Everything that goes into a construction project — building materials, construction supplies, equipment — comes at a cost. And in our industry, we’ve become accustomed to those costs going up. Sometimes it’s gradual. Other times, it’s a sudden spike.
In any case, cost escalations are often not isolated to the item itself; they can have a profound ripple effect that goes far beyond the line-item cost for that material.
The most obvious is the ensuing unpredictability of project outcomes. There’s heightened uncertainty around the impact on the final project cost, particularly if it’s a critical commodity for your project. Or you may be forced into pushing out project completion timelines as other options are explored.
Another potential effect? Compromising the quality of the structure itself. To accommodate cost spikes, the design team may have to face tough decisions in coming up with alternatives in materials, including lower-grade ones, even if more readily available. However, this may not be as much of an issue given the weight assigned to structural integrity, quality and compliance requirements.
And commodity pricing can be fickle, subject to the whims of causes and scenarios that are as wide-ranging as their effects. In the last few years, we’ve had no shortage of them. We’re currently experiencing inflation coupled with the anticipation of an economic blip or an actual full-on recession. Fluctuations in energy and production costs have created volatility in construction commodity pricing. We’re witnessing the disruption of international supply chains stemming from the geopolitical climate (such as the Russia-Ukraine war and Brexit). The randomness of weather- or disaster-related events further threatens supply stateside. While a very good thing for the construction industry and the economy, the increase in infrastructure projects may trigger a corresponding bump in materials pricing due to higher demand. And, of course, we’ve already experienced the far-reaching and devastating macroeconomic effects of a significant health crisis with COVID-19.
Cost escalations are inevitable during long-term capital builds. So, how can you account for them in the planning (and estimating) stage? And how do you manage through them during the construction phase, particularly when they’re unexpected?
Knowing the typical causes of cost escalation is the first step in strategizing how to best navigate through or around them. It can help you take a more proactive approach to cost management that can help improve project outcomes — while maintaining resilience.
Assess the cost performance of past projects to learn how pricing-related risks played out.
What was the impact on the budget? How about the bottom line? Were contingency plans implemented to account for price fluctuations, and how well did they work? If you’re relying on project performance measures like earned value management (EVM), look specifically at the cost performance index (CPI). Its sensitive responsiveness to risk factors makes it a reliable gauge for monitoring the effect of those factors and any backup plans in real time.
Create contingency plans around pricing fluctuations.
As you’re considering the effectiveness of contingency plans from prior projects as a real-world guide for what is likely to work or not, also look at what is happening in the industry and the economic and political landscape so you can take those into account.
Address risk allocation during contract development and negotiation.
Contractors have often been on the hook for absorbing rising costs. But owners may not have visibility into their budget impact. Rather than one party assuming the bulk of the financial burden, surface sharing risk of these cost escalations as the contract is being prepared. Risk sharing sets the stage for a more collaborative approach among owners and contractors to better control and respond to risks and minimize the financial impact for all parties.
Negotiate pricing during procurement and order inventory ahead of time.
This is a preemptive move to take advantage of any negotiated lower rates on readily available materials. It may mean acquiring them en masse — which will undoubtedly be an advantage if they become unavailable down the road, forcing a premium on its pricing. Be sure to weigh any cost savings against the outlay for storing and maintaining excess inventory for the long term.
Use construction-specific cost management software to calculate realistic cost escalation impact.
Meeting established budget outcomes depends in part on how — and how well — you manage costs and mitigate the effect of escalations. Construction cost management software serves as a single source of truth where all cost data lives, from estimating to forecasting to analysis. Its visibility into this real-world data makes it easy to track costs in real time and assess the impact of commodity cost escalations — fueling faster, better-informed decisions and contingency plans that help keep those costs in check.
Indeed, cost escalations present their unique challenges. While such volatility is par for the course in any capital project, how well you anticipate and prepare for them counts. Are you confident in how you’re currently managing the roller coaster of commodities pricing for your projects? If you think you may benefit from a conversation about how construction technology can improve your efforts, set up a time to talk with us — we’re here to help.
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