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The estimator therefore must, based on these information, make decisions concerning the type of building material used, equipment required, labour content, sequence of operation, site conditions and make allowances for other foreseeable risks such as waste, delays, natural disaster and weather, The Code of Estimating Practice (CIOB, 2009) identified that the estimating department within a construction company, while preparing the cost estimate, takes an overview of the project and considers factors that may have an impact on pricing for the project.
Risk is inherent in construction project from inception to completion (Baccarini & Archer, 2001; Odeyinka, 2007, Winch, 2002). Various parties within the construction industry are continuously faced with a variety of situations involving many unknowns, unexpected and frequently undesirable and unpredictable (Akintoye & MacLeod, 1997). The management of risks in construction, in general, has received a lot of attention in researches across the world because cost overrun is a common problem in the industry. However, risk management in construction cost estimation, despite being the most important activity in the duration of the construction process receive very little attention.
The aim of this research is, therefore, to examine the estimator's perception of pricing risk in the construction industry and proposing rational optimization strategies in order to deal with these risks.
The rationale behind selecting the residential construction industry is because most of the literatures and previous studies conducted concentrates on the perception of contractors' risks on non-residential (commercial or infrastructural) works, construction estimator's perception within the residential construction industry, despite its value of building work put in place (Figure 1) is nearly always over and above the value of non-residential work (Statistics New Zealand, 2011), receive very little attention. As for the selection of geographical area - Auckland, this is because it is the largest city in New Zealand and is the area that has the majority of construction activity.
Figure - Building work put in place (Statistics New Zealand, 2011)
Perception of Pricing Risks
Risk in a broader context, as defined by the AS/NZS 4360:2004, is "the chance of something happening that will have an impact on objectives". Odeyinka (2006) defines risk in construction as "a variable in the construction process whose variation results in uncertainty as to the final cost, duration and quality of the project" and Cooper and Chapman (1987) as cited in Olupolola, Agnes & Adeniyi (2009) define risk as "exposure to the possibility of economic or financial loss or gain, physical damage or injury, or delay, as a consequence of the uncertainty associated with pursuing a particular course of action"
Risk has different meanings to different people; the concept of risk varies according to educational background, cognitive characteristics, viewpoint, attitude, and experience of individual (Akintoye & MacLeod, 1997; Baloi & Price, 2003). Choffray & Johnson (1977) and Richie & Marshall (1993) as described in Akintoye & MacLeod (1997), concludes that the perception of risk is influenced by people's belief, attitude, judgment and feelings as well as information available and peer group influences (Akintoye & MacLeod, 1997). Odeyinka (2006) has similar view by saying "risk as a psychological phenomenon that is meaningful in terms of human reaction and experiences and as an objective phenomenon that may or may not be recognized in terms of human reaction and experience"
Akintoye & MacLeod (1997) draws similar conclusion and goes further by saying that risk perception "cannot be reduced to a single subjective correlated of a particular mathematical model, such as the product of probabilities and consequences because this imposes unduly restrictive assumptions about what is an essentially human and social phenomenon."
Kwakye (1994) as cited in Akintoye (2000) defined cost estimating as the "technical process or function undertaken to assess and predict the total cost of executing an item(s) of work in a given time using all available project information and resources". The Chartered Institute of Building has similar interpretation by defining estimating as "the technical process of predicting costs of construction" (CIOB, 2009).
A number of studies conducted earlier, although investigated the cost estimating practice, failed to address the risks and factors considered by the construction contractors' estimator. Azzaro, Hubbard & Robertson's study (1987) as described in Akintoye (2000), surveyed 11 main contractors and 2 subcontractors in UK and identified several cost estimating techniques and types of database used by the respondent to arrive at tender prices from the viewpoint of the quantity surveyors working in the contracting sectors, failed to investigate the factors considered by estimators as part of construction contractors' estimating practice (Akintoye, 2000).
Skitmore & Wilcock (1994), investigated the estimating processes involving eight smaller builders in UK has arrived at an important conclusion that not enough is known about factors involved in cost estimating practice. Tah et al. (1994), investigated the practices of estimating the indirect cost involved in tendering for construction work, also failed to identify factors that are considered by estimators in arriving at decisions on cost estimates and Akintoye (2000) and Elhag, Boussabaine and Ballal's (2005) both revealed the fact that no attempt had been made to consult cost estimator who primarily deal with construction cost, about cost influencing factors of construction project at the pre-tender stage. All of above research, pointing to one fact that the most important element of the construction cost estimating process - considering and dealing with the factors influencing the cost estimating process, has has not received much attention.
