Wrong Cost Estimates? – Solutions to Improve Project Profitability

Wrong Cost Estimates? - Solutions to Improve Project Profitability
Solutions To Improve Project Profitablity

During project execution most of us have dealt with the issue of wrong cost estimates. This issue becomes a serious concern especially when you are working on a fixed price contract, these contracts pose a great risk to project margin as the team has to work with zero escalation of costs until the delivery of the project. While developing the budget for a new project it is an accepted practice to refer to costs incurred in a previous similar project. Though this is a very simple and established method of arriving at the project cost, it has its own drawbacks. Since projects are unique it is expected that the costing methodologies adopted should also be different for each project and moreover it should produce reliable and accurate results which can ensure that the project is not subjected to the shocks of blowing cost estimates.

Reasons for Inaccurate Cost Estimation

Based on my experience of handling EPC projects I have worked out the list of causes that lead to errors in the project costs. Neglecting these issues pose a serious threat to the overall health of the project as project margins are under grave risk of erosion. Following are the likely causes for wrong project cost estimates.

  • Lack of Trained / Experienced Resources

  • Ambiguous Project Requirements

  • Not Referring To Lessons Learned

  • Expected Market Trends

  • Overall Project Schedule

  • Taxes & Duties

  • Exchange Rates

  • Finance Costs

  • Logistics Cost

A brief explanaition of the above factors is as follows.

1. Lack of Trained / Experienced Resources

Many organizations do not have costing and estimation department, during the bid phase of the project, a team is nominated to work out the project cost. Not all team members are trained in costing and estimation process, moreover, this work is done in addition to routine activities of other ongoing projects. Since the activity is being carried out by untrained / inexperienced resources some important facts or specifications are likely to be missed out. Not everyone has the experience and knowledge to read in between the lines of a voluminous contract or tender specifications and understand the implication of their action. Hence it is pertinent to mention that the team carrying out the costing work is competent enough to understand long term implications of their acts of omission and commission.

2. Ambiguous Project Requirements

The project cost is developed based on tender documents offered by the customer. Despite the detailed specifications mentioned in the tender some important and critical details are missed. These details cannot be left to somebody’s assumptions but needs to be clarified before firming up the final costs. The missing requirements are not limited to technical specifications of the plant or equipment alone but can also be from areas like:

Factors That Add Inacuracies to Project Cost

  • Payment terms and conditions

  • Quality and inspection requirements

  • Document submission and approval

  • Plant performance and acceptance criteria

  • Minimum manpower deputation criteria

  • Boarding, Lodging and Local Conveyance

  • Site visits and project review meetings

The above list is not all inclusive, based on the industry there could be other issues affecting the costs.

3. Not Referring To Lessons Learned

Not all organizations follow the best practice of documenting lessons learned prior to project closure. These organizations tend to repeat the same mistakes over and over again. Even if, it is the same person, involved in costing as well as project execution, he may not remember every area of cost overrun and may not even be in a position to understand the reasons for the same, hence he may not be in a position to take corrective and preventive actions while developing costs for a new project.

The experience of the previous project should be thoroughly analysed, areas where there was cost overrun in the previous similar project should be studied and the probability of re-occurrence should be estimated and sufficient contingencies added for any surprises.

If the excess cost was due to incorrect technical specifications, a good way of reducing the impact on a new project could be to approach the customer and seek approval on the revised technical specifications.

4. Expected Market Trends

Relying totally on past procurement prices could be dangerous. Even if the team is working with fresh quotes it is advised that these prices be revised upwards with a suitable factor based on the present market trends and the market forecast. This is relevant for items like stainless steel, or other imported items which are affected by global market trends. Many websites track global commodity prices and these can be handy while developing project costs.

5. Overall Project Schedule

Neglecting the project schedule can cost dearly. The overall execution schedule should also be referred to while developing the project costs. If the procurement activity is scheduled to commence say after 6 months of project start then the market conditions that are likely to prevail during that phase of the project needs to be anticipated and accounted for in the costing process.

6. Taxes & Duties

Understanding various taxes and duties applicable on project deliverable is a complicated affair but should always be catered for by the project costing team. If required assistance of various relevant departments should be ascertained to avoid any surprises during the execution phase of the project. Customer can also be involved in this exercise as there are many benefits that can be passed on to the customer.

7. Exchange Rates

Another complex area for project managers and team members, but an absolutely essential issue, that needs to be considered while working on project costs. There are competent departments to work for in this area and there inputs should always be considered especially if the project has imported components. Other factors like local taxes and duties, transportation charges, loading and unloading of the material should be incorporated for imported components as well.

8. Finance Costs

Considerable amount of cost is incurred while dealing with banks for activities like receiving payments through Letter of Credit (LC), revisions to LC documents, extension of Letter of Credit etc. If not explicitly mentioned in the contract these charges should be considered for the compete life cycle of the project.

9. Packing Cost

For domestic as well as international projects, the packing and logistics charges are quite substantial. Especially, for large fabricated equipment, as shown in the tweet below, if the cost for support structure, loading of the equipment for transportation has not been considered, it can have an adverse impact on the overall cost of the project. Tender documents clearly specify the kind of packing required, if this is not stated then it needs to be clarified with the customer. 

10. Logistics Cost

During the shortlisting of logistics provider for the project in consideration, it is essential that every logistics provider carry out a survey of the transportation route. Route survey becomes critical if the project is being executed in a remote location. At times consignments get stuck in remote areas leading to unforeseen delays and cost overrun as additional resources needs to be deployed to bail out the situation. Adequate contingency for unforeseen events like floods, etc, should be built up in the schedule while estimating duration for transportation of goods.

Attributes Of A Good Costing Model

No one likes surprises, especially if it is a project. Every effort needs to be made to eliminate all reasons that can have negative impact of project performance, however , some imperfections will always remain. The window to work out a project cost is very narrow, the costing team / project team does not have the liberty to work on all aspects and develop a full proof project cost. Spending too much time on costing has its own risks of missing the proposal submission deadline or submitting exorbitant high cost and thus loosing the order. Hence , the project team should develop a costing model such that

What a Good Project Costing Model Should Have?

  • It can with stand the test of time.

  • Can be used for varying scenarios and complications.

  • Is easy to use by team members.

  • Flexible enough to cater for changing needs of the project / customer.

  • With minimal or no tailoring can be applied to both large and small projects.

Summing it Up

Hope I have incorporated major factors that affect costs of engineering, procurement and construction  projects and have also suggested remedial measures. I would like to hear from you if there are other issues that can prevent wrong estimation and solutions that can help improve project profitability.

For any queries please use the contact form.

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