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17 Table 3.1. Typical risks and outcomes across the project phases. Project Planning Programming Design Phase Typical Fatal or significant Changes in design Changes in design Risks environmental economic requirements requirements impacts Costs of environmental Market conditions, Funding uncertainty compliance permit requirement Uncertain political and Right of way acquisition changes public support delays Competing interests and Technical uncertainties competing projects Funding uncertainty Expected Better understanding of List of major project Prioritization of risks Outcomes environmental, risks based on impacts to total engineering, and Reasonable estimate of project cost and duration construction issues risk costs, and probable Costs / benefits of risk facing each project total project costs and mitigation and risk alternative duration allocation strategies Order of magnitude risk Long list of risk Risk management and costs and possible total mitigation strategies allocation plan cost range for each option Preliminary risk management plan, focused on design and constructability risks Preliminary risk allocation planning As discussed in Chapter 2, contingency is linked integrally the remainder of this Guidebook. Each of these five steps is to risk management in the context of cost estimating and cost discussed in the context of project complexity and the proj- control. However, contingency application is not listed as one ect development phases. of the five risk management steps. The application of contin- gency is part of the risk mitigation and planning step. If an agency chooses to accept an identified risk, it should include 3.2 Risk Management in Support an appropriate contingency amount in case that the risk is re- of Cost Estimating alized. Tracking and resolution of contingency is part of the and Cost Management risk monitoring and control step. Uncertainty and risk can play a major role in causing cost These five risk management steps provide the framework escalation if not properly treated during project develop- for the discussion of risk management practices and tools in ment. Cost estimating methods and tools must relate and adapt to the various phases of project development. When es- timating costs, particularly on large and complex projects, Monitor Identify this becomes even more profound. In the Planning and Pro- and gramming Phases of project development, estimators have Control very little information with which to develop a project cost, Risk and the information that they do have is often fraught with Management uncertainty. The Washington State Department of Trans- portation (WSDOT) developed a cost estimate classification Allocate Process Assess/ Analyze system based on a similar system developed by the Associa- tion for the Advancement of Cost Engineering International (AACEI). This system has five classifications and provides an Mitigate expected range of accuracy for each classification given proj- and Plan ect maturity and a representative estimating methodology. Figure 3.1. Risk management process Table 3.2 shows the estimate classification system as it cor- framework (varies by project responds to the project development phases described in this development phase and complexity). Guidebook. Planning estimates are based upon the lowest

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18 Table 3.2. Cost estimate classification system (WSDOT). Project Maturity Project (% project Purpose of the Estimating Development Estimate Range definition Estimate Methodology Phase completed) 0 to 2% Conceptual Estimating Parametric Estimate Potential (Stochastic or -50% to +200% Funds Needed Judgment) (20-year plan) Planning 1% to 15% Conceptual Parametric or Estimating Historical Bid- Prioritize Needs for Based -40% to +100% Long Range Plans (Primarily (HIP 10-year plan) Stochastic) 10% to 30% Design Estimating Historical Bid- Establish a Baseline Based or Cost- Scoping Cost for Project and Based (Mixed, -30% to +50% (Programming) Program Projects but Primarily (HIP and STIP) Stochastic) 30% to 90% Design Estimating Historical Bid- Manage Project Based or Cost- Design Budgets Against Based -10% to +25% Baseline (Primarily (STIP, Contingency) Deterministic) 90% to 100% Cost-Based or PS&E Estimating Historical Bid- Compare with Bid Final Design Based Using -5% to +10% and Obligate Funds CES. for Construction (Deterministic) level of project definition, and Final Design Phase estimates uncertainty. The first point is that there should be a reduction are closest to full project definition and maturity. in the range of cost uncertainty as a project proceeds from con- Table 3.2 conveys several key concepts. First, it describes a cept to completion. The reduction in estimated cost is a result number of end usages for estimates, which relate directly to of better cost variable definition and eliminating uncertainty as the risk management practices and tools described in this cost factors are ultimately incorporated in the project budget. Guidebook. Second, it describes the methodological approach The second point is that, if the problems or uncertainties in- to the estimate as either stochastic2 or deterministic, depend- cluded in the early stages of a cost estimate do materialize, ing upon the level of design and information available. While then a higher range of the cost estimate will be expected. In deterministic cost estimating methods have been the prevalent contrast, when risk management and other cost control estimating method in highway development, they do not processes are used effectively, a lower range of expected costs support robust risk management analysis and contingency will likely result. estimation. This is an important concept and change. To help describe contingency, Figure 3.3 presents three basic Figure 3.2 depicts how identifying, quantifying, and manag- types of cost estimate information or lack of knowledge. At any ing cost uncertainty relates to cost management. Two primary point in the project development process, an estimate should points are illustrated in Figure 3.2, which applies to situations account for these three types of information. First, the estimate where the scope is unchanged and where an estimate includes should clearly describe the known and quantifiable costs (also referred to as the known/knowns). Estimators should prepare their estimates considering what is defined in the project scope 2 Stochastic estimates combine traditional estimating methods for known items and quantities with risk analysis techniques to estimate uncertain items, uncer- or drawings and apply the appropriate estimating method to tain quantities, and risk events. The stochastic portion of the estimate typically determine the base estimate costs. A second type of costs con- focuses on a few key uncertain variables and combines Monte Carlo sampling sists of the known but not quantified costs (also referred to and heuristics (rules-of-thumb) to rank critical risk elements. This approach is as the known/unknowns). These are the costs that are known used to establish the range of the Total Project Cost Estimate and to define how contingency should be allocated among the Stochastic estimates apply only to to be in the project scope, but for which there are no defin- most complex (major) projects, as explained later in this Guidebook. able quantities at the point in project development when the