Risks in construction industry, in general, can be grouped into several categories including physical, design, logistics, natural/environmental, financial/economical, legal/regulatory, political, construction and operational. (Smith and Bohn, 1999; Odeyinka, 2006 and Ahmed and Azhar, 2004)
Akintoye (2000) investigated the factors influencing contractors' cost estimating practice when estimating for construction work in a survey or contractors in UK. A list of 24 factors thought to be potentially influencing cost estimating was identified from literature and were sent to contractors of various sizes to provide opinion on the extent of influence of each factor. The subsequently analysis found that the main factors influencing cost estimating practice are complexity of the project, scale and scope of construction, market condition, method of construction, site constraints, client's financial position, buildability and location of the project. It was concluded that, regardless of company size, the construction firms have similar opinions regarding the factors influencing cost estimating practice.
Another study done by Elhag, Boussabaine and Ballal's (2005) extracted the views of quantity surveyors in the UK on evaluating and raking factors affecting the tender cost estimates of construction project. Through literature and interviews, sixty-seven variables affecting pre-tender construction cost estimates were identified in the study and 218 quantity surveyors were surveyed with a 31% response rate.
The result shows that there was a strong agreement between quantity surveyors in the ranking of the cost factors. In terms of ranking in category, consultant and design parameter was ranked top followed by client characteristics with four out of the ten top factors being related to these categories. The order of importance were followed by the project characteristics (3rd) external market conditions (4th), contract procedures and procurement methods (5th) with the contractor attributes category scoring last. The top risk factors includes, in order, absence of alterations and late changes to design, suitability, experience and performance of management team; priority on construction time/deadline requirement; completeness and timeliness of project information (design drawings, specification) and variation orders and additional work (magnitude, timing, interference level).
Odeyinka (2007) study done in Lagos, Nigeria, surveyed from 55 respondents' (with almost half of respondent being quantity surveyors) perception of the likelihood of risk factors occurring at the project level in traditionally procured building projects and found that under-estimation, completion delays, inadequacy of cashflow, poor site investigation, change in scope of work, defective construction works non-availability of fund and under-valuation were considered critical. Another study done in Nigeria by Onukuwbe, Adenuga and Enagn (2009) identified 22 factors (5 financial risk factors, 7 construction risk factors, 3 design risk factors and 7 political risk factors) which contractors take into account while pricing building projects. Material availability, type of client, financial capability of client and risk involved on the project are considered very important. Note that although these studies are done in Nigeria, which has different cultural, economic and political background as in developed countries. The perceived risk for a construction project is not much different.
Olupolola and Agnes (2009) investigated construction professionals' (including architects, builders, engineers &quantity surveyors) perception on risk inherent in building projects. It is concluded that 8 risk factors (out of 28) had critical impact on construction cost. Quantity surveyors (49% respondent) perceived that, completion delays, change in scope of work, under-estimation, inadequacy of cashflow and defective design are the most important risk factors in terms of probability of risk occurrence, in terms of risk impact, under-estimate, change in scope of work, poor site investigation, loss or damage by fire, poor site investigation and defective construction work are the most significant. On the combined risk occurrence and impact score, the top risks, in order, is under-estimation, change in scope of work, completion delays, inadequacy of cashflow and defective design.
Studies done in Hong Kong construction industry by Wong and Hui (2006) identified the factors influencing a contractor's pricing for the construction project risk and evaluate their importance shows that past experience in similar project; low reliability and high uncertainty in costs estimates and very tight contract period are the three most important factors.
From the literatures review, we can see that although studies are conducted in different countries across the world, similar conclusion can be drawn on the perceived risk from the quantity surveyor's perspective. The risk factor considered to be the most important and influential to the quantity surveyors is design changes and development which includes change in scope of work and variation by client. This was identified repeatedly across most literatures regardless of the location of the project. (Akintoye, 1998; Elhag, Boussabaine and Ballal, 2005; Jackson, 2004; Odeyinka, Weatherup, Cunningham, McKane and Larkin, 2010; Odeyinka, 2007; Olupolola and Agnes, 2009)
Other risk factors perceived to be important including factors relating to site including location, site condition, site constraints and site investigation (Odeyinka, Weatherup, Cunningham, McKane and Larkin, 2010; Odeyinka, 2007; Olupolola and Agnes, 2009); estimating method and under-estimation (Jackson, 2004; Odeyinka, Weatherup, Cunningham, McKane and Larkin, 2010; Odeyinka, 2007; Olupolola and Agnes, 2009); inadequacy of cashflow and delay in payment (Odeyinka, 2007; Olupolola and Agnes, 2009); completion delay (Odeyinka, 2007; Olupolola and Agnes, 2009); market condition and price fluctuation (Akintoye's 1998; Elhag, Boussabaine and Ballal, 2005); defective construction work and information availability (Jackson, 2004; Odeyinka, 2007; Olupolola and Agnes, 2009).
