken by other international players. Another flaw is the inevitability of losses. Even a small project can become a failed venture without proper prior knowledge of the target market, legal aspects, and other aspects of the undertaking. The company is forced to pay to learn from mistakes. Lastly, experience from minor projects does not always translate well into larger venues. The possibility of underestimating risks remains.
Legal Counseling
In terms of mitigated risks in comparison to required costs, legal counseling is potentially one of the best strategies for mitigating jurisdictional risks. It involves contacting legal entities within the target country in order to provide the construction company with information and expertise regarding local matters, including governmental regulation, laws, contracts, dispute management, local customs, and other fields of knowledge that could help mitigate construction risks (Kerur and Marshall 12). These legal entities tend to have experience in the field and a significant base of knowledge that they areableto access in order to find solutions pertaining to the client’s situation. The only risk that the use of legal counseling offers is the fact that a third party is trusted with potentially sensitive corporate information. However, with the use of non-disclosure agreements, this risk can be substantially mitigated. All in all, the benefits of using a dedicated advisor far outweigh the disadvantages.
National Employment
As suggested by Ashworth and Perera (208), one effective risk management strategies involves hiring professionals and construction managers from within the country. These employees are expected to be familiar with the market and able to offer instructions and information similar to counseling services and joint ventures, while at the same time lacking the obvious tradeoffs of both due to not being as centralized. Many construction companies hire on location in order to avoid any issues with licensing and visas. It enables the company to conduct projects and ventures similar to the personal experiences model, while at the same time coming out vastly more prepared for the conditions and inherent risks of the market. However, this approach has several weaknesses to it as well. The information provided by individual specialists is fragmented at best, meaning that the company faces more difficulties when trying to piece it all together. In addition, information can be contradictory or inaccurate, which offers additional risks during construction. Lastly, without any solid knowledge about various risks and knowledge requirements, the company cannot accurately determine the qualities of the professionals it needs to hire in order to establish itself in the market.
Managing Construction Risks in the UAE
The UAE is a prospective market for many international construction companies due to its sprawling and quickly-developing infrastructure. The government is interested in building business centers, new airports, telecommunications towers, oilrigs, stadiums, and various other large-scale constructions. At the same time, the UAE has many legal aspects of construction that are foreign to international contractors and require solid risk management plans to overcome.
The UAE regulations for construction companies are useful tools, as they enable international contractors to avoid certain issues and jurisdictional risks on their own. One of the largest issues for foreign construction companies in the UAE revolves around legal entity establishment. Under the existing UAE regulations, foreign companies can establish branches to operate on the country’s territory. However, establishing a branch company generates a variety of jurisdictional and financial risks—a branch is not treated as a separate legal entity, which creates issues with taxation, dispute management, and monetary exchange. One possible way to avoid this issue is to create a separate legal entity through a joint venture. However, under existing UAE law, an Emirati shareholder musts have the control package of shares (51%), which effectively removes the international company from active decision-making (DLA Piper 1111).
Another major risk related to UAE construction regulations exists because of dispute-establishing mechanisms. According to El-Sayegh (435), some of the most frequent risks associated with construction in the UAE are subcontractors’ poor performance and unreasonably tight scheduling. Dealing with these issues requires the opening of disputes. Many foreign construction companies include dispute resolution mechanisms in their contracts with customers, subcontractors, and suppliers. However, despite these precautions, disputes have been a difficult issue in the UAE due to the deletion of the Dispute Adjudication Board from the FIDIC standard (DLA Piper 1112). As such, there are many issues regarding the enforceability of judgments and arbitral rewards. While a company may opt to request arbitration from the Dubai International Arbitration Center, the process takes a long time due to overcrowding, and even then, there is still a risk of being unable to effectively enforce an award.
The last major risk associated with construction work in the UAE is due to currency fluctuations. According to El-Sayegh (435), currency risks are among the most likely to occur, and they have a significant impact on the project, resulting in price changes and additional expenses. One of the tools proposed to foreign companies by UAE regulatory bodies is to use hedging as means of minimizing inflation and currency exchange risks. The existing regulations on hedging are similar to Europe’s Bazel and MIFID standards, on which they were modeled, with adjustments for regional requirements and standards. Although the UAE has several limitations on industries in regards to hedging (in particular, oil hedging), it does not have any significant barriers for the construction industry, thus enabling companies to avoid currency risks by building hedge funds in local currencies (DLA Piper 1113).
Conclusions
Risk management is an important aspect of the international construction business. Although construction is in general an expensive and risky venue due to the amounts of money, resources, and people that must be involved in the long-term process, these risks are increased when a company decides to go global and discover potential markets outside of its country of origin. In addition to various operational risks, the large body of jurisdictional risks that can no longer be dealt with at a solely corporate policy level. While the company may be prepared to deal with legal, contractual, and dispute aspects of construction process back at their home country, the differences between the legal systems have the potential of exposure to sets of completely new risks. These risks have the potential of stalling the construction process, adding additional expenses, and causing various inconveniences that would increase the total cost of the project.
Several strategies can be used to deal with these risks, based on the theories of avoidance, mitigation, transfer, and retention. Every effective strategy employs all four approaches, as the number and nature of construction risks are too broad and varied for any company to be able to encompass all of them with a single strategy. Some of the more familiar strategies used by construction companies include joint ventures, learning from mistakes, legal counseling, and local employment. The UAE construction regulations provide solutions to some of the risks involved, especially regarding hedges and legal entity establishments. However, the proposed solutions generate more issues than they solve, which is why the UAE remains a lucrative but risky market for international construction companies. Companies planning to work in the UAE are recommended to create joint ventures with local companies as means of avoiding issues in establishing legal entities and be able to solve disputes in adherence to the local laws.
Works Cited
Ashworth, Allan, and Srinath Perera. Contractual Procedures in the Construction Industry. 7th ed., Routledge, 2018.
Bernstein, Harvey, et al. Mitigation of Risk in Construction: Strategies for Reducing Risk and Maximizing Profitability. 2011, Web.
DLA Piper. Real World Law: Full Handbook. 2018, Web.
El-Sayegh, Sameh Monir. “Risk Assessment and Allocation in the UAE Construction Industry.” International Journal of Project Management, vol. 26, no. 4, 2008, pp. 431-438.
Kerur, Sachin, and William Marshall. “Identifying and Managing Risks in International Construction Projects.” International Review of Law, vol. 8, 2012, pp. 1-14.
Walker, Anthony. Project Management in Construction. 6th ed., Wiley, 2015.