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I wrote an article back in March on the top 20 reasons why so many construction projects overrun their budgets. This is Part 2 on how to alleviate or minimize these issues.
Large & mid-sized CAPEX & Infrastructure construction projects are many times intricate & demanding with the majority of these projects significantly not meeting their pre-established cost & schedule goals.
What are the reasons for cost overruns on many construction projects?
Over the last decade & specifically In the last (18) months we have reviewed & analyzed over 20 major construction projects (Oil & Gas, Infrastructure, Pharmaceutical & Commercial Buildings) where the final construction cost exceeded the approved authorized budget by more than 15% & in some specific cases, these cost overruns exceeded 75%.
Our research has determined the following major reasons of why these types of projects experience cost overruns.
- 27% of these overruns were caused by flawed estimates that were based on inadequate / incomplete scope definition or scope that was changing prior to & after the projects’ Final Investment Decision (FID) authorization.
- 32% were due to estimating errors related to quantities, bulk material prices, man-hours & field in-direct requirements.
- 12% delivery delays of Major Equipment, modules & piping systems causing additional general conditions / preliminaries costs were the reason.
- 11% field productivity issues (some of these projects did not consider, tight or overcrowded work areas, were the use of construction equipment was restricted & actual field performance).
- 9% were due to higher than anticipated labor, material & in direct costs.
- 6% the execution / contracting approach was flawed.
- 3% the commissioning & start up scope was not fully considered.
It is worth noting that more than one of these issues were encountered on some of these projects that were researched.
Our research did not consider construction related “soft costs” such as pre-construction expenses, environmental & construction permits, owner involvement (buy out of long lead items & EPC oversite), state & country grants / incentives, tax holidays, future workforce training grants, FEED / front-end studies, offsite temporary storage, state tax exemption credits, attitude & ability of the Project Management team. For example: Project Management Team A may be much more knowledgeable, energetic, cost cognizant & schedule driven than Project Management Team B or Team C, utilizing Project Management Team A can result in significant field construction cost savings – this is extremely hard to measure, however experience indicates that this situation is a reality.
So what can we learn from the above analysis?
Construction cost overruns are an everyday occurrence on mid-sized & large multi-million $ EPC projects around the world. As many as 6 out of 10 major construction projects fail to meet their established cost & schedule goals. Why is this? I will endeavor to list out possible ways this situation can be corrected. This article is focused / biased towards Industrial – Process CAPEX / EPC related projects valued up to one or more billion dollars, however it also is germane to Infrastructure type projects. Conceptual / Front End estimates are many times underestimated due in many cases to inadequate or poor scope definition. Estimates that are based on preliminary scope & design basis should of course contain a higher percentage of contingency than estimates supported by more complete / solid design & scope deliverables. For the last 35 years, I have been a Senior Construction Manager & Chief Estimator with both Owners & 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 a number of failures on these types of projects. I frequently get asked my opinion on this topic, the following is my observations & comments on this important topic. In March, I listed out the top 20 reasons (Part 1) why so many construction projects overrun their budgets, this Part 2 focuses on how to possibly minimize these overrun issues.
1. SCOPE ISSUES:
Sufficient time & resources must be allocated to defining the scope of the project, the relevant team members must identify the project goals & objectives, function, operating systems, project phases, future EPC activities, schedule & any constraints, all EPC work items must be listed out, work items that are overlooked or are ambiguously described & ill-defined will many times have a negative impact on the final estimated cost. Scope growth during the initial stages of the project must be evaluated & included where possible in the cost estimate. The resulting scope statement /report will be the road map for all team members of what is included in the scope of work & what is excluded from the future project.
2. ESTIMATING METHODS & APPROACH:
The Estimating Team / Estimator(s) need to be fully familiar with the scope of work of the project to ensure no work is overlooked or missed in the CAPEX Cost Estimate. Often, too little time & resources for completion of the Estimating / Proposal effort is a major reason for cost overruns. An early cost estimating & schedule kick-off meeting is crucial for all estimating / proposal team members, estimate timing, roles, responsibilities & estimate deliverables should be discussed & documented. An Estimating Plan should be initiated following the kick off meeting. The Estimate Plan outlines the information that the Estimating Team requires to complete the estimate. It should list out the individuals & the dates that information is required. Questions such as who provides the priced out major equipment list, plot plans, temporary site facilities, construction execution philosophy, site staffing needs, major milestone schedule indicating the start & finish dates of the civil, structural steel, process & utility piping. Who is responsible for obtaining prices on the major equipment? Who decides on which vendor quote to use in the estimate, the lowest cost or the mid cost range? All of these questions need to be raised. Other design deliverables, sketches & other key items that are needed should be requested. On large complex projects the estimating effort could take 4 to 8 weeks to complete, the Estimate Plan should be updated each week & focus on any delays or roadblocks that could jeopardize the estimate completion date.