Interestingly, factors such as weather conditions, natural or environmental disasters such as earthquake and flood, shortage of material, procurement method, poor project and contract management and method of construction are rarely mentioned in the studies. However, it will be interesting to find whether the perception of risk changed after the Christchurch and Japan earthquake will change the perception of natural and environmental risks in quantity surveyors' point of view
Rational optimization strategies to reduce pricing risks
Before proposing rational optimization strategies to reduce pricing risks, one needs to look at the cost estimating practice first and then identify the underlying risks within the practice.
In regards to the cost estimating practice, Akintoye & Fitzgerald (2000) investigated 84 contractors for construction projects in UK with company size range from very small to large found that the three most common methods used for cost estimating are estimating standard procedure, comparison with similar projects based on documented facts and comparison with similar projects based on personal experience. Followed by established standards, intuition, simple arithmetic formula, estimating by software, published priced information and capital estimating factors.
Other not so common techniques identified in the study includes shared information with subsidiary of the firm, range estimating (based on probabilistic technique), guessing, shared information from other construction firms and complex statistical formula being the lease used technique. Akintoye & Fitzgerald (2000)
The most common method - estimating standard procedure, is the method taught in most estimating textbooks where the total construction cost consists of a base estimate includes estimation of labour, plant, material and subcontractor's quotes in a logical manner based on historical cost data and anticipated production output. (Akintoye & Fitzgerald, 2000)
The second and third most common method is comparison with similar projects based on documented facts followed by comparison with similar projects based on personal experience. The three most common methods are defined by Ntuen & Mallik as cited by Akintoye & Fitzgerald (2000), as "experience-based" models which are deterministic in nature and has been criticized for its wide variability (Ashworth & Skitmore, 1983) and failure to deal with the uncertainties. (Curran,1989) as described in Akintoye & Fitzgerald (2000).
Odeyinka and Iyagba (2000) as cited in Olupolola, Agnes & Adeniyi (2009) addressed the importance of integrating risk management techniques into estimation of construction project's cost by saying "in order to effectively manage these risks, the integration of risk management techniques into estimation of construction project's cost other than purely common sense and instinct becomes necessary to curb cost overrun". (p228, Olupolola, Agnes & Adeniyi, 2009)
Like many other risks. Pricing risk associated with estimator's estimate is inherent in the process of estimation. Some of the risks associated with the construction process are fairly predictable or readily identifiable; others may be totally unforeseen (Ahmed and Azhar) and the same theory can be applied to pricing risks.
Some of the pricing risks identified from the literatures may include: (RICS, 2009; Akintoye & Fitzgerald, 2000; Towner and Baccarini, 2007)
Lack of experience
Lack of understanding in the process or standard of estimating
Lack of understanding of project requirements
Pressure from management
Poor project cost feedback from previous projects
Lack of diligence by estimators
Lack of adequate guideline for estimating
Poor analysis of cost data
Incomplete design and project information
Reliability of estimating data
Use of provisional sum (do not give price certainly)
Insufficient time for preparing the estimate
Delay in receiving subcontractors' quote
Unfamiliarity with specialized construction method
Poor understanding of how specialist trades are costed and output standard are hardly known
Reliance of subcontractors to provide specialist knowledge
Unrealistic design and construction programme
Unsuitable or unconventional contract strategies
Number of competitors tendering the same job
There are a wide range of techniques available for the construction estimator to quantify risks and hence determine suitable allowance and/or contingencies for their estimate. A major limitation of most of these models is that they only take account of significant factors that can be readily quantified. Most significant factors affecting project costs are qualitative and therefore, difficult to structure and quantify. Despite their importance, most of these factors are often ignored by current forecasting techniques. (Elhag et. al., 2005)
Tah et al. (1994) surveyed seven contractors in UK and found that all contractors classified risks into quantifiable and unquantifiable risks. With quantifiable risks, the estimator includes a suitable costing for the risks in the estimate; while for the unquantifiable risks, an amount based upon the management's perception is added to the base estimate either by a percentage in the profit margin, a separate percentage on all the costs; a lump sum in the preliminary bill or a percentage in one bill if the risk is in that bill alone.
