Guidance for Cost Estimation and Management for Highway Projects During Planning, Programming, and Preconstruction (2007)

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13 Before the strategies, methods, and tools are developed to address cost escalation problems, the causal factors that influ- ence and create changes in cost estimates must be delineated and explained. This chapter first identifies the causal factors and then presents the strategies to address specific problem areas. Cost Escalation Factors The factors that lead to project cost escalation have been identified through a large number of studies and research proj- ects. These factors can be distilled into 18 fundamental cost escalation factors, as depicted in Table 3.1. Each cost escalation factor describes a reason behind changes in cost estimations. These factors can be managed throughout the project devel- opment process either through cost estimation practice or cost estimation management methods and tools. Internal Cost Escalation Factors Bias is a systematic tendency to be overly optimistic about key project parameters. It is often viewed as the purposeful underestimation of project costs to ensure that a project remains in the construction program. This underestimation of costs can arise from the state highway agency estimators’ or consultant’s identification with the agency’s goals for main- taining a construction program. The project development process in some states is such that the legislature establishes a project budget by legislative act and that budget is based on preliminary cost estimates. Later, if the department’s estimate is higher than the budget, the project may not be let. As a result, engineers and the state highway agencies feel the pres- sure to estimate with an optimistic attitude about cost. (Akinci and Fischer, 1998; Condon and Harman, 2004; Bruzelius et al., 2002; Flyvbjerg et al., 2002; Hufschmidt and Gerin, 1970; Pickrell, 1990; Pickrell, 1992) Delivery and procurement approach affects the division of risk between the state highway agency and the constructors. When risk is shifted to a party that is unable to control it, proj- ect cost will likely increase. The decision regarding which proj- ect delivery approach (e.g., design-bid-build, design-build, or build-operate-transfer) and procurement methodology (e.g., low bid, best value, or qualifications-based selection) affects the transfer of project risks. In addition to the question of risk allocation, lack of experience with a delivery method or pro- curement approach can also lead to underestimation of proj- ect costs. (Harbuck, 2004; New Jersey DOT, 1999; Parsons Brinckerhoff Quade & Douglas, Inc., 2002; SAIC, 2002; Weiss, 2000) Project schedule changes, particularly extensions, caused by budget constraints, timing of fund allocations, environmen- tal impacts, or design challenges can result in unanticipated in- creases in project overhead and/or inflation. Additional project overhead costs can be incurred by both the state highway agency and the consultants, designers, and contractors. Project sched- ule changes can be viewed in terms of the time value of money. There are two primary components to the issue: (1) the infla- tion rate and (2) the timing of the expenditures. Many state highway agencies have a fixed annual or bi-annual budget, and project schedules must often be adjusted to ensure that project funding is available as needed for all projects. Estimators fre- quently do not know what expenditure timing adjustments will be made by management or caused by external circum- stances. (Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Hufschmidt and Gerin, 1970; U.S. General Accounting Office, 1999a; Sem- ple et al., 1994; Touran and Bolster, 1994) Engineering and construction complexities caused by the project’s location or purpose can make early design work very challenging and lead to internal coordination errors between project components. Internal coordination errors can include conflicts or problems between the various disciplines involved in the planning and design of a project. Constructability prob- lems that need to be addressed may also be encountered as the project develops. If these issues are not addressed, cost C H A P T E R 3 Factors and Strategies