Communicate Estimators names / emails & phone numbers to all team members, select the Lead Estimator that all communications should be sent to. Decide estimate format, which WBS / COA will be utilized Owners or Contractors. Where will the Material, Labor, Construction Equipment unit rates come from – internal sources or sub-contractor pricing? How will waste / over purchase of quantities be determined? The Estimator needs understand the construction / contracting approach, i.e. Union or Open Shop Labor, Direct Hire or Sub-Contractors. The Estimator needs to ensure / compile an accurate quantity take-off of all the engineered & bulk material required for the project. If some of these quantities are provided by an independent engineering group or a third party the Estimator needs to complete a spot check of some of these quantities to ensure the accuracy of the quantities.
The Estimator(s) need to interact with the Procurement Group to understand major equipment / production equipment pricing, delivery issues, who will set & align equipment, how was the freight determined, are there any import duties, how is the cost of inspection / witness testing of major equipment determined, vendor assistance costs should be included in the estimate, should spare parts be part of the estimate?
The Estimator / Estimating team needs to visit the site. Are there any obstructions such as existing pipe racks / bridges that will get in the way with allowing major equipment deliveries , heavy lift cranes to get onto site, will demolition of existing facilities be required, are any existing equipment items & piping systems to be re-used or relocated, where will material / production equipment laydown areas be located, is there a need for temporary a parking lot for the possible 500 to 1,500 construction workers, will buses be needed to transport works onto the site & the location of existing utility tie in points, is the process / utility piping to be fabricated at site? If possible obtain / understand local bulk material pricing, local taxes, VAT rates – are they applicable to materials, import duties? Review site logistic issues such as will there be a need to produce / batch concrete at the site or purchase concrete from a vendor, will a sizeable effort be needed to establish temporary roads onto the site, will these need to be maintained & eventually removed, plant hire / construction equipment needs, field offices, temporary camp for the workforce, offsite storage trailers need to be considered. Maintaining sketches & locations of these assumptions are vital. It is essential that the lead Estimator maintain a complete “Cost Estimate” file that contains, memos, minutes of meetings, emails, quotations, list of drawings, scopes of work, sketches, work breakdown structure, conference calls, important telephone conversations, scope revisions, photographs / videos & site visit reports. It is very important to keep & make notes that will most probably be required later on in the projects’ life cycle. An inconsistent cost estimate that is based on inaccurate quantities, bulk material unit costs, labor rates, major equipment costs, construction equipment / in-directs & labor productivity expectations can have a serious cost impact on the final cost estimate. This in turn can lead to an unreliable schedule & increase the risk of an estimate overrun.
Is the project in an overseas country? Labor productivity may be different in “tight” work areas where construction equipment use is limited vs open field areas.
The Estimator(s) of course must develop the appropriate bulk & engineered material unit prices, major equipment prices & installation values, man-hour production rates, wage rates & in-directs need to be estimated. Labor productivity value for each craft / work area needs to be estimated, productivity will vary from congested / tight / restricted work areas from open areas.
The basis of estimate needs to be comprehensive, listing all the estimating assumptions & exclusions; what is included & excluded from the estimate, what Provisional Sums, allowance & assumptions have been made in the CAPEX Cost Estimate, including the list of drawings & revisions that the CAPEX Cost Estimate is based upon. The estimate basis should described in detail, the engineering deliverables / drawings c/w drawing #’s, revisions, sketches, (SOW) documents, inclusions, assumptions, exclusions & estimating assumptions, currency exchange rates, US & International inflation rates that were utilized & import duties / taxes that the estimate is based on. A number of work activities such as startup or shut downs may possibly need to be completed using shift work, weekend work or on overtime, make sure this cost is captured in the CAPEX cost estimate.
Field In directs / Preliminaries or General Conditions as it may time referred to should be itemized in the estimate, many times a percentage of direct field labor is used, this method is not accurate. The estimating team should list & price out field supervision, fringes / burdens, site establishment / temporary facilities, small tools, scaffolding, construction equipment, heavy lift cranes, clean up, field expenses & the like.
If the project is located overseas the CAPEX Cost Estimate should include a statement / language of what the currency exchange rates were on the particular date the estimate was compiled or what the exchange rates were on specific items of major equipment (for example the major equipment could be coming from numerous European & Asian suppliers).
