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Cost Overrun in Construction Projects

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Any opinions, findings, conclusions or recommendations expressed in this material are those of the authors and do not necessarily reflect the views of UK Essays.

Published: Fri, 09 Feb 2018

Aim

The aim of the dissertation is to identify and explore the various causes of cost overrun associated with construction projects.

Objectives

  • Identifying the main causes of the cost overrun in the construction projects through literature review.
  • To identify the various measures of cost overrun in construction projects.
  • To examine the affects of the cost overrun by analysing the case of a construction industry.
  • Analysing the information from the literature review and case studies to provide further recommendation and suggestions to overcome the cost overrun effect.

Research Methodology

To achieve the above aims discussed above it is very important to do extensive research by studying books, journals, articles on internet. Qualitative method is the research method that will be the main research method used incorporating

Observations

Questionnaire

Case studies

Present dissertation the author has used two main research methods questionnaire survey, case studies. The author has prepared questionnaire with 18 questions and forwarded to 10 companies. The questionnaire survey provided valuable data that can analyse, useful for outcome of the research. The author has studied different case studies from India to identify various causes for failure of the project. Analysis on the case studies gives the idea of various measures to overcome cost overrun.

Introduction

Constructions are full of risks and include those that may relate to cost overrun, external commercial factors, design, construction and operation. In any construction projects the three primary factors that is time, cost and quality will be likely to subject to risk and uncertainty. This cost overrun can be minimised by the realistic estimation which can be anticipated from the experience and foresight. Managing project costs accurately and responsively is a challenging task for the design team, construction manager, builders and consultant. Effective cost management is dependent on following a consistent methodology, utilizing appropriate standards, concentrating efforts for maximum effectiveness and utilizing all the tools available. The major problem that arises in construction projects is that projects often overrun their cost estimate. This risk of the overrun of cost estimate occurs even with the projects where carefully constructed bottom up cost estimates completed to a very detailed level. In every construction projects the main problem where cost of the entire project is not getting most likely, is because of the usual way of constructing a project estimate at completion is that adding the estimates for all work breakdown structure components (WBS). By conducting a cost risk analysis provides a more accurate and realistic estimates of project costs.

Chapter-2

2. Literature Review

2.1 Definition:

The process of project of an infrastructure project when planned is the sponsoring department prepares estimates of time and costs or funds needed to complete the project. The expected date of the completion is also announced. But there will arise some different between the actual date of completion from the expected date. We define “time overrun” as the time difference between the initially planned i.e. expected dates of completion. Therefore, for each project we can define percentage time overrun as the ratio of time overrun and the implementation phase of the project. The implementation of the project is defined as the duration in which project is completed, i.e. the time between the date of approval of the project and the expected date of completion of the project. Similarly cost overrun is defined as the difference between the actual cost and the expected cost of the project. The actual cost is the cost that can be calculated only at the end of the project and the estimated cost is the estimated when the project is planned. The percentage of cost overrun is defined as the ratio of the cost overrun and the initially anticipated cost of the project (Ram Singh, 2009).

According to Lewis and Atherly 1996 a delay may have the direct cost implications in terms of an extended construction period. In other words delay leads to the cost overrun and the extended time will have extra expenses or loses by both parties of the project. When a delay can increase cost and reduce profits then organizations will have more considerations on bottom line (Lewis and Atherly 1996)

2.2 Causes of Construction Cost Overrun

The survey conducted by Iyer and Jha (2005), on the factors affecting the cost performance of Indian construction projects, including the extent of adverse climatic and economic conditions; unfavorable project specific attributes; top management support; monitoring; feedback, coordination, conflict and knowledge of the project participants; and reluctance to make timely decisions. Of these, coordination among project participants was found to be the most significant of all factors, having a maximum positive influence on the cost performance.

Semple et al. (1994), examined causes of claims, delays and cost overrun on twenty four projects in western Canada. The study identified the following as critical factors that lead to cost overruns are (1) contract variations and extras, (2) disputes, (3) soil and site conditions, and (4) delays. The author stressed the need by the industry practitioners (clients, contractors, professionals) to pay maximum attention to the critical factors in order to minimize cost overrun risks.

Chan et al. (1997), examined the principal and common causes of delays which leads to cost overrun in Hong Kong construction projects. The study identified the following factors (1) Poor site management and supervision, (2) unforeseen ground conditions, (3) low speed of decision making by project teams, (4) client-initiated variations and (5)necessary variations of work, as major cause of delay.

