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 a result project team has to work with zero escalation of costs until completion. This post identifies reasons for wrong cost estimates and also presents solutions to prevent project cost estimates going haywire.
Wrong Cost Estimates Causes.
Based on my experience of handling EPC projects I have worked out the list of causes that lead to inaccurate project cost estimates. Neglecting these issues pose a serious threat to project health as project margins are under grave risk of erosion. Following list enumerates the causes of wrong cost estimates.
- Cost Data of Previous Similar Project
- 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 explanation of the above factors is as follows.
Cost Data of Previous Similar Project
While developing the project budget 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. Each project is unique. Thus it is advisable to adopt a different costing methodologies for each project. Moreover, costing methodology adopted should produce reliable and accurate results. So that, wrong cost estimates do not adversely affect project margins .
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. Certainly, not all team members receive adequate training to carry out costing. Moreover, project team carries out this work at the expense of routine project activities. If untrained or inexperienced resources carry out cost estimation this may add errors to project costs. Not everyone has the experience and knowledge to read in between the lines of a voluminous contract. Hence the costing team should be competent enough to understand implications of their acts of omission and commission.
Ambiguous Project Requirements
The tender documents forms the basis for project cost calculations. Despite the fact that a tender consists of detailed project specifications it may lack some details. It is a good practice is to clarifying these details before firming up the costs. Sometimes, the missing requirements are from areas other than technical specifications. But can also be from different areas. Neglecting these factors often results in wrong cost estimates of a project.
Project Assumptions That Lead to Wrong Cost Estimates
- Payment terms and conditions
- Documents required to receive payments
- Quality and inspection requirements
- Document submission and approval criteria
- 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.
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. Involving the same team for costing as well as project execution does not solve the problem. He may not remember every area of cost overrun. He may also not be in a position to understand the reasons for cost escalation. Hence he may not be in a position to take corrective and preventive actions while developing costs.
Analyse lessons learned of previous project for cost overrun. Estimate probability of recurrence and add sufficient contingencies to meet any surprises.
If the excess cost was due to incorrect technical specifications. Then a good way to reduce cost of new project is to approach the customer to revise the technical specifications.
Expected Market Trends
Relying totally on past procurement prices could be dangerous. Revised prices upwards even if the team is working with fresh quotes. Use a suitable factor based on present market scenario and future trends. Global market trends affect prices of items like stainless steel, or other commodities. Hence during cost estimation these material require special. Many websites track global commodity prices and these can be handy while developing project costs.
Effect of Project Schedule on Wrong Cost Estimates
Neglecting the project schedule can cost dearly. Refer to the overall execution schedule while developing the project costs. If the procurement activity is likely to commence say after 6 months of project start; then anticipate market conditions likely to prevail during the period. Revise the cost with a suitable factor that can account for price escalations.
Taxes & Duties
Understanding various taxes and duties applicable on project deliverable is a complicated affair. But the project costing team should always consider the impact of taxes & duties. Team should ascertain assistance of relevant departments in order to avoid any surprises during project execution.
Figuring out impact of exchange rate variation is a complex area for project team. But it is an absolutely essential issue, that needs consideration while working on project costs. Consider inputs from competent departments to avoid any cost burden form in this area . Especially, if the project has imported components. Other factors such as local taxes & duties, transportation charges, loading and unloading of the material should be incorporated for imported component.
Financial transactions incur considerable cost. It is prudent to include cost of activities such as revisions to Letter of Credit (LC,) and extension of LC. Moreover consider finance costs taking into account all project eventualities.
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. The costing team should seek clarifications if any ambiguity persists.
While shortlisting a logistics provider, it is essential to survey the transportation route. Route survey becomes critical project sites in remote location. Failing to conduct a route survey leads to stuck consignments in remote areas. This further results in schedule delays and cost overrun. Bailing out the situation calls for deployment of additional resources. Moreover in the absence of route survey the schedule needs adequate contingency for unforeseen events like floods. Thus unnecessarily increasing the project timeline.
Wrong Cost Estimates Implications
Inaccuracies in project cost estimation has serious implications to any project. Following list enumerates the most common impact of wrong cost estimates
- Wrong cost estimates can seriously dent project margin
- The project may suffer from numerous delays
- Wrong cost estimates may lead to a shelved project.
- The organization may even decide to terminate the project suffering from serious cost inaccuracies.
- Inaccurate cost estimates may impact the quality of deliverables.
- Reduced overall customer satisfaction.
Wrong Cost Estimates Solutions
No one likes surprises, especially if it is a project. The costing team makes all effort to eliminate causes that can negatively impact project performance. However, some imperfections will always remain. The costing team does not have liberty to work on all aspects to develop a full proof project cost. Spending too much time on costing has its own risks of missing proposal submission deadline or submitting exorbitant high cost. Thus losing the order. Hence , the project team should develop a costing model such that:
Attributes of A Good Costing Model
- It can withstand the test of time.
- Suitable for use in varying scenarios.
- Is easy to use by team members.
- Flexible enough to cater for changing needs of the project / customer.
- Applicable to both large and small projects, with minimal or no tailoring.
Wrong Cost Estimates Conclusion
Finally, I hope that I have incorporated major factors that lead to wrong cost estimates of engineering, procurement and construction projects and hope I have also suggested remedial measures. I would like to hear from you if there are other issues that can prevent wrong cost estimates and provide solutions that can help improve project profitability.