Construction Project Cost Overruns (Part One)

  Filed under: Cost Estimates

Why Projects Overrun Why do so many construction projects overrun their budgets by as much as 10% to more than 100% and how can this be rectified? This continuing situation costs the industry millions of dollars each year and wastes valuable engineering / construction labor resources. This article is focused on Industrial – Process CAPEX / EPC related projects valued up to one or more billion dollars, however it also is pertinent to Infrastructure type projects. Construction cost overruns are an everyday occurrence on mid-sized and large multi-million $ EPC projects around the world. Studies on this subject would indicate that as many as 6 out of 10 major construction projects fail to meet their established cost and schedule goals. Why is this? I will endeavor to list out the causes and possible ways this situation can be corrected. For the last 30 years, I have been a Senior Construction Manager & Chief Estimator with both Owners and Contractors involved with 100’s of mid-sized & large EPC related Process, Industrial, Infrastructure & Pharmaceutical Projects in the USA & around the world. I have been involved with a lot of successes, however I have seen some failures on these types of EPC projects. I frequently get asked my opinion on this topic, the following is my observations & comments on this important topic. The top 20 reasons why so many construction projects overrun their budgets.  
  1. SCOPE ISSUES: The Scope of Work (SOW) is all of the work that is to be completed to execute the project, any work item that are missed or ambiguous / unclearly described & defined will many times have a negative impact on the final estimated cost. Scope creep / growth during the early stages of the project must be priced out and included in the cost estimate.
  2. ESTIMATING METHODS & APPROACH: (A) An incorrect or flawed cost estimate that is based on incorrect quantities, bulk material unit costs, labor rates, major equipment costs and construction equipment / in-directs and labor productivity expectations can have a serious cost impact on the final cost estimate. This issue can lead to an unreliable schedule and increase the risk of an estimate overrun. (B) The cost estimated should be prepared or at least reviewed and validated by an experienced cost estimator that is cognizant of the (SOW). Not everyone is skilled in estimating labor, materials, in-directs, future escalation and a host of other items that need to be part of the final cost estimate, it is important that an experienced estimator be involved with the estimating effort. (C) Many times not enough time is allocated to QA / QC and reviewing the final estimate and making sure the estimated cost values align with the (SOW) descriptions. (D) A benchmark evaluation comparing the current estimate with historical values could be beneficial in conditioning the final estimated cost. (E) Many times the cost estimate is compiled with an attitude of arriving at the lowest cost, this can sometimes be detrimental to the final estimated cost. (F) The estimate should describe in detail, the engineering deliverables /drawings c/w drawing #’s, revisions, sketches, (SOW) documents, inclusions, assumptions, exclusions and estimating assumptions, currency exchange rates, US & International inflation rates that were utilized and import duties / taxes that the estimate is based on.
  3. OPTIMISTIC ESCALATION / INFLATION / CURRENCY EXCHANGE RATE ESTIMATES: Many times, the estimate is compiled utilizing the most optimistic escalation rates, major projects that are in the field for 2, 3 or 4 years are particularly susceptible to increased costs related to labor, bulk & engineered materials & in-directs. Many early / front end cost estimates tend to be over optimistic, that unfortunately can lead to an underfunded cost estimate.
  4. LACK OF EPC STRATERGY: Absence of a detailed Engineering, Procurement Construction (EPC) and handover execution strategy / plan many times can result in cost increases; Is the project going to be stick built or modularized? Is the labor cost based on Union or Open Shop labor? Can the field in-directs be reduced if a high percentage of modularization is utilized? The cost estimated needs to reflect the planned EPC approach.
  5. EARLY ESTIMATES / FEED STUDIES / CONCEPTUAL ESTIMATES: Early Cost Studies, Conceptual Designs & FEED studies many times are completed by individuals or teams that have a vested interest in the future project moving forward, this predisposition can impact the estimated cost. Conceptual and early estimates many times have an optimistic bias built into them. The estimate is often based on a best case outcome that has (in some cases) overlooked some of the technical and logistical risks and challenges associated with the project.
