Cost Estimation Contingency Risk Construction Essay

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This proposal is written to give an overview over proposed compulsory student assignment in the 7th semester part of a Bachelor of Architectural Technology and Construction Management degree course - no responsibility is taken for any advice, instruction or conclusion given within!

Acknowledgements

I want to thank those who left me with materials and research in support of my discussion topics and of course teachers of Via University, for reading, inspections and faith in the project and an everlasting inspiration.

Index:

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Abstract

This report has been written as a compulsory assignment in the 7th semester part of a Bachelor of Architectural Technology and Construction Management degree course.

This report discusses the phenomenon of cost estimate in construction projects, the main focus is on the project estimator, and how he can handle risk and contingency. In this report are given ways to accomplish better performance dealing with cost and contingency, recognize risk and opportunity in time and take action implementing technique and methods to make reliable estimate throughout the project live cycle.

Problem background

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Cost estimation in construction project live cycle is one of the most critical task architects and designers are facing during the design phase of a construction project. From the beginning of an idea of a business case, clients are depended on cost estimation of a certain range of certainty. To be able to give this estimation and the investors are possible use it for their business model and decide on the feasibility of project, we would think that the construction needed to be engineered and designed fully for the most accuracy of the estimate. In most cases this is not an option for the investors, they want to minimize the cost in the first period of the live cycle and decide with confidence to proceed with the project.

Problem Statement

The traditional approach to cost estimating is to derive a best estimate from knowledge of existing conditions based on current rates and prices in similar situations with adjustments to reflect anticipated differences in ground conditions, site accessibility, and other factors. A contingency allowance, which varies according to type of work, anticipated risk, and project stage, is added to cover unforeseen expenditure.

Dealing with large project that ranges over long period of time, there will be risk factors that will be harder to deal with and the uncertainty will increase in the same time. This report is supposed to deal with such influence and give a guideline of how to handle conflicts of that kind.

Dealing with risk and contingency in construction projects could sometimes been referred to as an art not a science. The idea with this report is tough to somehow proof that estimating construction cost is in fact a science and if done in ways designers and experienced estimators has described in books and articles.

The tools and technique demonstrated in this report for making bankable cost estimation in any stage of the project live cycle will be adopted from various literatures available. The report should give a good example of how to make estimation witch can be used as a reliable document in the process of financing or analysing the feasibility of construction projects of any kind.

Research question

How can a risk analysis be made for a construction project? (section 1 in problem statement)

How is currency inflation in cost estimate dealt with? (section 2 in problem statement)

What techniques and management tools are available to make cost estimation? (section 3 in problem statement)

What is the role of cost estimate during the project live cycle? (section 4 in problem statement)

Key words

Construction, Cost estimate, planning, project live cycle, project management, Estimator, Contingency, Risk, Management Reserve,

Methodology

I am going to write this project mainly by collecting information from books, like published literature from management associations and universities, municipality, organizations and private companies in the construction sector in the form of published statistic, reports and communications. I will interview experienced estimators for common practice in estimating large project like power plants and aluminium production plants in Iceland.

Introduction

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Construction estimating is the determination of probable construction costs of any given project. Many items influence and contribute to the cost of a project; each item must be analysed, quantified, and priced. Because the estimate is prepared before the actual construction, much study and thought must be put into the construction documents. The estimator who can visualize the project and accurately determine its cost will become one of the most important persons in any construction company.

For projects constructed with the design-bid-build (DBB) delivery system, it is necessary for contractors to submit a competitive cost estimate for the project. The competition in construction bidding is intense, with multiple firms vying for a single project. To stay in business, a contractor must be the lowest-qualified bidder on a certain number of projects, while maintaining an acceptable profit margin. This profit margin must provide the general contractor an acceptable rate of return and compensation for the risk associated with the project. Because the estimate is prepared from the working drawings and the project manual for a building, the ability of the estimator to visualize all of the different phases of the construction project becomes a prime ingredient in successful bidding. The working drawings usually contain information relative to the design, location, dimensions, and construction of the project, while the project manual is a written supplement to the drawings and includes information pertaining to materials and workmanship, as well as information about the bidding process. The working drawings and the project manual constitute the majority of the contract documents, define the scope of work, and must be considered together when preparing an estimate. The two complement each other, and they often overlap in the information they convey. The bid submitted must be based on the scope work provided by the owner or the architect.