The Estimator(s) must validate if the CAPEX estimate is in concurrence with the established project scope. An In depth QA / QC review needs to be implemented by the estimating / proposal team prior to estimate finalization to ensure the correct labor costs, man-hours & productivity targets have been appropriately estimated. Adequate time must be assigned to a detailed review of the final estimate, ensuring the estimated cost values align with the (SOW) descriptions. A benchmark evaluation comparing the estimate with historical values will be beneficial in conditioning the final estimated cost to ensure all scope items have been captured. Determine totality of the CAPEX estimate & make certain that there is no omitted scope of work or discrepancies.
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. Senior management typically makes the final decision on overhead costs, engineering man-hours & costs, contingency, management reserve, warranty guarantees & profit margins after they have been fully briefed by the estimating team.
Severe weather conditions, is there language in the CAPEX Cost estimate basis that spells out the assumptions made when compiling the estimate.
All provisional sums & cost allowances should be fully described & priced out. Consequential / Liquidated damages & penalty clauses – has this issue been addressed & priced out in the CAPEX Cost Estimate?
Shortage of skilled site construction workers, for example does the contractor have to hire pipefitters from 100 – 500 miles away, has this travel / lodging cost been accounted for in the CAPEX Cost Estimate?
The need for hot work permits in an existing operating facility & the time lost by specific work crews waiting for the required signed off documentation needs to be estimated & described.
Contractual Terms & Conditions on issues such as Owner Provided Equipment c/w with delivery dates at site, Owner Provided Insurance (OPI), BAR Insurances, Performance Bonds, Payment timing (i.e. 45 – 90 days before payment), Extended Warrantee issues, Substantial completion definition, Scope changes, Performance Guarantees, Parent Company Guarantees, Retention funds and the like. The cost of these items needs to be established and be made part of the CAPEX Cost Estimate.
Many construction related organizations (Owners & Contractors) do not provide adequate support (estimate budget, manpower, estimating department overtime & travel costs to site) during the estimating effort. This coupled with Senior Managements’ predictable predisposition in reducing engineering hours, allowances, contingencies, overhead & profit margins in their quest to ensure the project moves ahead. These issues together with not spending an adequate amount of time in fully understanding the overall scope, project risks & conferring in detail with the Estimator(s) on these important issues is another cause for cost overruns.
The CAPEX cost estimate should be accepted by all the project team members. This calls for a rigorous interaction & agreement with the Owner, EPC Company, Design Team, Project Management, Procurement, Project Controls (Estimating) & Construction Team.
3. OPTIMISTIC ESCALATION / INFLATION / CURRENCY EXCHANGE RATE ESTIMATES:
Frequently CAPEX estimates are compiled utilizing the most optimistic escalation rates. Major projects that are in the field for 2, 3 or 4 years are particularly vulnerable to increased costs related to labor, bulk & engineered materials & field in-direct costs. The correct path forward is to investigate, research & document various escalation / inflation index & indices such as Government agencies publications: Wall Street Journal, World Bank publications on projected escalation & currency exchange rates. State what the basis of escalation & exchange rates were at the time the cost estimate was produced. Increases of 2% or 3% each year over say a 3 year execution period can equate to a sizeable component in the estimate. Currency fluctuations is another issue that needs to be addressed, just consider the currencies of the UK, Turkey & Mexico in the last two years, the exchange rates that were utilized in compiling the estimate needs to be stated in the basis of estimate (BOE).
4. LACK OF EPC STRATERGY:
Lack of a detailed Engineering, Procurement Construction (EPC) & handover execution plan many times will result in cost overruns; is the project going to be stick built or modularized? Is the field labor cost based on Union or Open Shop labor? Can the field in-directs be reduced if a higher percentage of modularization is utilized? The estimated cost needs to reflect the planned EPC approach & strategy. There are an assortment of project delivery possibilities available to construct a facility, selecting the appropriate delivery method is important & can have cost ramifications. Some of the more frequently used methods are: Turnkey, Engineering, Procurement & Construction (EPC). Design Build (DB), Target Price with shared savings, Construction Management & Guaranteed Maximum Price. Issues to consider in the selection criteria are cost, schedule & contractor capability & risk reduction. Front End Planning is the critical activity that Project Managers / Project Control professionals have in minimizing cost estimating overruns & experiencing schedule delays. The more time & resources that can be allocated to this effort usually pays off in minimizing future cost & schedule issues.
5. EARLY ESTIMATES / FEED STUDIES / CONCEPTUAL ESTIMATES:
Early / Front End cost estimates many times have a tendency to contain errors such as, missing scope, understated quantiles, inaccuracies in determining wage rates, bulk material unit price oversights & establishing the field force labor productivity rates. Another area that can cause overruns is underestimating the field in-directs. On some occasions these Early / Front End cost estimates are completed by individuals or teams that have a vested interest in the future project moving forward, this bias can seriously impact the estimated cost. The only way of dealing with this situation is for an independent expert to review the estimate or for the Estimator / Estimating team to painstakingly review & check the details of the latest estimate to ensure this situation is rectified.