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19 High end of possible Total Project Cost Estimate Project Cost More Threats Realized Cost Range Fewer Opportunities Realized Low end possible Total Project Cost Estimate Planning Programming Design Final Design Project Development Process Figure 3.2. General refinement of a cost estimate. Unrecognized Cost (Unknown/Unknowns) Known but not Quantified Costs Project Cost (Known/Unknowns) Known and Quantifiable Costs (Known/Knowns) Planning Programming Design Final Design Project Development Process Figure 3.3. Need for estimate contingency.

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20 estimate is prepared. An example for this could be that an es- phase that the baseline estimate is set and cost control begins. timator knows there is a need for noise walls on a project, but Third, Figure 3.4 illustrates a case where the final engineer's does not know the quantity that will be needed because a com- estimate is equal to the baseline estimate. In this case, risks plete engineering study is not yet available. The final type of were identified during early contingency estimation and the information is the unrecognized costs (also referred to as the estimate of the contingency was accurate. unknown/unknowns). These are costs that an estimator typi- Figure 3.5 illustrates an excellent example of cost control cally will not account for in an estimate because they are un- and contingency management. Figure 3.5 illustrates a case foreseeable or happen so infrequently that they would make where the engineer's estimate is less than the baseline estimate. the project estimate unrealistically high. Contingency is needed In this case, risks were identified during early contingency in an estimate to account for the known but not quantified estimation in the Programming Phase, but these risk were costs and the unrecognized costs. Risk management practices mitigated (or not realized) in the Design and Final Design and tools can assist in the calculation of appropriate contin- Phases. In this case, the SHA should have a policy on what the gencies to account for these costs. project team should do with the unused contingency. If the Figure 3.4 builds from Figures 3.2 and 3.3 to illustrate how purpose and need of the project is met, this policy would ide- contingency can be resolved throughout the project develop- ally ask the project team to return the contingency to the over- ment process. Figure 3.4 illustrates three key points. First, an all program instead of adding scope to the project baseline. estimate at any given point is made up of a base estimate com- Figures 3.2 through 3.5 show how risk and contingency can ponent and a contingency component as described in Chap- be incorporated into cost estimating and cost management ter 2. As the project progresses in development, the contin- (or cost control) throughout the project development process. gency amount is expected to decrease because the project A few key points from these figures are summarized here: information is refined. Often the base estimate increases as some of the contingency is realized and included as part of the Use of Cost Ranges at the Planning Phase--Planning Phase base estimate. The second point is the transition from a range estimates, particularly on a more complex (major) project estimate to a baseline estimate when moving from the Plan- should be communicated through a range. Planning Phase ning to the Programming Phases. It is in the Programming estimates contain the most uncertainty of any estimate Project Cost Cost Baseline Estimate Range & Engineer's Contingency Contingency Estimate Contingency Base Estimate Base Estimate Base Estimate Base Estimate Planning Programming Design Final Design Project Development Process Figure 3.4. Refinement of a cost estimate with engineer's estimate equal to the baseline cost estimate.