The estimator is responsible for including everything contained in the drawings and the project manual in the submitted bid. Because of the complexity of the drawings and the project manual, coupled with the potential cost of an error, the estimator must read everything thoroughly and recheck all items. Initially, the plans and the project manual must be checked to ensure that they are complete. Then the estimator can begin the process of quantifying all of the materials presented. Every item included in the estimate must contain as much information as possible. The quantities determined for the estimate will ultimately be used to order and purchase the needed materials. The estimated quantities and their associated projected costs will become the basis of project controls in the field. Estimating the ultimate cost of a project requires the integration of many variables. These variables fall into either direct field costs or indirect field costs. The indirect field costs are also referred to as general conditions or project overhead costs in building construction. The direct field costs are the material, labour, equipment, or subcontracted items that are permanently and physically integrated into the building. For example, the labour and materials for the foundation of the building would be a direct field cost. The indirect field costs are the cost for the items that are required to support the field construction efforts. For example, the project site office would be a general conditions cost. In addition, factors such as weather, transportation, soil conditions, labour strikes, material availability, and subcontractor availability need to be integrated into the estimate. Regardless of the variables involved, the estimator must strive to prepare as accurate an estimate as possible. Since subcontractors or specialty contractors may perform much of the work in the field, the estimator must be able to articulate the scope of work in order for these companies to furnish a price quote. The complexity of an estimate requires organization, estimator's best judgment, and complete specialty contractors' (subcontractors') bids, accurate quantity take-offs, and accurate records of completed projects.

Project Management

PM is a structured framework around a defined project. In some sense, it is used by everyone every day. During any given day, person's brain, with the help of his or her body, indicates, initiates, defines, plans, breaks down, executes, monitors, controls and closes multiple projects; this is the goal of a good PM. In this example, one's brain is so good at managing these tasks that one does not know it is doing it. Thus, the challenge is to also apply this organized approach to the work we do consciously. It can be said that everyone applies this methodology; we just recently defined it as PM.

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The definition of PM that is widely accepted and is used in this thesis is stated below:

Project management is the planning, organization, direction, and controlling of company resources for a relatively short-term objective that has been established to complete specific goals and objective. Furthermore, project management utilizes the systems approach to management by having functional personnel (the vertical hierarchy) assigned to specific project (the horizontal hierarchy) (Kerzner 2009).

To this can be added the following:

Project management is the application of knowledge, skills, tools and techniques to project activities to meet project requirements. Managing a project includes:

Identifying requirements

Establishing clear and achievable objectives

Balancing the competing demands for scope, quality, time and cost

Adapting the specifications, plans, and approach to the different concerns and expectations of the various stakeholders. (PMI 2008)

From these definitions it is clear that PM spans a large field and requires specific knowledge, organisation, and discipline. It can be difficult to justify the application of all the elements that have been recognized in connection to PM, especially when dealing with smaller projects. The Project Manager must evaluate what tools and method he needs for the successful completion of each project he manages.

The PM knowledge areas, as they have been depicted by PMI are listed here below.

Project Integration Management

Project Scope Management

Project Time Management

Project Cost Management

Project Quality Management

Project Human Resource Management

Project Communications Management

Project Risk Management

Project Procurement Management

The area that will be the focused in this report falls under the fields of Project Cost Management.

Project

It is important to realize when an idea can become defined as a project because there is a significant difference between these two terms. As soon as an idea moves to being a project, it is of great importance and should be treated as such. How it is treated should give indication of its size and importance. The theory of PM should be used to handle its quickly growing complexity. The definition of a project is given below:

A project can be considered any series of activities and tasks that:

Have a specific objective to be completed within certain specifications,

Have defined start and end dates,

Have funding limits (if applicable),

Consume human and nonhuman resources (i.e., money, people, equipment),

Are multifunctional (i.e., cut across several functional lines)(Kerzner 2009).

This definition coincides with what the PMI, a world-leading organization in PM, accepts as appropriate (PMI 2008).

Basic Cost Estimate Documents: Inputs

Enterprise Environmental Factors

The Enterprise Environmental input refers to factors that are outside the project but might still influence the success of the project. Heldman (2009) and PMI (2008) suggest some factors that should be considered when formulating a project. The factors that influence the Estimation of cost include (PMI 2008):

Market conditions: Here description of products, service, and resources are available in the market. It should also describe from who they are and what terms and condition may apply.