6. INSUFFICIENT EARLY / FRONT END PLANNNING:
Early team planning sessions is the key to success on any major industrial project, these meetings can mitigate possible future cost & schedule problems. Having a team planning session / estimate – schedule kick-off meeting allows the Estimating / Proposal team to layout issues, timing, roadblocks & possible solutions to meet the estimate due date.
7. SCOPE CHANGES / LATE DESIGN CHANGES:
The Estimator / Estimating team must endeavor to base the estimate on the original scope document. Dealing with scope changes is one of the leading issues the Estimator / Estimating Team has to contend with. What would seem to be a minor change to a major piece of equipment can have serious consequence to foundations, piping systems & insulation to mention just a few. The only way to deal with this is to base the estimate on a documented list of drawings & specifications. Scope modification / design changes can significantly impact early received quotes related to major equipment & engineered materials (i.e. tagged items). Engineering / sizing changes to major equipment many times increases the cost of major equipment items & increases the flow rates, pumps & piping sizes. Some design changes are inevitable, the only way to deal with this is to base the “baseline” estimate on a documented list of drawings & specifications & include these comments in the (BOE).
8. OVER OPTIMISTIC SCHEDULES:
A vigorous independent in depth review of the schedule utilizing experienced planning professionals is required to mitigate this problem. If the estimate is incorrect, then there is a high probability that the schedule will be wrong. The schedule should carry enough “float “to allow for late major equipment delivery, accidents, re-work, field change orders & possible extreme weather.
9. ABSENCE OF RISK MANAGEMENT SYSTEMS:
Every construction project has challenges & associated risks. The estimating / tender team & individual’s familiar with “Risk Management” are required to list out specific technical & commercial risk related possibilities & situations that could arise on the future project. When the technical & commercial risks have been identified, the risks can be scoped out & evaluated, priced out & where appropriate, included within the estimate.
10. INEXPERIENCED PROJECT & CONSTRUCTION MANAGEMENT:
Inexperienced Project Managers that lack critical know-how & the self-confidence to lead the project team can be a serious problem that can lead to cost overruns. A high percentage of major projects & their budgets (estimates) get into trouble because inexperienced / unproven Project & Construction Managers are managing the EPC effort. To successfully execute one of these multimillion dollar major complex industrial projects the Project & Construction Managers should have at least 10 years direct experience in managing, estimating, procuring, scheduling & 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 & other issues that add costs to the project & cause delays that lead to extending the field in-directs.
11. LACK OF PROJECT ORGANIZATION / ROLES & RESPONSIBILTY:
Projects that lack an organization structure many times lead to internal personnel disputes & poor interactions. To be successful, individuals need to understand their roles & responsibilities. Basic manpower loaded schedules are needed to be established, indicating start & 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:
Project cost control entails evaluating & accumulating actual material, labor, quantities installed to date, in-direct cost data & forecasting the final cost of a specific line item being analysed. On many construction projects, 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 & procedures, together with limited proactive follow up to schedule slippage & low field productivity will many times set the stage for cost overruns. The final detailed cost estimate contains the material, labor & in-directs data for controlling project costs. The Project Control team needs to be proactive & involved with all project related activities, advising the Project Manager on man-hour trends & budget variances so that mid-course corrections can occur.
13. INADEQUATE CONTINGENCY / ESTIMATE ACCURACY:
Historically, a large number of construction projects have utilized between 5%-10% of the projects bottom line construction cost to establish the contingency value, this is the wrong approach. Sufficient time must be assigned to determining the correct contingency value. This estimate component can be a sizable value of possibly more than 10% of the projects final cost. The Estimator(s) need to be cognizant of the conceivable risks & challenges the construction effort will encounter & apply the acceptable contingency / management reserve fund that hopefully mitigates these issue. Unrealistic & inadequate contingency / management reserve funds contained in the final approved project estimate can lead to estimate overruns. A detailed Monte Carlo / Range Estimating evaluation or a planned contingency session should be initiated towards the completion of the final cost estimate to determine the appropriate value.
14. CONSTRUCTION MANAGEMENT:
Selecting the “best” Construction Management team is the # 1 solution for successfully managing the construction effort. The key factors to consider are the skills, resourcefulness & abilities of the Construction Management team. Construction Management Team A may be much more knowledgeable, energetic, cost cognizant & schedule driven than Construction Management Team B or Team C, utilizing Construction Management Team A can result in saving significant field construction costs. Safety, quality control, cost control, communications & physical progress are the key issues that need to be achieved during the construction effort.