increases are likely to occur. (Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Hufschmidt and Gerin, 1970; U.S. General Accounting Office, 1999a; Touran and Bolster, 1994; U.S. General Accounting Office, 2003; U.S. General Accounting Office, 1997; U.S. General Accounting Office, 2002) Scope changes, which should be controllable by the state highway agency, but which still happen, can lead to project cost escalation. Such changes may include additions to or deletions from the project scope. Examples of this phenomenon are the addition of a lane to the project scope or increasing the project right-of-way. (Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Chang, 2002; Harbuck, 2004; Hufschmidt and Gerin, 1970; Mackie and Preston, 1998; U.S. General Accounting Office, 1999a; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Semple et al., 1994; Touran and Bolster, 1994) Scope creep is the tendency for the accumulation of many minor scope changes to increase project cost. While individ- ual scope changes have only minimal cost effects, the accu- mulation of these minor changes, which are often not essential to the intended function of the facility, can result in a significant cost increase over time. Projects seem to often grow naturally as the project progresses from inception through development to construction. These changes can often be attributed on highway projects to the changing needs or environmental compliance in the area being served. (Akinci and Fischer, 1998; Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Chang 2002, Harbuck, 2004; Hufschmidt and Gerin, 1970; Mackie and Preston, 1998; U.S. General Accounting Office, 1999a; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Semple et al., 1994; Touran and Bolster, 1994) Poor estimation can also lead to underestimation, which subsequently translates into increases in project cost as errors and omissions are exposed. Estimation documentation must be in a form that can be understood, checked, verified, and corrected. The foundation of a good estimate is the formats, procedures, and processes used to arrive at the cost. Poor esti- mation includes general errors and omissions relating to plan details and project quantities as well as general inadequacies and poor performance in planning and estimation procedures and techniques. Errors can be made not only in the volume of material and services needed for project completion but also in the costs of acquiring such resources. (Arditi et al., 1985; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Carr, 1989; Chang, 2002; Harbuck, 2004; Hufschmidt and Gerin, 1970; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Pickrell, 1990; Pickrell, 1992) Inconsistent application of contingencies causes confusion as to exactly what is included in the line items of an estimate and what is covered by contingency amounts. Contingency funds are typically meant to cover a variety of possible events and problems that are not specifically identified or to account for a lack of project definition during the preparation of plan- ning estimates. Misuse and failure to define what costs contin- gency amounts cover can lead to estimation problems. In many cases, it is assumed that contingency amounts can be used to cover added scope, and planners seem to forget that the pur- pose of the contingency amount in the estimate is lack of design definition. State highway agencies run into problems when the contingency amounts are applied inappropriately. During project execution, contingency funds are often inap- propriately used to cover project overruns, instead of being applied to and available for their intended purpose. (Noor and Tichacek, 2004; Ripley, 2004; AACE International, 1997) Faulty execution by the state highway agency in managing a project is one factor that can lead to project cost overruns. This factor can include the inability of the state highway agency’s representatives to make timely decisions or actions, to provide information relative to the project, and to appreci- ate design and construction difficulties caused by coordina- tion of connecting work or work responsibilities. (Committee for Review, 2003; Callahan, 1998; Chang, 2002; Merrow et al., 1981; Merrow, 1986; Touran and Bolster, 1994) Ambiguous contract provisions dilute responsibility and cause misunderstanding between the state highway agency and other contractual parties, including design consultants and/or project constructors. Providing too little information in the project documents can lead to cost overruns during the execution of the contract. When the core assumptions under- lying an estimation are confused by ambiguous contract pro- visions, forecast accuracy cannot be achieved. (Callahan, 14 Table 3.1. Factors causing cost escalation of projects*. Source Factor 1. Bias 2. Delivery/Procurement Approach 3. Project Schedule Changes 4. Engineering and Construction Complexities 5. Scope Changes 6. Scope Creep 7. Poor Estimation 8. Inconsistent Application of Contingencies 9. Faulty Execution 10. Ambiguous Contract Provisions Internal 11. Contract Document Conflicts 1. Local Concerns and Requirements 2. Effects of Inflation 3. Scope Changes 4. Scope Creep 5. Market Conditions 6. Unforeseen Events External 7. Unforeseen Conditions * Note: these factors are numbered for reference only. The numbering does not indicate a level of influence.