It is also interesting to find, from majority of literature, that most contractors do not perform at all any or perform limited form of statistical or probabilistically model (such as Sensitivity Analysis and Monte Carlo Analysis) or formalized risk management strategies to determine allowance for risks (Laryes, 2008; Mc Namee & Perera, 2010; Smith & Bohn, 1999; Tah et al., 1994, Wood & Ellis, 2003).
Instead, the most predominant used strategies for assessing and apportioning risk in the construction industry is the application of their intuition, judgment and experience. (Ahmed & Azhar, 2004; Akintoye and MacLeod, 1994; Laryes, 2008; Lyons & Skitmore, 2004; Mc Namee & Perera, 2010; Tah et al., 1994; Towner and Baccarini, 2007; Wood & Ellis, 2003)
In Towner and Baccarini (2007), all interviewees agreed that experience and intuition is very important (than any procedures or tool), some of the comment from interviewees are "Each completed project builds a company's understanding of risks and how to approach future tender with regard to risk. Many times you can't really tell the magnitude or likelihood of a risk until you have experienced its consequences", "Pricing of risk cannot be too scientific, therefore it comes down to intuition to strike the balance between risk acceptance and competitiveness"
Some of the reasons for not using a formal risk management technique being:
Each risk was unique and should be evaluated on its own based on different methods of construction (Lyons & Skitmore, 2004; Tah et al., 1994)
"no single technique is best for all cases may in part be the reason why the respondents have opted for the simplest approach" (p60, Lyones & Skitmore, 2004)
Statistical and probabilistic methods were considered too difficult, too time consuming, and expensive to implement (Akintoye and MacLeod, 1994; Akintoye and Fitzgerald, 2000; Mc Namee & Perera, 2010; Tah et al., 1994; Wood & Ellis, 2003)
"Consultants appear relatively self-assured about their ability to rely on their professional experience and judgments as a form of risk management rather than implementing a structured approach, which is considered time consuming and resource intensive." (p17, McNamee & Perera, 2010)
Question on suitability of formal techniques for managing risk (Ahmed and Azhar, 2004; Akintoye and Fitzgerald, 2000; Mc Namee & Perera, 2010)
Skeptical about their usefulness (Wood & Ellis, 2003),
No knowledge of or is unfamiliar with the formal techniques (Akintoye and MacLeod, 1994; Akintoye and Fitzgerald, 2000; Ahmed and Azhar, 2004; Smith & Bohn, 1999),
The degree of sophistication involved in the techniques is unwarranted compared with project size (Akintoye and MacLeod, 1994; Akintoye and Fitzgerald, 2000; Ahmed and Azhar, 2004)
Majority of risks are contractual or construction-process related and are fairly subjective, hence are better dealt with based on experience from previous contracts (Akintoye and MacLeod, 1994; Akintoye and Fitzgerald, 2000; Ahmed and Azhar, 2004)
Questioned the risk management techniques due to the fact that availability of sound data is difficult to collect to ensure confidence. (Akintoye and MacLeod, 1994; Akintoye and Fitzgerald, 2000; Ahmed and Azhar, 2004)
In conclusion, the reviewed literatures have failed to identify a rational optimization strategy to reduce the pricing risk in construction. The only conclusion that can be drawn is that formal statistical or probabilistic techniques based on complicated data collection and analysis are rarely use by construction estimators and vast majority of estimator rely on intuition, judgment and experience regardless which country the contractor is based on and size of project they are working with.
From the literatures review, we can see that although studies are conducted in different countries across the world, similar conclusion can be drawn on the perceived risk from the quantity surveyor's perspective. The risk factor considered to be the most important and influential to the quantity surveyors is design changes and development which includes change in scope of work and variation by client which was identified repeatedly across most literatures regardless of the location of the project.
Other risk factors perceived to be important including factors relating to site including location, site condition, site constraints and site investigation; estimating method and under-estimation; inadequacy of cashflow and delay in payment; completion delay; market condition and price fluctuation; defective construction work and information availability.
In regards to identify a rational optimization strategy to reduce the pricing risk in construction, it is concluded that the reviewed literatures have failed to reach a conclusion apart from the conclusion that can be drawn is that formal statistical or probabilistic techniques based on complicated data collection and analysis are rarely use by construction estimators and vast majority of estimator rely on intuition, judgment and experience regardless which country the contractor is based on and size of project they are working with.