Best practice risk management approach for asset replacement programmes

25 August 2016

Nations have trillions worth of assets, ranging from houses and industrial buildings to infrastructure and utility networks. A large share of these assets age however, and studies show that today billions in assets are either up for maintenance or replacement, or are nearing that point. As a result, large scale replacement programmes have over the years become more common in the industry.

Organisations that undertake large scale infrastructure replacement programmes, face a range of strategic challenges. The chief factor considered a burden is the sheer cost of execution – such programmes can sometimes gulp up to 60% of the available CAPEX budget. As a result, the room left behind for alternative decision-making in the investment portfolio is significantly reduced – an issue for many organisations, in light of the magnitude of change being faced, including the likes of the Internet of Things, big data and “smart” technology solutions. Moreover, managing such large programmes is challenging, with tasks commonly highly specialised and resources scarce.

The risks associated with such programmes are immense, ranging from business and financial risks to safety and liabilities in the value chain. For asset managers, the key question that arises is: how long can you continue with a re-active replace after failure strategy? The other end of the spectrum – moving to a pro-active replacement approach – can be more fruitful, yet, if the timing is off track, then companies (and even society) could be exposed to risks deemed unacceptable.

It is this combination of high risks with high investments that makes large scale replacement programmes one of the most complex projects of their kind to execute.

Risk management approach for asset replacement programmes

Risk management approach for asset replacement programmes
In a bid to optimise the way how asset management owners run their programmes, UMS Group recently developed a best practice approach to applying, measuring and using risk for such investment decisions. The consulting firm, specialised in the field, was asked for advice by a gas infrastructure company that faced a large-scale replacement issue. On one hand the company had no immediate indication of significant threats, however, known was that the infrastructure structure was ageing, leaving the infrastructure provider wondering how other asset owners deal with similar situations and what best practices there are in the market. 

UMS Group performed a study at seven major asset owners to assess their practices. To pinpoint how these organisations perform, the consultancy develop a process framework of four steps and each of these steps were evaluated using a six scale maturity model. The maturity model – spanning from innocent (least mature) to excellent (most mature) is compliant to the scales used in the international standard of ISO55000. “For every phase in the approach, characteristics of each maturity level have been developed. By aggregating scores and benchmarking those against a best practice in the industry, organisations can find how they perform vis a vis their peers and unravel improvement potential”, says Jan Schipper, Managing Director at UMS Group and author of the best practice model.

The first step looks at the existing risk position of the organisation. “At the beginning of the reinvestment process, it is key to introduce a step to define the company’s current risk position, as well as understand the board’s level of risk tolerance. The level of accepted risk tolerance is then used as one of the constraints for the overall reinvestment programme”, explains Schipper. Best practices in this phase include a clear governance on the relationship between risk and time (“this determines the ‘ramp up’ time of a program and the pace at which investments are done”) and a robust quarterly reporting process (“risk reporting is a must for executive buy-in”).

Maturity model for asset replacement programmes

On the back of insight in the risks, the next phase focuses on identifying mitigation strategies. Key here is to distinguish between risks that are deemed acceptable, in line with planning, and those that exceed the level of risk tolerance. “A prioritisation methodology based on integrity assessments should be applied. This involves both desk analysis and technical studies, and once scores are assigned to assets, an overall guideline rolls out.” Mitigations are then developed, he adds. The dataset reveals that best practice companies focus on initiatives with the highest impact in risk reduction to determine the scope of work in terms of the level on reinvestment per year per region. “They prioritise those investments which will reduce risk the most. The scope of work is identified via a long-term perspective based on a total cost of ownership approach”, comments Schipper.

Then an important next stage in the process starts, highlights Schipper, since it is now known per region which assets should be started with first. However, many scenarios are still on the table: is replacement the best strategy, should the technology be upgraded or could a small modification instead of a replacement sufficiently mitigate the risk exposure? The different strategies are subsequently assessed, weighted for impact and evaluated for practical feasibility, and out of this comes an overarching assessment of the amount of risk reduction that can be sought after. “The mitigation strategy results in a portfolio of projects for each service region. For each project, the impact on risk reduction can be calculated by determining the risk mitigation per invested euro. These can be summed up to provide a measure of the total Risk Reduction per region, which is then included in the quarterly risk reporting”, explains Schipper.

The fourth step turns decision making into action – the actual optimisation of the portfolio. In this step of the process, the overall portfolio of investment projects, maintenance projects and other projects for all asset classes in a service area are combined in one proposed portfolio for the region. Sophisticated skills, methods and tools are applied to the portfolio to perform short-term scenario testing and risk optimisation. Each programme or project within a service area is evaluated on the value it adds to meeting strategic objectives and reducing risk (risk mitigation per euro spend). To ensure consistency of scoring across projects a standard set of scoring tools and templates are used.

Two-step decision-making process

Then constraints like budget and/or resource are set and an optimisation of the project portfolio is performed. “For the scenario testing, tools are used that have intelligent logic to run mathematical equations and solve the multi-constraint optimisation problem. The final result is an optimal scenario to meet the short term objectives!” explains Schipper. 

Two-step decision-making process
Besides growing the level of maturity per phase, Schipper says that, according to the study, there is one main feature found that underpins a best practice method for reinvestment strategies: an approach built around a two-step decision-making process. The first step relies on taking a long-term perspective, and is typically developed between the first and second phase. “The majority of leading companies in this respect apply evaluation methods based on ‘total cost of ownership’ to defend the investment decisions made”, reflects Schipper. The second step that is regarded as a differentiator is the ability to focuses on dealing with short-term constraints (e.g. budget limitation or resource constraint). “This step commonly comes into play in the fourth phase, portfolio optimisation.” In doing so, leader companies use a range of sophisticated modelling techniques leveraging optimisation algorithms to solve multi-constraint bounds.

Bottom-line benefits of portfolio optimisation

“Not all companies applied this two-step decision making process balancing between long term and short term strategic objectives. Only those companies that have to deal with very tight constraints in terms of compliancy, shareholder requirements, limited budget and limited resources apply the two stage decision making model”, says Schipper. Case studies show that an effective application of best practices can lead up to 20% more flexibility in the portfolio, which down the line frees up valuable, previously strapped, resources for other uses. “This bolsters the return on investment on projects, paves the way for more focus on innovation, and to an extent relieves an organisation from a tough working capital challenge.”