A detailed cost estimate for a capital project is a very complex series of assumptions that are made about construction that may take place in the future. These assumptions include costs for resources, such as labor, equipment and materials, and also the relative availability of long-lead items and specialty services. It is a very common construction practice to solicit and receive quotes from services providers and materials vendors when putting together cost estimates for capital projects, especially as projects near the execution phase. And in almost all cases, these quoted prices come with an expiration date.
But the environments in which those quotes live can change rapidly, directly affecting capital projects. Back in the early 2000s, the industry saw a sharp rise in metals prices as copper soared from around $.60 per pound in 2001 to almost $4 per pound in 2008. Just recently, we’ve seen other real-world examples. This includes the imbalance between supply and demand in the lumber market resulting in materials prices jumping 300% in just a few months, with very little forewarning. Price fluctuations have also recently affected fuel costs, which has a ripple effect on the costs of asphalt, plastics and other petroleum-based chemicals and commodities commonly used in construction.
Though contractors can include any shelf-life caveats as a part of their bid proposals to project owners, what if the contractor is assuming some of the risk while acting as an EPC? And how can owners best insulate themselves from price fluctuations as candidate projects progress through a lengthy and detailed series of stage gates prior to an investment decision being made?
Leveraging for the Unknown
By tying together cost models and schedules, a time-phased view of budgets and resource utilization can help identify when specific costs are expected to be incurred. For some predictable cost increases, for instance a new labor union agreement taking effect, the cost impact can be easily handled through escalation percentages applied to date ranges. As schedules shift during the pre-construction phase, cost estimates can be easily and dynamically updated as schedule activities slide into and out of pre-defined escalation periods. Some cost increases may not be as easy to predict, however. This is where trend analysis may be leveraged to create a contingency reserve for the “known unknowns” facing a project.
Many organizations have developed the ability to leverage past costs and productivity measures, allowing them to predict the directions in which these costs may be moving as particular trends can be identified for specific types of work. Several factors can affect these benchmarks, ranging from increased commodity pricing to the aging and retirement of skilled workers being replaced by a lesser skilled workforce. Contingency reserves can be created, either as specific dollar amounts or as a percentage of specific anticipated costs. As cost escalations occur, budget moves can manage the process of offsetting increased costs from these contingency reserves. Many organizations have developed strict guidelines as to how much contingency should be set aside for a project as it progresses through approval gates and into execution.
The Triangle of Time, Cost and Scope
Time, cost and scope of project management can also come into play if a capital project’s budget is hindered by unexpected cost increases. In this case, a time phased escalation of costs or a contingency reserve may not have been planned in advance, while a fixed budget may exist for the project. Robust cost modeling capabilities can help organizations decide which elements of the scope can be preserved or omitted from the project as “what-if” analysis is performed to ensure the appropriate return on investment for each dollar of spend. In some cases, it may be decided that certain work may be deferred until such time when commodity prices are expected to stabilize.
Remaining Realistic WHen Planning Capital Projects
While it is unlikely that all risk due to cost fluctuations can be eliminated for all capital projects, organizations can develop best practices to ensure that trends are taken into consideration when planning capital projects. With the vast amount of data that surfaces during the course of project planning and execution, those organizations that are able to harness and leverage that data will be setting themselves up for continued success.
When you’re ready, contact InEight for a demo of our integrated construction management software and see how we can streamline your project processes.