Published commercial information: Information on resources cost rate is sometimes available from commercial databases that provide skills and human resources cost, including also standard cost for material and equipment. Published seller price is also a source of information

Organizational Process Assets

Organisational Process Assets refers to an organisation's policies, guidelines, procedures, plans, approaches, and standards for executing work (also project work). According to Heldman (2009) and PMI (2008), these include a wide range of elements that can affect the project, such as:

Organisation standard processes, and definitions

Financial controls

Communication requirements

Issue and defect management procedure

Change control procedures

Risk control procedures

Procedures used for authorizing work

Performance measurement criteria

Organisation standard policies

Project management policies

Safety policies

Templates

Project charter templates and etc.

Historical information and lessons learned knowledge base.

Previous project risk

Performance measurements

Earned value data

Schedules from previous projects

Historical information has been shown to help with the project charter, project scope statement, development of project management plan, the process of defining and estimating activities, etc. (Heldman 2009). The value of historical data should not be underestimated.

Project Schedule

The Project Schedule is an output document that is created in the Develop Schedule Process which is a part of the Project Time Management. That process analyses activities sequences, durations, resources requirements and schedule constrains. Scheduling tools are used for creating the schedule; it can be iterative work to produce an acceptable schedule (PMI 2008).

The Project Schedule determines the planned start and finish date for project milestones. The schedule requires constant maintaining to keep a realistic schedule throughout the project work process (PMI 2008). Scheduling requires activities of the project to be identified. These are all the activities necessary to complete the work packages that are defined in the WBS (see section 3.5) (APM 2006).

Human Resources Plan

The Human Resource Plan is a part of the Project Management Plan4, it describes how human resources are to be defined, staffed, managed, controlled and released. It describes how human resources are to be managed and what they should do. The Human Resource Plan should at least include the following documents:

Roles and responsibilities,

Project organization charts, and,

Staffing management plan (PMI 2008).

Scope Definition and Baseline

Define scope

The process of defining scope is the development of a thorough description of the project and product(s). The grounding of a solid project scope statement is crucial to a project's success. It is based on the major deliverables, constrains and assumptions that should be documented during the project initiation. When the project moves on to the planning phase, the scope is fine-tuned and defined in more detail as more information has become available. All known constraints and assumptions are analyzed as best as possible; if any new risks, assumptions or constraints are found to be necessary later in the project, they must also be added (PMI 2008).

Scope Baseline

The Scope Baseline is one of the main components of the Project Management Plan. It is the baseline against which all changes to the project will be measured. Once the items to be included in the scope baseline have been approved, formal change management for the project begins (Norman et al. 2008). According to PMI (2008), the scope baseline should include:

Project scope statement,

WBS, and

WBS dictionary.

The Project Scope Statement is discussed further here below, but WBS and WBS dictionary are covered in Chapter 3.5.

Project Scope Statement

The purpose of the Project Scope Statement is to describe in detail the project objectives, the deliverables, and the work required to produce the deliverables. The scope statement is an agreement that states precisely what the project will produce. This provides an understanding of the project scope among the project stakeholders. It is important to list what is part of the project and what is excluded from the project, as this is a key in managing stakeholder expectations. The scope statement can be used to direct the project team's work, and is a basis for future project decisions (Heldman 2009, PMI 2008). It is critical to include a high level of detail in the scope statement because this determines how well the project manager can control the project scope.

Work Breakdown Structure

The use of WBS goes back to the 1960's when the U.S. Department of Defence (DoD) and National Aeronautics and Space Administration (NASA) used it for aiding their planning and controlling of large projects (Cleland 1964).

WBS is defined by PMI (2008) as:

"A deliverable-oriented hierarchical decomposition of the work to be executed by the project team to accomplish the project objectives and create the required deliverables, with each descending level of the WBS representing an increasingly detailed definition of the project work. The WBS organizes and defines the total scope of the project, represents the work specified in the current approved project scope statement."

Without a well-developed and properly managed WBS, the likelihood of a project's success is severely diminished (Norman et al. 2008).

WBS

The WBS provides a clear vision for the project leaders, participants and stakeholders. It breaks-up the project scope into manageable, hierarchical and definable packages of work that make it possible to balance the control needs of management, with a sufficient level of detailed project data. This creates a framework for the project deliverables over the life cycle of the project. This break up of project work makes it possible to communicate with everyone involved in the project, and clearly identifies accountability within the project (PMI 2006). With respect to accountability, the WBS is connected to the OBS [1] and Responsibility Assignment Matrix6 (RAM).