15. POOR COMMUNICATIONS:
Project communications need to be clear, concise & unequivocal, otherwise, disorder & possible schedule slippages will occur. Communications between all of the EPC team members, including the construction field force on the project is essential to meet major milestones & budget targets. Good communications is essential to the successful handover of all construction projects. Flawed communications will many times lead to conflicts, delays in misunderstandings, delays & possible change orders.
16. OVERCOMPLEX SPECIFICATIONS / EPC PROCEDURES:
Complex specifications, EPC procedures & reporting systems such as RACI matrix type tools & the like that are many times not fully understood or correctly utilized by the EPC team can lead to man-hour & budget overruns, many of these systems do not add value to the project & can indirectly result in cost overruns. As we move into the future latest technology like Building Information Modelling (BIM) 3D model-based procedures provide tools to cost-effectively map out, engineer, procure & construct various facilities. Developing standardized specifications is another area were resources & costs can be optimized.
17. LOW CONSTRUCTION PRODUCTIVITY:
Low labor productivity is a significant cause for costs overruns on construction projects. Construction productivity can be improved by utilizing more offsite or onsite pre-fabrication methods such as pre-cast concrete, piping systems, modules & pre-assemblies. To maximize worker productivity – Issues such as busing the workers to their work area each morning, bulk materials & construction equipment should be readily available close to the work area, toilets & change rooms should be clean & close to the field force, keeping the field force appraised of the projects status. Other issues that can impact productivity & costs are high field labor turnover & poor field supervision. Issues that negatively impact productivity are deficient material logistics, periods of extended overtime, restricted & congested work areas / space, worker turnover / non-attendance, wrong crew size, lack of correct construction equipment & hazardous or restrict work areas. If these issues can be resolved then construction productivity can be improved.
18. POOR CONSTRUCTION CONTRACTS:
Contractual Terms & Conditions on issues such as Owner Provided Equipment c/w with delivery dates at site, Owner Provided Insurance (OPI), BAR Insurances, Performance Bonds, Payment timing (i.e. 45 – 90 days before payment), Extended Warrantee issues, Substantial completion definition, Scope changes, Performance Guarantees, Parent Company Guarantees, Retention funds & the like. The cost of these items needs to be established and be made part of the CAPEX Cost Estimate. In addition, if the contract calls for Consequential / Liquidated damages & penalty clauses, these requirements / issues need to be addressed in the CAPEX Cost Estimate. Confrontational contracts & contracting methods that are ill-defined & that lack a detailed unit prices / labor – construction equipment rates / schedule of rates for change orders can lead to disputes & cost overruns.
19. LACK OF COMMISSIONING / START UP PLAN:
The commissioning & start up activities can be characterized as the interim step between facility completion (construction) & the facility operations / production life cycle (operations). Commissioning & Start up includes such items as hydro & pressure testing, systems checking & plant turnover, equipment performance / witness test examinations. Commissioning & start up activities also includes leak tests on flanges, fittings, connections, gaskets, welds, valves, acid washing / passivation activities, if required. These activities need to be evaluated & be price out & included in the CAPEX cost estimate.
20. FIELD MOBILIZATION:
Field mobilization, i.e. going onto the construction site & establishing the temporary construction facilities & operations required for the construction of a project is an important milestone that needs to be carefully coordinated with major equipment deliveries & the need to construct various foundations & incoming unities. General Condition’s / Preliminaries (field staff, trailers, construction equipment) durations & potential cost overruns can occur if the mobilization effort is not carefully scheduled & the field staff is at the construction site 2 or 3 months before they are required.
I invite your feedback & comments on this interesting subject.
John G McConville CCP John is the Operations Director of Compass International he has 35 years of Project Management & Estimating experience. 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 serves the Oil, Gas, Chemical, Manufacturing, Pharmaceutical &Infrastructure / Commercial Construction Sectors.
Our services include production of (7) Annual Cost Databases, Estimate Reviews / Estimate Validation Services, Turnaround of Problem Projects, Independent Check Estimates for Owners & Value Engineering on a wide variety of EPC projects.
Compass International Inc. is a Cost Estimating / Procurement Consulting & Publisher firm. Compass International, is known around the world as “the experts” on US & International Construction Costs, Global EPC Procurement & 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/View Our Books
For additional information contact: John G. McConville CCP – Operations Director of Compass International for additional information or comments: Telephone (609) 577 4505 private email firstname.lastname@example.org https://www.compassinternational.net