1998; Chang, 2002; State of Alaska, 1994; Harbuck, 2004; Mackie and Preston, 1998; MassHighway and ACEC, 1998; Tilley et al., 1997; Touran and Bolster, 1994) Contract document conflicts lead to errors and confu- sion when preparing an estimate and cause change orders and rework during project construction. (Callahan, 1998; Chang, 2002; State of Alaska, 1994; Harbuck, 2004; Mackie and Preston, 1998; MassHighway and ACEC, 1998; Tilley et al., 1997; Touran and Bolster, 1994) External Cost Escalation Factors Local concerns and requirements typically result in miti- gation efforts to minimize project effects and negotiated scope changes or additions. Actions by the state highway agency are often required to alleviate perceived negative impacts of construction on the local societal environment, as well as on the natural environment. Local government con- cerns and requirements can affect the project costs during any project development phase, especially as legislatures seek to add specific scope to a project. Similar to the effects during the planning phase, mitigation actions imposed by the local government, neighborhoods, and businesses as well as local and national environmental groups during the construction of a project can extend the project duration, thereby affecting inflation allowances, and can add direct cost. By not antici- pating these changes, state highway agencies can be plagued by project cost increases. (Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Chang, 2002; Daniels, 1998; Hall, 1980; Harbuck, 2004; Hudachko, 2004; Utah Department of Trans- portation, 2004; Mackie and Preston, 1998; U.S. General Accounting Office, 1999a; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Parsons Brinckerhoff, 2002; Pearl, 1994; Sawyer, 1951–52; Schroeder, 2000; Maryland DOT, 2002; Touran and Bolster, 1994; Woodrow Wilson Bridge, 2002) Effects of inflation add cost to a project. The time value of money can adversely affect projects when (1) the project esti- mates are not communicated in year-of-construction costs; (2) the project completion is delayed, and, therefore, the cost is subject to inflation over a longer duration than anticipated; and/or (3) the rate of inflation is greater than anticipated in the estimate. The industry has varying views regarding how inflation should be accounted for in the project estimates and in budgets by funding sources. (Akinci and Fischer, 1998; Arditi et al., 1985; Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Hufschmidt and Gerin, 1970; Merrow, 1988; Pickrell, 1990; Pickrell, 1992; Touran and Bolster, 1994) Scope changes, which are not controllable by the state highway agency, can lead to underestimation of project cost escalation, similar to internal scope changes. (Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/ McGraw-Hill, 1995; Callahan, 1998; Chang, 2002; Harbuck, 2004; Hufschmidt and Gerin, 1970; Mackie and Preston, 1998; U.S. General Accounting Office, 1999a; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Semple et al., 1994; Touran and Bolster, 1994) Scope creep from external causes is similar to scope creep from internal causes; however, the former category is usually the accumulation of minor scope changes from external partic- ipants. (Akinci and Fischer, 1998; Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Chang, 2002; Harbuck, 2004; Hufschmidt and Gerin, 1970; Mackie and Preston, 1998; U.S. General Account- ing Office, 1999a; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Semple et al., 1994; Touran and Bolster, 1994) Market conditions or changes in the macroenvironment can affect the costs of a project, particularly large projects. The size of the project affects competition for a project and the number of bids that a state highway agency receives for the work. Inaccurate assessment of the market conditions can lead to incorrect project cost estimation. Changing market conditions during the development of a project can reduce the number of bidders, affect the available labor force, or result in increased commodity prices, all of which can disrupt the project schedule and budget. (Committee for Review, 2003; Booz Allen & Hamilton, Inc., and DRI/McGraw-Hill, 1995; Callahan, 1998; Chang, 2002; Hall, 1980; Mackie and Preston, 1998; U.S. General Accounting Office, 1999a; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Pearl, 1994; Sawyer, 1951–52; Maryland DOT, 2002; Touran and Bolster, 1994; Woodrow Wilson Bridge, 2002) Unforeseen events are unanticipated occurrences that are not controllable by the state highway agency, such as floods, hurricanes, tornadoes, or other weather-related incidents. Typ- ically, these events are called “acts of god.” These acts can bring construction to a standstill and have been known to destroy work, thereby creating the need for extensive rework or repair. Events controlled by third parties that are also unforeseen include terrorism, strikes, and sudden changes in financial or commodity markets. These actions can have devastating impacts on projects and project cost. (Akinci and Fischer, 1998; Arditi et al., 1985; Callahan, 1998; Chang, 2002; Hufschmidt and Gerin, 1970; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Semple et al., 1994; Touran and Bolster, 1994) Unforeseen conditions are notorious for causing project cost overruns. Unknown soil conditions can effect excavation, compaction, and structure foundations. Contaminated soils may be present, thereby resulting in the need for special miti- gation work. Utilities are often present that are not described or are described incorrectly on existing drawings. There are a multitude of problems that are simply unknown during the early project phases and that can increase project cost when they become apparent during construction. (Akinci and 15

