Professional Documents
Culture Documents
Cost Overruns Notes
Cost Overruns Notes
How many times do you hear about project costs overrunning and exceeding their budgets? No doubt far
too many compared with the number of times you can remember a project coming in well within budget.
Keeping costs within the project budget and getting value for money and return on investment is even
more important in these times of economic hardship and market competitiveness but how many companies
address this openly passionately and proactively with well tried tools and methods.
This paper explains the typical causes of project cost overruns and provides some insights on the use of
various techniques and tips for managing and reducing costs.
According to Wikipedia Cost overrun is defined as excess of actual cost over budget. Cost overrun is also
sometimes called "cost escalation," "cost increase," or "budget overrun." It is simply calculated in one of
two ways: either as a percentage, namely actual cost minus budgeted cost, as a percentage of budgeted
cost, or as a ratio, viz. actual cost divided by budgeted cost. For example, if the budget for a project was
£100 million and the actual cost was £150 million then the cost overrun may be expressed as 50 percent or
by the ratio 1.5.
Background
Cost overrun is reportedly very common in infrastructure, building, and technology projects. One of the
most comprehensive studies [1] of cost overrun that exists entitled Megaprojects and Risk by Bent
Flyvbjerg in 2003, found that 9 out of 10 projects surveyed overran, and that overruns of 50 to 100
percent were common. For IT projects in particular, an industry study [2] by the Standish Group in 2004
found that the average cost overrun was 43 percent, and that 71 percent of projects were over budget,
over time, and under scoped.
Spectacular examples of cost overruns have been well documented. For example, the Sydney Opera House
had a 1,400 percent overrun and the Concorde supersonic aeroplane experienced a 1,100 percent overrun.
Cost Overruns
So what causes projects to incur cost overruns? The fishbone diagram below highlights many of the factors
that contribute to increased costs and overruns.
Some obvious causes of cost overruns are listed below:
project and requirements not clearly defined , agreed and prioritised e.g. as evidenced by
"wish lists"
inappropriate choice of design
inadequate data and hidden or unforeseen problems and costs
scope creep
absence of controls over spend e.g. accountability for spend not matched with responsibility,
costs not monitored or reviewed, lack of any change control
skills and resources not available when needed or not managed effectively
timescales extended
insufficient checking of work, waste and rework
lack of project direction and weak and inexperienced project management
little or no evaluation of cost drivers or understanding of direct and indirect project costs
insufficient use of planning tools and techniques e.g. little or no evaluation of the critical path
and the impact of change in a critical activity on the plan
poor estimation or forecasting especially of demand and revenue
lack of option appraisal on costs, quality and time and the evaluation and impact of lower
cost alternatives
absence of a quality plan and lack of agreement on quality as evidenced by the setting of
deliverables, review mechanisms and acceptance criteria
inbuilt complexity and time delays e.g. over-engineering or inappropriate use of time buffers
during or at the end of the project plan
poorly integrated plans and imbalance between people processes and systems - resulting in
additional costs later to correct the imbalance and avoid failure
inadequate account of safety, legal, regulatory and environmental factors
lack of agreements /contracts where there are dependencies on third parties, or contracts
with third parties not aligned to internal project objectives, costs and benefits
risk averse culture or just simply issues and risks not adequately considered and dealt with
political pressure, vested interest groups, or simply fear of lack of approval
poor communication and decision making
By way of example, the Sydney Opera House overran primarily because construction was pushed ahead
before technical design problems were solved leading to significant rework and rebuild. Pressure was then
placed on costs and payments resulting in the resignation of the key architect and further delays.
Concorde overran primarily because it was politically led with contractors working to government, with
duplicate assembly lines then established in France and the UK and high-cost high-fuel consumption
aeroplanes purchased only by the respective state airlines.
Whilst culture and politics may be difficult to deal with and may be beyond the capability of a single project
manager, programme and project managers can nonetheless draw on various project management
methods and tools to assist them to manage and reduce costs.
The
relationship between cost drivers and project management tools is displayed in the
table below.
Clearly the table suggests that the above tools and techniques can have a significant impact on many
potential cost drivers.
"The first step in reducing project costs overrun is to acknowledge that a substantial risk of overrun exists".
Techniques and supporting measures need to be put in place to manage and reduce the risk.
These include:
Details on some of the above techniques and how to use them are set out below.
Use of accepted project management methodologies and tools such as Prince 2 or PBOK along with a good
degree of common sense will go some way to getting the project setup properly.
A clear project brief with defined objectives and scope plus assigned and agreed ownership of
clearly defined deliverables and built in
Review mechanisms for review and sign off
Detailed tasked and integrated project plan with discrete manageable stages including
sensitivity analysis and evaluation especially of the critical path, supported by a detailed
agreed resource plan including unavailability e.g. holidays
Clearly defined individual team and stakeholder responsibilities and accountabilities
Processes defined for identifying, recording and managing risks, issues, assumptions,
dependencies and decisions (often referred to as a RAID Log) and changes.
Finally it's important that leadership, stakeholder and risk management issues are factored into projects
early and discussed openly at project board and steering group meetings. Projects should be run on the
principle of "no surprises" supported by an open supportive culture, thus avoiding the practice of issues
typically being discussed behind closed doors.
Fundamentally the business case must be detailed, timed, easily understood with clearly defined itemised
costs and benefits and a ROI signed off and monitored by at least Finance.
