The Hidden Reasons Behind Construction Budget Overruns
June 08, 2022
As many as nine out of ten capital projects experience budget overruns, with the average overrun being between 25-30% of the project’s budgeted costs.
There are several reasons why project overruns exist, but if we look at the life cycle of a project, we can identify areas where we’re more likely to run over budget. The following image is a simplified representation of a project’s journey from inception to operations:
It All Starts with ROM
During the project identification stage, rough order of magnitude (ROM) estimates are typically prepared to create a budget for the project. This budget may be + / – 50% of the project’s actual costs but is an important step to get decision makers aligned on the cost of the project relative to the value the project brings to the organization.
What are some ways in which organizations can tighten up this initial ROM estimate? Many organizations rely on benchmarks, which are most valuable when a normalized history of like work, geography, skill level of local labor force, commodity pricing and other issues (regulatory, statutory, etc.) can be leveraged.
If an organization’s history does not align with these factors, then some reliance upon industry data for typical construction tasks (“norms”) can be expected. But will those norms encompass the actual work conditions expected in the field, or should they be factored to more accurately reflect the project being considered? Congested areas, incomplete design, political risks and extreme weather can all negatively affect the project’s execution performance and should be considered as early as possible in the project’s journey through the various phases of planning.
Rolling with the Changes
As the project’s scope becomes more refined, changes to the design and engineering occur frequently. Estimating teams often struggle to keep up with iterations in the project’s design, as engineers update their respective disciplines. Keeping track of those changes can be difficult, especially if the level of granularity between the estimate and the detailed design differs. In many cases, individual line items extracted from engineering tools are summarized into a cost estimate and new changes to those detailed line items can present an issue of understanding how those detailed changes affect the estimate’s summarization.
As project teams prepare for execution, it’s imperative that the actual contracts being created reflect the assumptions that went into the cost estimate. In some cases, a contingency fund can be included as a part of the estimate, to be able to offset market fluctuations such as supply chain issues and inflationary pressures.
How are changes to scope handled as the project moves into the execution phase? Ideally, the project’s scope will have been solidified and we shouldn’t expect major changes, but in some cases these can be inevitable. Should these changes exhaust a contingency fund at this point, or is it better to re-budget the entire project? Both can and do happen on capital projects, and having a disciplined approach towards drawing down contingency can help with this issue.
Executing On Point and On Budget
During the execution phase of a project, many opportunities exist to experience overruns of both cost and schedule, which are inextricably linked. The reasons for this can be numerous: how was the level of detail in the estimate communicated to the project team? In some cases, these details are summarized to the point where project teams aren’t able to leverage the granularity with which the estimate was created. In other cases, project teams have their own ideas of how the project will be executed, which may run counter to some of the assumptions made during the estimating process.
As execution progresses, short-interval planning can help project teams to ensure the pieces of the execution puzzle, such as construction work packages and installation work packages, are put together efficiently. Daily planning can ensure that the best use of onsite resources is achieved, helping to mitigate costly delays and overruns.
In many cases, “side” spreadsheets maintained separately by project team members are built to capture changes, productivity levels and other issues. However, having data in too many places can take too long to tie together, providing limited visibility to the broader team. As a result, it may be difficult to identify trends prior to cost and schedule damage taking place. Further, by the time these side sheets are compiled and reported upon, the net result is a widely fluctuating forecast of final costs, which causes project team members and management to lose confidence in these projections.
Closing Out with Confidence
Project close-out and commissioning, if treated as a discrete event, can cause schedule slippage, which negatively impacts the cost performance of the project. By waiting too long to create and gather the necessary documentation, project teams miss an opportunity to create a seamless handover. Successful project teams tend to act purposefully, creating and managing quality documentation and processes as they execute the project, so the ultimate close-out of the project is a byproduct of this careful planning process.
Throughout a project’s entire life cycle, another issue affecting cost performance is known as “optimism bias.” This is the tendency to disregard real-world factors, which can ultimately result in project cost and schedule overruns. Identifying these risks, and having a mitigation strategy for each, can help to protect budgets if, in fact, these issues do arise.
As we’ve seen, there is really no single trick to finding ways to keep a capital project running on time and on budget. Instead, there are several opportunities to protect budgets and schedules at the various stages within a project’s life cycle.
Ready to take a deeper dive? InEight can help get your projects where they need to go and help you create a solution or view that matches your needs while leveraging your teams’ existing strengths. Let us show you how.
 Construction Projects Cost Overrun: What Does the Literature Tell Us? International Journal of Innovation, Management and Technology, Vol. 8, No. 2, April 2017.