Flybjerg et.al. (2003), pointed out to cost estimates as highly, systematically and significantly misleading. According to Flybjerg et al. (2004), the causes for the cost overrun in the construction projects is as follows (1) The length of the project in the implementation phase, (2) the size of the project and (3) the type of project ownership.

According investigation carried by Assaf et al. (1995), on causes of delay in high rise building construction projects in Saudi Arabia, the most important causes are found to be as follows (1) Inadequate designs, (2) slow work progress on site, (3) late payment for completed works and (5) design changes by owners. Here from the above investigation it is proven that all these factors are caused by the lapses in human input factor.

N R Mansfield et al. (1994), investigated and examined the causes of delay and cost overrun in Nigerian projects. The investigation identified the following factors that are attributed to the overrun are finance and payments arrangements, poor or in experience contracting management, material shortages or excess of the materials, inaccurate estimating, and overall price fluctuations

The analysis according to Ram Singh (2009), has shown that there has been significant decline in the time and cost since from early 1980s in India. The investigation shows that major causes for the delays and cost overruns observed in India are deficient project planning process, use of inappropriate procurement contracts and faulty contract management. In regards to project type, the bigger projects are much more vulnerable to cost overruns. Ram Singh also stated that several kinds of organisational-cum-institutional failure also affect greatly to time and cost overruns.

The studies conducted by Elinwa et al. (2001) on the relative contribution of human personnel parties to the projects time overruns and cost overruns in Nigerian Construction industry states that the contribution of clients, contractors and others were 62%, 32% and 6%. The study stated that on the government or private sector projects the delays were at 89% with irrespective of project size. The study also identified the important factors of cost overrun and time overrun are mode of financing, payment delays for the completed works, improper planning and project time and cost underestimation.

Kaming et al. (1997), examined factors influencing constriction delays (time overrun) and cost escalations, in Indonesian cities. They identified project cost underestimation and project complexity as the main causes of project delays and cost overruns.

Chan and KumaraSwamy had conducted a survey on the factors causing the delays in Hong Kong construction projects and had classified them into two groups: (1) the role of the parties in the local construction industry (whether client, consultant or contractor) and (2) the type of projects. The result shows that five major causes for the delays and cost overrun were poor site management and supervision, unforeseen ground condition, low speed of decision making involving all project teams, client initiated variations and necessary variation of work.

Cost underestimation is the one of the main factors for the cost overrun in construction projects. According to the Flyvbjerg, (2003), the cost underestimation exists across 2 nations and 5 continents and it is global phenomenon. The explanation for the cost underestimation is in four types.

  • Technical
  • Psychological
  • Economic
  • Political

Technical Explanation:

Most studies in infrastructure projects that compare actual cost at the completion of the project and estimated cost at the initial contract explain as Forecasting Error in technical terms such as imperfect techniques, inadequate data, honest mistakes, inherent problems in predicting the future, lack of experience on the part of forecast, etc,. [Flyvbjerg, 2003].

Psychological Explanation:

Psychological explanations attempts to explain biases in forecasts by a bias in the mental makeup of the project promoters and forecasters. Politicians may have a Monument Complex engineers like build things, and local transportation officials sometimes have the mentality of empire builders in building roads, railways and bridges. The most common psychological explanation is probably “appraisal optimism”. According to this explanation, promoters and forecasters are held to be overly optimistic about the project outcomes in the appraisal phase, when the projects are planned and decided. [coated in Flyvbjerg, 2003].

Political Explanation:

Political explanations construe cost underestimation in terms of interests and power (Flyvbjerg, 1998). According to Flyvbjerg, 2003, one of the key questions for political explanations is whether forecasts are intentionally biased to serve the interests of project promoters in getting projects started. Cost estimation cannot be explained by the errors and seems to best explained by strategic misrepresentation i.e., lying. These questions of lying are notoriously hard to answer. For legal, economic, moral and other reasons, if promoters and forecasters have intentionally fabricated a deceptive cost estimate for a project to get it started, they are unlikely to tell the researchers and others that this is the case.

Economical Explanation:

Economic explanations say that cost underestimation in terms of economic rationality. Flyvbjerg, 2003, in his journal stated that there exist two types of economic explanation. One explains in terms of economic self-interest, the other in terms of public interest. In case of the economic self -interest, during the process of the project it creates the work for the engineers and construction firms, and many stakeholders who are directly or indirectly attached with the project make money. These stakeholders in directly involved in would influence the forecasting process of the project, which in turn influence the outcomes the ways that make it more likely that the project will be built. Stakeholders would likely increase in their revenues and profit by having the cost underestimation and benefits over estimation which would be economically rational for such type of stake holders. In case of the second term public interest, project promoters and forecasters may intensively underestimate cost in order to provide public officials with an incentive to cut costs and thereby to save the public’s money. According to this type of explanation, the more cost estimate is the incentive of the wasteful contracts to spend more of the tax payer’s money.