In building up the business case it is also important to establish realistic estimates of costs based ideally on
past experience or validated from various sources.
Identifying Costs
In identifying costs it is useful to distinguish between direct and indirect costs
Project Indirect Costs - Costs that cannot be associated with any particular work package or
project activity and tends to be fixed e.g. management, administration and interest
Direct Costs -Normal costs that can be assigned directly to a specific work package or project
activity e.g. labour, materials, equipment, and subcontractors
Once direct and indirect costs and key drivers have been identified it is then useful to prepare a cost
duration graph to inform project timeline decisions and run sensitivity analysis to inform which critical
activities and costs should be focused on.
Note reducing project duration may reduce indirect costs but may increase direct costs by having to put
more resources on the project.
Identify lowest cost activities which could reduce project duration and cost
Assess options and lower cost alternatives e.g. internal v external resources, insourcing v
outsourcing,
Explore different delivery options and processes e.g. run cross functional end to end process
workshops to drive requirements, run training internally
Compute the cost benefit of reducing project time and cost
Perform impact assessment on risks and issues and build in a contingency factor. A project's
budgeted costs should always include cost contingency funds to cover risks (other than scope
changes imposed on the project).
In summary, focus should be on what drives and adds value to desired project output (a lean principle) so
benefits should also not be ignored and often can alleviate cost increases by tying them to benefit delivery.
Spending time on benefit assessment can improve the viability of the project and identify further potential
benefits as well as quick wins which help deliver early benefit and commitment. But as evidenced below
calculating benefits and forecasting demand/ revenue isn't as straight forward as it seems.
The cost overrun for the Channel tunnel between the UK and France was 80 percent for construction costs
and 140 percent for financing costs. This coupled with a significant shortfall in revenue projections resulted
in near collapse and significant long term refinancing. Traffic forecasts were in the early years of the project
wildly optimistic. This was explained by the need to preserve shareholders and banks confidence when the
cost overruns became apparent. After the tunnel was completed the forecasts became more conservative.
Unfortunately, this is not untypical.
For example the UK Dept of Transport is reasonably satisfied if the original forecast of traffic flow for the
year after opening a section of a new road is within 20% of actual flow for that year. In a study carried out
by the Dept 22 of 41 road schemes were within this limit; the other 19 had differences from forecast from
-50 to +150 percent.
In summary Flyvbjerg in his book on Megaprojects and Risks argues that traffic and revenue forecasting
cannot be relied on and can have serious consequences on viability. He suggests that there is a need for
more institutional checks and balances, the use of performance specification, penalties for forecasting and
estimating errors and the use of risk capital to deliver a stronger commitment to produce more accurate
forecasts.
Sets out all the individual activities that make up a larger project
Shows the order in which activities have to be undertaken
Shows which activities can only take place once other activities have been completed
Shows which activities can be undertaken simultaneously, thereby reducing the overall time
taken to complete the whole project
Shows when certain resources will be needed.
In order to construct a CPA, it is necessary to estimate the elapsed time for each activity - that is the time
taken from commencement to completion.
Once the CPA is drawn up, it is possible to see the critical path - this is a route through the CPA, which has
no spare time (called 'float' or 'slack') in any of the activities. In other words, if there is any delay to any of
the activities on the critical path, the whole project will be delayed. The total time along this critical path is
also the minimum time in which the whole project can be completed.
A simple example of a CPA is shown below where the letters represent tasks and the numbers task
duration, with earliest start and latest finish times shown in the top right and bottom left respectively of the
circles. Critical path is shown in red where the earliest start and latest finish times are the same.
How much work should have been done to date - Budgeted Planned Work
How much money has actually been spent to progress the project to date - Actual Spending
What is the value of work that has been accomplished to date - Earned Value
The above terms are defined as:
Budgeted Planned Spending = Budgeted Cost of Planned Work (often referred to as BCPW)
Actual Spending = Actual Cost of Work Performed
Earned Value = Budgeted Cost of Work Performed. The value in terms of budget of what has been
actually completed at a given point in time (or, % complete X Planned Spending)
Earned Value Analysis can also be used to predict future performance by extrapolating the above with
estimates to complete based on performance to date ( assuming future performance will of course be the
same as that to date- which to be fair is rarely the case).
Set out below are tips on managing and reducing project costs:
Conclusions
This article has focused on techniques for managing and reducing project costs. We should not forget that
projects are run and delivered by people so stakeholder analysis, strong governance and effective
communication are equally important.
References:
[1] Megaprojects and risk: an anatomy of ambition, by Bent Flyvbjerg, Nils Bruzelius, Werner Rothengatter
[2] Standish Group, 2004. CHAOS Report (West Yarmouth, MA: Author)
[3] A study in project failure; Dr John McManus and Dr Trevor Wood-Harper Chartered Institute of IT
Dave Rochford is the Managing Director of Implement CRM and is a leading exponent of effective customer
service and management. He has been assisting companies to implement profitable customer service and
management solutions for the past 20 years.
You can e mail him at dave.rochford@implementingcrm.com or call him on +44 (0) 7765 235912
Impleme
nt CRM
Ltd
Home |
Services
| Case
Studies
|
Worksh
ops |
Events
&
Articles
|
Contact
Us |
Links
All Rights
Reserved
© 2010
Impleme
nt CRM
Ltd