  6. INSUFFICIENT EARLY / FRONT END PLANNNING (FEP): (FEP) is the key to success on any major industrial project. (FEP) can mitigate possible future cost and schedule failures. When the projects scope of work is defined and agreed, the next step is to define the various work packages and decide if the work is to be performed on a direct hire basis or are specialist sub-contractors to be used. If specialist sub-contractors to be used, make a list of qualified sub-contractors and review their qualifications / experience. Selecting and removing from site a non performing sub-contractor can lead to significant cost overruns and delays.
  7. SCOPE CHANGES / LATE DESIGN CHANGES: (A) Scope modification / design changes can significantly impact early received quotes related to major equipment and engineered materials (i.e. tagged items). (B) Engineering / sizing changes to major equipment that increases the cost of major equipment items and increases the flow rates, pumps and piping sizes. (C) Late engineering / design, procurement & scope modifications many times give rise to in additional manpower requirements, inflated construction re-work, out of sequence activities and additional field in-directs.
  8. OVER OPTIMISTIC SCHEDULES: Unrealistic, flawed and over optimistic EPC execution schedule based on manpower from a flawed cost estimate. An EPC project schedule fails to consider end date slippages related to major equipment delivery, accidents, re-work, major change orders, possible extreme weather, such as snow, cold temperatures, rain or extreme heat; these situations and conditions will impact field productivity and delay handover of project to the operations group.
  9. ABSENCE OF RISK MANAGEMENT SYSTEMS: Project risk items not completely evaluated, priced out & included in estimate. The estimating / tender team & individuals familiar with “Risk Management” are required to list out risk related events & situations that could go amiss on the future project, when the risks have been identified the risks can be evaluated, priced out & were appropriate included within the estimate.
  10. INEXPERIENCED PROJECT & CONSTRUCTION MANAGEMENT: A high percentage of major projects and their budgets (estimates) get into trouble because inexperienced / unproven Project and Construction Managers are managing the EPC effort. To successfully execute one of these multimillion dollar major complex industrial projects the Project and Construction Managers should have at least 10 years direct experience in managing, estimating, procuring, scheduling and controlling these types of projects. Owners / operators many times make the fatal mistake of choosing “MBA / Financial” type individuals, with little or no knowledge of EPC activities to look after their interests. The disturbing fact is that these individual don’t have the knowledge or experience to recognize (A) cost overruns, (B) schedule delays, (C) productivity trends and other issues that add costs to the project and cause delays that lead to extending the field in-directs. If Owners / Operating companies don’t have the insight to utilize experienced Project and Construction Managers described above, then cost overruns on major industrial projects will continue.
  11. LACK OF PROJECT ORGANIZATION / ROLES & RESPONSIBILTY: Many of these multimillion dollar major complex industrial projects lack organization charts and reporting lines, Project Management / Control job descriptions, roles and responsibilities and manpower loaded spread sheets indicating start and finish dates that the Project / Construction team will be mobilized & de-mobilized from the project. Failure to produce these documents can lead to individuals being on the project longer than required, resulting in potential cost overruns. Another issue is that new Engineering / Construction Management employees are not given initial onboarding information on project issues / procedures, that leads to these individuals spinning their wheels for the first 2 or 4 weeks of their assignment.
  12. FAILURE & LACK OF COST CONTROL: No real proactive cost engineering / project – cost control is performed. The cost control many times is an “accounting” effort, compiled after the work has been completed. Lack of project control / cost control tools and procedures, together with limited proactive follow up to schedule slippage & low field productivity will many times set the stage for cost overruns.
  13. INADEQUATE CONTINGENCY / ESTIMATE ACCURACY: Unrealistic and inadequate contingency / management reserve funds contained in the final approved project estimate. No Monte Carlo / Range Estimating evaluations have been applied. Many Owners complain if they see 5% or 10% added to the estimate, when in reality with only 20% or 30% of the detailed design completed the contingency should be 15% or 20% or possibly more to protect the estimates’ bottom line.
