Cost escalation is the increase in the price of materials, equipment, and labor between the time a project is estimated and the time the work is bought and built. On a multi-year capital project it is a certainty, not a risk, and it ripples beyond the line item into schedule, quality, and the owner-contractor relationship. Planning for it means knowing its causes, pricing it into the estimate and the contract, and tracking it against the budget as the project runs.
How Does Cost Escalation Affect a Capital Project?
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.
What Causes Cost Escalation in Construction?
Commodity pricing can be fickle, subject to causes that are as wide-ranging as their effects:
- Inflation cycles, and the talk of slowdown or recession each one brings, which changes how owners fund projects
- Swings in energy and production costs
- Geopolitical conflict and shifts in trade policy that disrupt international supply chains
- Weather- and disaster-related events that threaten domestic supply
- Surges in infrastructure spending that raise demand, and prices, for materials
- One-off shocks: the pandemic showed how far-reaching the effects of a single event can be
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.
5 Ways to Plan for Cost Escalation
Each of these works at a different stage of the project, from planning through construction:
| Strategy | Project stage | What it does |
| Assess past projects | Planning and estimating | Shows how pricing risks and contingency plans actually played out |
| Create contingency plans | Planning and estimating | Prepares responses to price swings, informed by past projects and current market conditions |
| Allocate risk in the contract | Contract negotiation | Shares escalation risk between owner and contractor instead of leaving it with one party |
| Negotiate early and order ahead | Procurement | Locks in lower rates on available materials, weighed against storage costs |
| Track costs in software | Construction | Shows the impact of escalation on costs as it happens |
1. Assess How Pricing Risks Played Out on Past Projects
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.
2. Create Contingency Plans for 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.
3. Address Risk Allocation in the Contract
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.
4. Negotiate Pricing Early and Order Inventory Ahead
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.
5. Track Escalation With Cost Management Software
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.
How InEight Estimate and InEight Control Help Manage Cost Escalation
Cost escalation has to be handled twice: once in the estimate, and again in the budget as the project runs. InEight Estimate covers the first. Built-in benchmarking compares estimate values and productivity rates against the high, low and average figures from your own past projects, and quote management keeps subcontractor and vendor pricing in one place so late price changes can be updated before the bid is final.
InEight Control carries that estimate forward. It creates the construction budget directly from the estimate, keeps multiple budget versions as it evolves, and updates the baseline automatically as change orders are approved. Forecasts for remaining work draw on actuals from the field and your financial system, and you can compare forecast versions and run what-if scenarios to see how a price spike would play out before it reaches the bottom line.