Fischer, 1998; Arditi et al., 1985; Callahan, 1998; Harbuck, 2004; Hufschmidt and Gerin, 1970; Merrow et al., 1981; Merrow, 1986; Merrow, 1988; Semple et al., 1994; Touran and Bolster, 1994; U.S. General Accounting Office, 1999) Strategies The methodology used to develop the potential list of strate- gies, methods, and tools focuses on the causes of cost escalation and potential strategies that would address these causes. This linkage between the causes of cost escalation and strategies was found in the estimation literature, in an assessment of current practice, and in a review of deficiencies found in unique prac- tice approaches. From the literature concerning project cost estimation and from interviews with people in the industry, it is clear that there exist eight overarching or global strategies that can affect the accuracy and consistency of project estimates and costs. As mentioned previously, a strategy is “a plan of action intended on accomplishing a specific goal.” This definition is used as the basis for developing short statements about each strategy as follows: • Management strategy—Manage the estimation process and costs through all stages of project development; • Scope and schedule strategy—Formulate definitive pro- cesses for controlling project scope and schedule changes; • Off-prism strategy—Use proactive methods for engaging external participants and assessing the macroenvironmen- tal conditions that can influence project costs; • Risk strategy—Identify risks, quantify their impact on cost, and take actions to mitigate the impact of risks as the proj- ect scope is developed; • Delivery and procurement strategy—Apply appropriate delivery methods to better manage cost because project delivery influences both project risk and cost; • Document quality strategy—Promote cost estimate accu- racy and consistency through improved project documents; • Estimate quality strategy—Use qualified personnel and uniform approaches to achieve improved estimate consis- tency and accuracy; and • Integrity strategy—Ensure that checks and balances are in place to maintain estimate accuracy and to minimize the impact of outside pressures that can cause optimistic biases in estimates. Management Strategy Manage the estimation process and costs through all stages of project development. State highway agency leadership can advance an estimation management strategy that fosters and supports estimate accuracy and consistency through all phases of project development. The highest levels of state highway agency leadership have the responsibility to publicly explain how the project development processes works and most importantly to ensure that cost estimation practice and cost estimation management processes are transparent. To produce accurate estimates, state highway agency personnel must be properly trained, there must be established estimation processes, and there must be critical reviews of all estimates. Currently, 40 state highway agencies use only on-the-job training to train their estimators. Twenty-six state highway agencies have no published standard estimation procedures. (Schexnayder et al., 2003) Senior management must take an active role in advancing strategies to increase estimator knowl- edge and estimate consistency. Scope and Schedule Strategy Formulate definitive processes for controlling project scope and schedule changes. Scope control ensures that project changes are identified, evaluated, coordinated, controlled, reviewed, approved, and documented. Scope control requires that the proposed scope of a project be continually evaluated against the essential functions necessary to accomplish its intended purpose. Projects often take years to move through the devel- opment process. As the time frame is extended, there are more opportunities for external and internal parties to suggest changes in scope. Additionally, if the schedule is extended, cost impacts will result from increases in land costs and inflation effects. The cost effect of a change depends on the point in time when it is introduced. Early in project development, before estimations are prepared, a change in scope does not cause sig- nificant problems. Scope changes during the later stages of engineering design and construction have ripple effects and can increase project cost exponentially. Off-Prism Strategy Use proactive methods for engaging external participants and assessing the macroenvironmental conditions that can influence project costs. In the case of most projects, engineers focus on technical solutions with little attention to community inter- est or concerns and often fail to recognize market and macro- economic changes. These cost drivers are termed “off-prism” items in the literature because they are not within the roadway prism. The lack of focus on such external issues has been changing as some state highway agencies are experimenting with context-sensitive design and construction. (Neuman et al., 2002; Werkmeister and Hancher, 2001) However, tech- nical alternatives are frequently discussed at early stages of 16