Hence the both types of the economic explanation account well for the systematic underestimation of the costs.

Several researchers on the subject of construction cost overruns have come out with significant findings that factors that leads to time overrun (construction delays), will eventually leads to cost overrun. From the above literature it is also found that the size of the construction project is also one of the main reasons which influence the cost overrun. The researchers stated that the main factor leading to delays have been always studied alongside those leading to cost overrun.

2.3 Cost overrun in India

Background

Cost overrun is becoming common in infrastructure projects. Through the various analyses it is found that the time delay and the cost overrun are the main reasons for the poor project performance. Morris and Hough found 63% of 1778 different types of projects funded by the World Bank between 1974 and 1988, experienced significant cost overrun. kamrul Ahsan and Indra Gunawan, (2008), in studies conducted on the time and cost performances in Asian countries had found out only few projects i.e. 13% are completed within time and budgeted cost. In contrast more projects are time delay and cost over run on an average amount of over spending U.S. $73million, i.e. 22% average planned cost. The case study conducted by the Standish group (2004) for IT projects the has found that the average cost overrun was 43%, 71% of projects were over budget, over time and under scope and the total waste was estimated at U.S. $5 billion per year in U.S.A alone. In-accuracy in cost estimates is also one of the main factors for the cost overrun in the construction projects. According Flyvbjerg (2002), the under estimation of costs in construction were almost 9 out 10 projects. For randomly selected projects, the likelihood of actual costs being larger than estimated cost is 86%. The likelihood of the actual costs for the construction projects is being lower than or equal to estimated cost is 14%. The actual cost of the projects on average is 28% higher than the estimated cost. The best example for the above case is Suez Canal was constructed at costs three times of the estimated cost with 1,900 percent (Flyvbjerg et al, 2002). The Kakkad hydro -electric projct could be commissioned in time in 1986 itself, 8 years after its construction started. Accounting for general price inflation during this period , thecapital cost of this project by 1986 would be atmost only rs 39.66 crores, savings as much as Rs. 113.86 crores, almost enough to construct 3 more similar plant, or to add to the system capacity y another 140 MW at the nominal cost of Kakkad project in Kerala (Kannan and pillai 2001).

The ultimate motive in undertaking the project is to make profit. These profits may be measured in different ways and the most familiar profit is money. The goals of the others in making the project may be to make work, to improve living standards, in produce of the products to the others who require it or in scarce, to obtain votes for the political carrier and many others. The ultimate result should be the positive outcome during the construction of the project or in the life of the project.

Every project has to undergo several stages starting from the planning of the project, approval, awarding the project to the actual construction and so on. The project life cycle has been divided into three phases they are development phase, construction phase, and operation and maintenance phase. For every project during the development phase the project authority will approves the time and funds needed for the completion of the project. Then after the approval of the project the construction phase will start with the signing of a contract between the sponsoring department and the contractor. Generally the contractor of the project will be selected through the tender or bidding process. For some projects contractor will be for only procurement process. During the construction phase it is very important for the timely completion of the project, so there should be the active cooperation between the sponsoring authority, the contractor and other departments. The project success i.e. whether the project can be delivered on time and on cost depends on how well all the activities of the projects, departments of the projects and individuals concerned are coordinated. The failures among the contractor activities will cause delays in the project and cost overruns. For the ease of exposition, it is helpful to divide the set of possible causes in the following subgroups (Ram Sing, 2009).

2.3.1. Technical and Natural Factors:

It is a complex problem for the estimation of the time and cost for an infrastructure projects, though the techniques for the estimation have been sophisticated there are many imperfect estimations. The contractors and the authorities of the project will better understand about the materials requirement and the necessary changes in the project as the work on the project starts. For example, during the construction phase of the road project, an unexpectedly poor quality of soil may make the changes in the design and quality of the bitumen, from what was initially planned. Because such changes the project may require extra time as well as funds. But in some cases the sudden changes may turn in favor of the project and the parties may find the excessive funds and time. Similarly natural factors like floods and so on also impact the cost and time and as well as destroy the project assets. The natural factors also make favorable conditions in saving the construction time and cost. However, one would expect the effects of the technical and natural factors to be random without any bias. Also form the above discussions the time delay and cost overrun is expected to come down over the years. Therefore if the decline in the time delay and cost overrun is expected to be statistically significant, we attribute the decline to the technical and natural constraints. Time and cost overrun. Hence, the Design changes, unforeseen geological and weather condition during the construction phase are the major causes of the cost overrun. (Ram Singh, 2009)

