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3 CHAPTER 1 Introduction 1.1 Introduction Systematic and uniformed approaches for documenting and tracking risk; Highway design and construction projects can be extremely Appropriate timing of risk management procedures given complex and are often fraught with uncertainty. Engineers various levels of project complexity during the different and construction managers who lead such projects must co- project development phases; ordinate a multitude of human, organizational, technical, and Anticipate and manage policy, political, and communica- natural resources. Quite often however, the engineering and tions uncertainties; construction complexities of transportation projects are over- Appropriate organizational structures and required orga- shadowed by economic, societal, and political challenges. The nizational commitment to achieve a risk management cul- impact of not addressing these external challenges has often ture; and resulted in significant project cost escalation. If a SHA fails to Appropriate performance measurements and accountability deliver individual projects and programs within established tools that can exist within transportation agency organiza- budgets there is a detrimental effect on later programs and a tional structures. loss of faith in the agency's ability to wisely use the public's money. Project cost escalation is therefore a serious problem for Rigorous risk analysis and risk management has the poten- SHAs. To aid SHA's in managing their construction programs tial to minimize the cost escalation problem. This Guidebook the NCHRP conducted Project 8-49 that developed cost esti- presents a systematic process to apply risk analysis tools and mation and management guidance. This guidance can be management practices to aid SHA management in controlling found in NCHRP Report 574: Guidance for Cost Estimation and project cost growth. The Guidebook addresses risk identifica- Management for Highway Projects During Planning, Program- tion, assessment, analysis, mitigation, allocation, and tracking ming, and Preconstruction. That research presented a strategic and control in a manner that is systematically integrated into approach to cost estimating and cost estimate management. the organizational structure and culture of U.S. SHAs. However, the research team and the NCHRP research panel members identified the need for more detailed tools and man- 1.1.1 Cost Escalation and Cost Containment agement practices in the area of risk analysis and risk manage- ment practices, particularly in the long-range transportation The problem of project cost estimates continuing to increase planning, priority programming, and preconstruction stages in magnitude as a project moves from the conceptual stage to of the project development process. Therefore, NCHRP exe- construction is a major performance issue for many SHAs. The cuted Project 8-60 to produce a "Guidebook on Risk Analysis ramifications and effects that result from differences between Tools and Management Practices to Control Transportation early project cost estimates and the bid price or the final project Project Costs." The research objective of Project 8-60 was to cost are significant. This fact is illustrated by the media cover- develop tools and management practices to address: age and political response to bids significantly above agency es- timates in the case of the Wilson Bridge in Washington, D.C. Consistent definitions for "cost escalation," "uncertainty," and the San Francisco-Oakland Bay Bridge East Span, and to "risk," and "contingency"; the significant cost escalation experience over just the construc- Guidance for consistent application of contingency to risk tion phases of the Central Artery/Tunnel project in Boston management and cost estimation; (National Academy of Engineering 2003). These problems

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4 are pervasive in the transportation industry on projects both ment practices at the earliest stages of the project. To neglect large and small. A study of 258 infrastructure projects spanning using risk analysis and management tools at the earliest stages a time period of more than 70 years found that project costs of the project development process will diminish the practi- were underestimated for approximately 90 percent of the cal application of this research. Risk assessment, cost esti- projects examined, and that their actual costs average 28 per- mating, cost management, and cost containment techniques cent higher than the estimated cost (Flyvbjerg, et. al 2002). must be implemented at the earliest stages of the project de- Although highway projects fared better than rail and fixed- velopment process even if the transparency of uncertainty linked projects, the highway sample still displays an average in- in the engineering and political process is difficult to define crease in project costs of more than 20 percent. As a result of and manage. both higher bids and project cost growth, estimating for proj- ects over $10 million was recently a topic of review by the Fed- 1.1.2 Guidebook Concepts eral House Subcommittee on Transportation Appropriations (Federal-Aid 2003). The FHWA provides clear guidance that This Guidebook presents a systematic approach for the ap- risks and an associated contingency must be addressed in plication of risk analysis and management practices that are major project cost estimates (projects above $500 million) linked to the planning and the project development process (FHWA 2007). This guidance should apply to small projects and project complexity. This Guidebook defines risk in the as well as major projects because even small projects can be project development process as: extremely complex. Clearly, a majority of SHAs are involved in numerous complex projects and additional guidance in the Risk An uncertain event or condition that, if it occurs, has a area of risk management to control transportation project negative or positive effect on a project's objectives. costs will assist in better management of the project develop- ment process. The fundamental steps in the risk process remain consis- Managing development of major highway projects involves tent, but the application is affected by both a) when the analy- dealing with organizational, technical, and external issues sis is being applied in the project development process and which are oftentimes volatile. Uncertainty and risk play a b) the level of project complexity. Risk analysis tools and major role in cost escalation throughout the project devel- management practices should align with the project devel- opment process. Inadequate estimating invariably leads to opment process and project complexity. The output of the misallocation of scarce resources. If estimates are consis- process is a risk-based contingency for controlling project tently high, compared to bid costs and ultimately final cost and a risk register for tracking, managing risks, and re- costs, fewer projects will be authorized than could have solving contingency throughout the project development been performed with available resources, resulting in loss process. of benefits. If estimates are consistently low, more projects The overall framework of the Guidebook includes three will be authorized than can be fully funded, resulting in main elements. The interaction of these steps in the risk man- project slowdowns, scope changes, and performance short- agement process with the project development process and falls, and generally higher costs and lower benefits. If estimates project complexity is shown schematically in Figure 1.1. are neither consistently high nor low, but still inaccurate, the estimated benefit/cost ratios will not be correct and the most beneficial projects may not be authorized, while less beneficial projects are constructed. All of these conditions Monitor and Identify result in misallocation of resources and a loss in benefits to Control the public. The use of risk assessment, cost estimating, cost manage- Risk ment, and cost containment techniques at the earliest stages Management in the project development process will yield substantial Process Assess/ value to a SHA. Cost engineering research has repeatedly Allocate Analyze demonstrated that the ability to influence and manage cost is greatest at the earliest stages in a project development ("Pre-Project Planning: Beginning a Project the Right Way" Mitigate 1994). A project management oversight function definitely and Plan has the ability to help manage the process especially in the Figure 1.1. Risk management process area of cost containment but it is imperative to examine the framework (varies by project problems and solutions for cost-risk analysis and manage- development phase and complexity).