The upper levels of the WBS are intended to reflect the major deliverable work areas of the project, but they can also be used to outline the major phases of the project's life cycle. These upper levels make it possible to create logical summary points for assessing the communication of accomplishments, performance of teams and individuals, and measurement of cost and schedule performance compared to specific deliverables as well as the overall project. In order to avoid confusion, it is best to define the levels of the WBS prior to construction (PMI 2006).

The lowest level of the WBS, called the "Work Package", contains all the planned work. A work package must be cost-estimated, scheduled, controlled and monitored. Using this work breakdown relationship "work" refers to the work products or deliverables that are the result of an effort but not the effort itself (PMI 2008). The deliverable-oriented WBS provides, at the least, the following benefits to the project (PMI 2006):

Better communication to project sponsors, stakeholders, and team members;

More accurate estimation of tasks, risks, timelines, and costs;

Increased confidence that 100% of the work is identified and included; and

A foundation for the control processes within the project.

The WBS transforms the boundaries and the scope into an easily understandable document that the whole project team and stakeholders can use. The creation of a WBS may seem like a challenge to people unfamiliar with the process, but it can be simple to begin with and then evolve as users become more comfortable with it. In conclusion, the outputs from this process are key in conveying and securing the scope and work of the project at hand.

In connection to Cost Estimating, the WBS is one of the fundamental tools for defining project cost elements. As such the WBS Quality Principles must be fulfilled

Deliverable-Based Management

The Deliverable-Based Management (DBM) takes the control concept beyond the Work Package to also include tasks and activities in the project schedule. All the tasks and activities produce individual deliverables that can be combined with other deliverables from the intended Work Package deliverables. This approach is used to manage the entire project by the creation and integration of individual and compound deliverables. By adopting this approach, the project can be managed at a detailed level. This makes it easy to sum up the deliverables based on the WBS hierarchy, which is the true power of DBM. It allows for cost, schedule, resources and quality to be understood, measured, aggregated and monitored for specific deliverables at higher WBS element levels. This enables the project manager to visualize and communicate how the project is performing. DBM is the management approach that should be used for most projects (Norman et al. 2008).

Activity/Task-Based Management

Activity-Based Management (ABM) is the opposite of DBM. It is a valid technique for supporting of on-going business operations. When ABM is used, the cost at activity level is most important factor of consideration when managing and controlling the cost of the business. Using ABM, the project manager can tie all project costs to specific operational activities, and therefore is able to control the projects connected costs. A detailed analysis of specific operational deliverables is time-consuming and costly to perform because activities often impact several deliverables simultaneously and can cross business units and functions. This inability to group work and cost against the WBS hierarchy and then show traceability is a serious problem for the manager. ABM is therefore appropriate for an on-going business operation; it is, however, inappropriate for the management of a project (Norman et al. 2008).

Importance of the WBS

There are many things that must be included in the management of a project if it is to be successful (as outlined in Chapter 3). The WBS is an important tool that can help secure project finish that is acceptable to all stakeholders. According to PMI (2006), the WBS does the following:

Defines all the work of the project, and only the work of the project, thereby clarifying the project scope;

Reflects the input from all team members to ensure buy-in;

Provides the baseline for subsequent change control;

Is a primary input to other project management processes-for example, resource planning, cost estimating, schedule development, and risk identification;

Provides the framework for project control, performance monitoring, and the foundation for communication with all stakeholders; and

Ensures the work of the project correlates appropriately with the RAM and the OBS.

In the field of Earned Value Management (EVM), performing a WBS of sufficient quality is vital if Earned Value (EV) is to be applied (PMI 2005)

WBS Quality

The quality of the WBS must to be considered; it is not enough just to make a WBS and then be done with it. Quality includes the ideas of harmony to requirements and fitness for use (that is to say, the project is fitting for its intended purpose) (PMI 2006). WBS should be created as early as possible in the life cycle and evolve as the project grows. It can therefore be described as a living document. The WBS must meet the project managers' requirements; it is of no use to make a WBS that overwhelms the project team. Its complexity has to be balanced so that it can both give guidance and help with decision making. Indeed, it is of little value if it is not actually used to manage the project (Norman et al. 2008).

According to PMI (2006), there are two main WBS Quality Principles that all WBS should incorporate. These principals are explained in Appendix II.

Construction Cost