2.3.2 The Contractual Failures.

As explained earlier the contractor enters the project mostly through bidding in implementation or construction phase by signing the contract with the sponsoring department. Thus for a project to be successful, mostly depends on the implementation of the activities by contractor and the joint and timely efforts of the sponsoring authority and the contractor(s). The actual initial construction or procurement contract is signed between the employer and the contractor is on a particular date. The contract agreement specifies the activities that are performed and delivery of the goods at the project execution by the contractor. In general, contract known as “complete-contingent-contracts which can ensure that the project is completed on time and within budget. These types of contracts are assumed to give the each and every detail of the activities that are performed by the contractor in each possible case during the construction phase. But in real case scenario, however, this is difficult to explain the every work which unfolds in construction phase during the initial phase of the contract. Moreover it does not explain the complete every relevant aspect of the project activities. The bounded relationship of the parties along with the technological constraints makes the contract very difficult in specifying the every aspect of the project till last detail, this is because of the nature of different states require different modifications in the assets to be built. This happens commonly for the contracts of the infrastructure projects because of its complex nature of the activities. Therefore the procurement contracts of the infrastructure projects will be incomplete nature. The need for the future works arises once when the contractors starts the work. For example, on a railway project it may be necessary to have more of manned-crossings or railway-over-bridges than were planned initially. These unplanned additional works requires more funds and also in some cases it takes more time. Therefore, from the above discussion the contract incompleteness is also a cause of the cost overrun in some cases. This contractual incompleteness increases with the increase in the project size. Bigger the project size the complexity also increases. As the complexity of the project increases it is very difficult to provide the each every detail in the initial contract. However the initial contract should be kept with less incomplete. A proper planning for the technical, materials and the activities aspects of the project can enable the parties involved in the project to make the detail initial contract properly and once the proper detailed initial contract is made the contractor may have the scope to make some allowance for the future works by keeping the initial contract with less incomplete. In contrast, the poor planning may lead to the bad estimation of the time and cost and so will be the initial contract. The process of project planning in India is infamous for its ad-hoc and lackadaisical approach. The detailed project reports and feasibility are prepared for the formality purpose and hence they are sloppy. This leads to the incomplete initial contract for the infrastructure projects. Thus this leads to sever problems for the complex projects, because, a lackadaisical planning will produces only sketchy estimates of time and cost. So, in these cases the initial contracts for the complex projects will inevitably omit many more detailed works of the project, which leads in cost overrun in the construction phase of the project. Neither the contractors nor the officials find these contracts are lack of details. From this the major cause which is leading to cost overrun in India is because of the contractual failures caused by the poor contracting processes and inferior project planning (Ram Singh, 2009). The example for the faulty planning techniques and construction made the cost and time overrun of the project in the Kerala state hydro project in kakkad where the leakage in the tunnel had costs the project extra 15 Lacks to repair the damage.( Kannan and pillai 2001).

2.3.3 Organizational failures:

As discussed from the above literature, for the successful completion of the infrastructure i.e. timely and efficient execution the project should have active participation of the all parties involved in the projects and as well as among various ministries. However, the government sector projects are inherently weak in the desired efforts from the people involved in the projects. There will be conflicts at each and every stage of the project with the individual and the social objectives. The wages and rewards given by the government for the working organization are not as effective from the view point as a motivation. Therefore, the government infrastructure projects have to face many sources of failures within the organization. These projects mostly in need of the several other organizations joint effort. In India different departments are responsible for different projects. For example, project implementation of power lines, water lines, sewer lines and environmental clearances and other such activities are performed by the different departments. Execution of the activities is highly dependent on the timely and joint efforts of the department. However the interdependence of efforts is that it will be easy for one department to pass the blame on others. So the infrastructure projects particularly India is vulnerable to these inter-organizational failures. In the project implementation stage as explained earlier several departments were involved in performing there concerned role. After all, the activities like land acquisition, shifting of utilities, etc., are performed by the state government. This says that if the project is span across more than one state, the project has deal with particular department in each state. Therefore the project which is spanning more than one state will have more chances to inter-organizational failures. If these projects are statistically causes the delay in time and cost overrun, then the project which are spanning across multiple states should experience the cost overrun and time delay. Most construction projects in government sector are Roads, Rail ways and urban development sector. The projects should need permission from the central and state government for the environmental clearance. When compared other sectors, these projects require more active cooperation of the several departments such as land acquisition, shifting of power lines, water lines, sewer lines etc. Hence the projects in these sectors are having more chances of the organizational failure. Thus projects in road, rail ways and urban development sectors will exhibits more time delays and cost overrun (Ram Singh, 2009). Kannan and Pillai 2001, in their studies on the cost and time overrun in Kerala Projects suggested that main cause of the cost overrun is due to the human resource management and labours strike.

