Why do so many construction projects have cost overrun by as much as 10% to more than 100%?
How can cost overrun be rectified?
This continuing cost overrun situations costs industry million dollars each year and wastes valuable engineering /construction labor resources.
Construction cost overruns are an everyday happening on mid-sized & large multi-million dollar 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 & schedule goals!
Why do cost overruns occur?
In this blog post, I will endeavor to list out the causes & possible ways the cost overrun can be corrected. My focus on this article is on Industrial – Process CAPEX / EPC related projects valued up to one or more billion-dollar. However, it also is pertinent to Infrastructure type projects.
For the last 30 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 some failures on these types of EPC projects. I frequently get asked my opinion on the topic of cost overrun. Following is my observations & comments on this important topic.
The top 20 reasons why so many construction projects overrun their budgets are:
1. SCOPE ISSUES
The Scope of Work (SOW) is all of the work that is to be completed to execute the project. Any work items that are missed or ambiguous / unclearly described and 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 & included in the cost estimate.
2. ESTIMATING METHODS & APPROACH
An incorrect or flawed cost estimate that is based on incorrect quantities, bulk material unit costs, labor rates, major equipment costs, 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 & increase the risk of an estimate/ cost overrun.
The cost estimated should be prepared or at least reviewed and validated by an experienced cost estimator who is cognizant of the SOW. Not everyone is skilled in estimating labor, materials, in-directs, future escalation, and 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.
Many times not enough time is allocated to QA / QC & reviewing the final estimate and making sure the estimated cost values align with the scope of work descriptions.
A benchmark evaluation comparing the current estimate with historical values could be beneficial in conditioning the final estimated cost.
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.
The estimate should describe in detail the engineering deliverables /drawings c/w drawing numbers, revisions, sketches, SOW documents, inclusions, assumptions, exclusions, and estimating assumptions, currency exchange rates, US and International inflation rates that were utilized & 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 STRATEGY
The absence of a detailed Engineering, Procurement Construction (EPC) & handover execution strategy/plan many times can result in a cost overrun.
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 estimates need 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 & early estimates many times have an optimistic bias built into them; the estimate is many times based on a best-case outcome that has in some cases overlooks some of the technical & logistical risks & challenges associated with the project.
6. INSUFFICIENT EARLY / FRONT END PLANNING (FEP)
Front End Planning (FEP) is the key to success in any major industrial project. FEP can mitigate possible future cost & schedule failures.
When the project scope of work is defined and agreed, the next step is to develop 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 and experience. Selecting and removing a non-performing sub-contractor from the site can lead to significant cost overruns and delays.
7. SCOPE CHANGES / LATE DESIGN CHANGES
Scope modification and design changes can significantly impact early received quotes related to major equipment & engineered materials (i.e. tagged items);Engineering/sizing changes to major equipment, that increases the cost of major equipment items and increases the flow rates, pumps, and piping sizes.
Late engineering/design, procurement, and scope modifications many times give rise to in additional manpower requirements, inflated construction re-work, out of sequence activities & additional field in-directs.
8. OVER-OPTIMISTIC SCHEDULES
Unrealistic, flawed and over-optimistic EPC execution schedule based on manpower from a flawed cost estimate is another factor that contributes to cost overruns.
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 & conditions will impact field productivity & delay handover of the project to the operations group.
9. ABSENCE OF RISK MANAGEMENT SYSTEMS
Project risk items not thoroughly evaluated, priced out and included in the estimate would result in a cost overrun.
The estimating/tender team and individuals familiar with “Risk Management” are required to list out risk-related events and situations that could go amiss on the future project.
When the risks have been identified, the risks can be evaluated, priced out and included within the estimate.
10. INEXPERIENCED PROJECT & CONSTRUCTION MANAGEMENT
A high percentage of major projects & their budgets (estimates) get into trouble because the 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 the cost overrun, schedule delays, 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 & Construction Managers, described above then cost overruns on major industrial projects will continue.
11. LACK OF PROJECT ORGANIZATION / ROLES & RESPONSIBILITY
Many of these multimillion-dollar major complex industrial projects lack organization charts and reporting lines; Project Management / Project Control job descriptions, roles & responsibilities, and manpower loaded spreadsheets 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 overrun.
Another issue is that new Engineering/Construction Management employees are not given initial on boarding 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 and LACK OF COST CONTROL
No real proactive cost engineering / project cost control would lead to a cost overrun.
The cost control many times does 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, and 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 is another contributing factor to cost overrun.
No Monte Carlo/Range Estimating evaluations have been applied. Many Owners complain if they see 5% or 10% added to the estimate. However, 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:
- Over-manning: 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.
- High fees are another issue to be cognizant of.
- The Construction Manager should provide a manpower loading chart, indicating job description / individual’s role, together with start & finish date.
- Limited optimization of plant hire/construction equipment. Construction equipment should be removed from the site when not being utilized or at least off-hire.
- Failure to optimize laydown areas, marshaling 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 could result in cost overruns.
15. POOR COMMUNICATIONS
Poor or limited communications between all of the EPC team members is another factor that leads to cost overruns. This includes communicating the construction field force on the projects current status, schedule, milestones to be met, current & future challenges, and the crucial activities that need to be accomplished in the near term to meet both budget & schedule goals.
Transparent and clear-cut communications are vital, or missteps will result in that lead to cost overruns.
16. OVERCOMPLEX SPECIFICATIONS / EPC PROCEDURES
EPC procedures & 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
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 & change rooms should be available, keeping the field force appraised of the project’s status.
Other issues that can impact cost are high field labor turnover & 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 and late payments to sub-contractors can lead to claims and cost overruns.
19. LACK OF COMMISSIONING / START UP PLAN
The absence of the commissioning plan/hand over sequence to the 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 Condition’s durations & potential cost overruns.
The above are some of the main issues leading to cost overruns. In the next article, I will discuss possible solutions to overcome these challenges.
What additional comments or issues you believe are relevant to this article? Please share below.
About the Author, John G McConville CCP
John is the Operations Director of Compass International, a Cost Estimating / Procurement Consulting & Publishing firm, which is known around the world as “the experts” on US & International Construction Costs, Global EPC Procurement & Construction Productivity.
John has over thirty years’ of experience related to Cost Estimating, Estimating Reviews / Validation Services, Turnaround of Problem Projects, Independent Estimates for Owners & Value Engineering on a wide variety of major EPC projects, including: Petro-Chemicals, Manufacturing, Industrial Gases, LNG, Ethylene, Pharmaceuticals, Pipelines & Offshore Facilities located in more than 25 countries.
John’s three decades of executing & researching major Industrial, Infrastructure & Commercial projects at Compass International, Mobil Oil, Bristol-Myers Squibb & Linde Gas has been the foundation of this expertise. He has analysed the many issues that influence EPC projects in succeeding or failing to meet their stated cost & schedule goals.
John is the Author of 9 important books on US / International Construction Cost & International Procurement Practices, He has presented more than 100 Conceptual – Detailed Estimating, Project Management & Value Improvement training programs to 3,000 + Construction Professionals from Government Agencies, Universities, Fortune 500 companies & EPC firms in USA, Canada, Venezuela, Norway, Netherlands, India, UK, Saudi Arabia & Malaysia.
John is a Certified Cost Professional (CCP) with the Association for the Advancement of Cost Engineering (AACEI).