  14. CONSTRUCTION MANAGEMENT: The assumption on this issue is the Owner is directly hiring a Construction Management firm to manage the construction effort, this could include procuring between 10 to 30 construction work packages. Issues to consider to minimize cost overruns are (A) Overmanning, Construction Managers are typically paid on a reimbursable or cost per hour for each individual, so the more individuals they have on site the more it costs. Many times, if a Construction Manager is calling for 25 site staff, the reality is that the project may only require 17 site staff. (B) High fees are another issue to be cognizant of. (C) The Construction Manager should provide a man power loading chart, indicating job description / individual’s role, together with start & finish date. (D) Limited optimization of plant hire / construction equipment, (construction equipment should be removed from site when not being utilized or at least off hire). (E) Failure to optimize laydown areas, marshalling areas, construction worker parking, changing rooms / toilets / lunch areas. All of these issues (if not adequately executed) can lead to poor work performance / productivity and result in cost overruns.
  15. POOR COMMUNICATIONS: Poor or limited communications between all of the EPC team members, including the construction field force on the projects current status, schedule, milestones to be met, current and future challenges and the crucial activities that need to be accomplished in the near term to meet both budget and schedule goals. Transparent and clear-cut communications are vital or missteps will result that lead to cost overruns.
  16. OVERCOMPLEX SPECIFICATIONS / EPC PROCEDURES: Over complicated specifications, EPC procedures and reporting systems such as RACI matrix type tools and the like that are not fully understood or correctly utilized by the EPC team can lead to man-hour and budget overruns, many of these systems do not add value to the project and can indirectly result in cost overruns.
  17. LOW CONSTRUCTION PRODUCTIVITY: Can lead to significant cost overruns, field productivity should be measured on a regular basis and steps should be made on an ongoing basis to maximize worker productivity – Issues such as busing the workers to their work area, materials and construction equipment should be readily accessible, toilets and change rooms should be available, keeping the field force appraised of the projects status. Other issues that can impact costs are high field labor turnover and poor field supervision.
  18. POOR CONSTRUCTION CONTRACTS: Confrontational contracting methods and ill-defined construction contracts that lack a detailed list / schedule of rates for change orders, late payments to sub-contractors can lead to claims and cost overruns.
  19. LACK OF COMMISSIONING / START UP PLAN: Absence of commissioning plan / hand over sequence to End User is a difficult scope to estimate at the early stages of a project, historical benchmarks can assist in ensuring a cost overrun does not occur.
  20. FIELD MOBILIZATION: Going to the field too quickly with incomplete construction information / AFC drawings can lead to longer General Conditions durations and potential cost overruns.
The above are some of the main issues, part 2 of this article will discuss possible solutions to overcome these challenges. John G McConville CCP has over thirty years’ of experience related to Estimating Reviews / Estimate Validation Services, Turnaround of Problem Projects, Independent Check Estimates for Owners / Value Engineering on a wide variety of EPC projects including: Petro-Chemicals, Manufacturing, Industrial Gases, LNG, Ethylene, Pharmaceuticals, Pipelines & Offshore Facilities located in more than 25 countries. John is the Author of (9) International Estimating & Procurement books, he is a Certified Cost Professional (CCP) with the Association for the Advancement of Cost Engineering (AACEI). Compass International Inc. is a Cost Estimating / Procurement Consulting & Publisher firm. Compass International, is known around the world as “the experts” on US and International Construction Costs, Global EPC Procurement and Construction Productivity. Compass International is based in Philadelphia, USA and also has offices in Florida, USA. Our (7) annual estimating / procurement books & PDF’s are available https://www.compassinternational.net/books/ Contact: John G. McConville CCP – Operations Director of Compass International for additional information or comments: Telephone (609) 577 4505 private e mail mcconvil@rcn.com https://www.compassinternational.net