According to the Auti, et,al. (2008), there has been several changes which should be made to the quality and standards, personal interests, low transparency and corruption . This also suggests that changes should be made in government policy and the way public sector projects are carried out.

2.3.4 Economic Factors:

In India the projects are located in some states and the economy of the state also impacts the cost overrun of the projects. That is the states having the good transportation facilities, power and telecommunication infrastructure to easily execute the project. This shows that project with more economic factors like good infrastructure will face less cost overrun and time delays and vice versa. The income level of the state will also affect the project cost and time (Ram Singh, 2009).

2.3.5 Inflation:

The inflation is defined as the rate of increase in the price level of the materials than they are in an economy (Adamson, 1996). Thus because of the inflation the materials cost will be increased than they during the initial contract, thus increases the estimated cost of the project. The affect inflation may cause the loss in profit to the contractor and project overrun cost to the project sponsor by the nature of process and the return of the work undertaken during the construction process. For example the kakkad(Kerala, India), hydro electric plant which has the time overrun 13 years as in 1999, when it was finally commissioned, the cost escalation of this project was 725 percent over the above estimates i.e. 8 times more than the actual cost the author says the cost escalation of this project is because of the price inflation(Kannan and pillai 2001 ).

2.3.6 Quality of the materials

The low quality materials cause higher construction costs than expected because of lack of standards in the materials. This results in the loss of materials and poor management system (Thungphanich, 1997).

2.3.7. Shortage in materials

Shortages in basic materials like sand, cement, stones, iron and brick causes major delay in the construction. The non availability of the machinery at the right of the construction process is also major cause for the delay in the construction.

The following table shows that the various sectors which went the time overrun and cost overrun in India. These are the delays and the cost overrun during the years April 1992- September 208

S. No.

2

SECTORS

3

Total no. of projects completed

4

% of projects with Time overrun

5

% Time overrun (as % of implementation phase)

6

% of projects with Cost overrun

7

Cost overrun as a %age of initial cost of all projects

8

% Projects with cost but not time overrun

1

Atomic Energy

11

90.91

84

27.27

84

09

2

Civil Aviation

43

90.70

60

41.86

-01

00

3

Coal

92

60.87

28

22.83

-17

03

4

Finance

1

100.00

303

100.00

133

00

5

Fertilizers

16

62.50

25

25.00

00

13

6

I & B

7

100.00

190

42.86

09

00

7

Mines

5

80.00

45

0.00

-26

00

8

Steel

41

80.49

51

19.51

49

05

9

Petrochemicals

3

100.00

74

33.33

14

00

10

Petroleum

119

78.99

33

20.17

-11

03

11

Power

101

62.38

41

47.52

26

05

12

Health and Family Welfare

2

100.00

228

100.00

265

00

13

Railways

120

98.33

83

83.33

84

00

14

Road & Transport

147

86.39

47

53.74

08

05

15

Shipping and ports

60

95.00

78

30.00

01

02

16

Telecommunication

60

90.00

109

16.67

-55

00

17

Urban Development

22

100.00

54

40.91

99

00

Total/Overall projects

850

82.35

56

41.06

21

03

Source: Ram Singh, 2009.

2.4. Measures for the cost overrun

2.4.1. Cost Estimates:

For any project the most important aspect in order to meet the funds of the project is the cost estimation. Small misleading in the cost estimation will lead to the project cost overrun or under run.

Kerzer (2006) have explained about the factors which are affecting the process of the estimation and which results in the faulty estimation for the construction. The factors such as Misinterpretation of statement of the works, Omission or improperly defined scope, poorly defined or overly optimistic schedule, inaccurate work break down structure, applying improper skill levels to tasks, failure to account of risks, failure to understand or account for cost escalation and inflation, failure to use correct estimating technique. The important aspect to be considered is that many of the above factors which are affecting the cost estimation of the construction cannot be found until and unless the cost control system is implemented within the project.

Kerzer (2006) also explained various types of measures in estimating and their accuracy in the cost overrun, they are as follows.

(1) Order -of-magnitude estimates: There is no necessary of any engineering data for these types of estimates. Hence they are prepared without any engineering data and mostly they are based on the past experience. The accuracy


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