project development before community outreach efforts are undertaken, and concerns related to the external effects are not addressed until later in the development cycle. “Lack of public involvement also tends to generate a situation in which those groups who feel concern about the project . . . are inclined to act destructively.” (Bruzelius et al., 2002) Additionally, how environmental compliance and the acquisition of right-of-way impacts the public is a consideration when addressing off- prism issues. Finally, few state highway agencies ever evaluate the impact of macroeconomic market forces on project cost. Risk Strategy Identify risks, quantify their impact on cost, and take actions to mitigate the impact of risks as the project scope is developed. The actual cost of a project is subject to many variables, which can and will significantly influence the probable range of estimated costs. The Census Bureau does not present a single forecast population growth; it offers projections based on different assumptions of fertility, mortality, and migration rates. In the case of state highway agency project estimations, any one cost number represents only one possible result based on multiple variables and assumptions. These variables are not all directly controllable or absolutely quantifiable. Therefore, cost estima- tion must consider probabilities in assessing uncertainties and related risks and translate these risks into costs. Delivery and Procurement Strategy Apply appropriate delivery methods to better manage cost because project delivery influences both project risk and cost. Delivery and procurement involves the process by which a construction project is comprehensively designed and con- structed for an owner, including project scope definition; determination of project size; determination of organiza- tion and selection of engineers, constructors, and various consultants; and determination of the contract types used to allocate risk and define payment. Open communication with the construction industry from initial project planning to contract award is the cornerstone for a successful project. Procurement documents tailored to project requirements improves source selection by focusing efforts on features crit- ical to a successful construction process. Document Quality Strategy Promote cost estimate accuracy and consistency through improved project documents. All documents used to prepare estimates, at any point during project development, must be clear and convey the intent of the project’s scope. In particu- lar, contract documents must be clear and unambiguous as to what must be constructed and what is standard. The docu- ments must clearly state the responsibilities of all parties— consultants, contractors, the state highway agency, and third parties. It is critical that all parties involved understand third- party involvement in the project construction process. Estimate Quality Strategy Use qualified personnel and uniform approaches to achieve improved estimate consistency and accuracy. It appears that the estimation practices of many state highway agencies are based solely on the experience of the personnel in charge of estima- tion, usually the head of the estimation section or the chief of design. State highway agencies must approach estimation devel- opment in the same manner as design and construction— with documented processes to guide cost estimation practice and cost estimation management throughout project develop- ment. Specifically, structured approaches to quality control (e.g., internal estimate reviews) and quality assurance (e.g., external estimate reviews) are also essential. Integrity Strategy Ensure that checks and balances are in place to maintain esti- mate accuracy and to minimize the impact of outside pressures that can cause optimistic biases in estimates. The potential for conceptual (e.g., parametric) or even design estimation error can result from pressure by project sponsors who seek the approval of their projects. (Cost/Schedule Controls Task Force, 1986) In a conceptual estimate, judgment replaces straightfor- ward material takeoffs and costing; therefore, it is difficult to justify estimates quantitatively. Estimators must be protected from internal and external pressures to produce estimates that are less than some preestablished budget amount. Summary The factors that lead to project cost escalation have been documented through a large number of studies and matched to changes in cost estimates. Each factor presents a challenge to the state highway agency seeking to produce accurate proj- ect cost estimates. These factors can be mitigated through the strategies that focus on controlling the possible effects of these factors. Table 3.2 illustrates the link between the strategies and cost escalation factors. This table is further developed for each of the project phases in Chapters 5, 6, and 7. The next chapter, Chapter 4, addresses the framework of this Guidebook and provides guidance for navigating through the Guidebook. 17

18 Table 3.2. Link between strategies and cost escalation factors. Global Strategies Cost Escalation Factors M an ag em en t Sc o pe an d Sc he du le O ff- Pr ism Is su es R isk D el iv er y an d Pr oc ur em en t D oc u m en t Q ua lit y Es tim at e Qu al ity In te gr ity Bias √ √ Delivery and Procurement Approach √ √ √ Project Schedule Changes √ √ √ Engineering and Construction Complexities √ √ √ Scope Changes √ √ √ √ Scope Creep √ √ √ Poor Estimation √ √ √ √ Inconsistent Application of Contingencies √ Faulty Execution √ √ √ Ambiguous Contract Provisions √ In te rn al Contract Document Conflicts √ Local Concerns and Requirements √ √ √ √ √ Effects of Inflation √ √ √ √ Scope Changes √ √ √ Scope Creep √ √ Market Conditions √ √ √ √ Unforeseen Events √ Ex te rn al Unforeseen Conditions √