Cost overrun is the increased cost compared to the actual cost of construction as per the cost estimation in the initial project planning. It is also known as budget overrun or construction overrun. Various factors, including scope changes and a major design error, can result in cost overrun.
Project cost overrun is one of the most prevalent problems in the construction industry today. It significantly impacts the project scope. Time delay is frequently associated with exceeding budget, often leaving the construction project in great trouble. Therefore, the cost is considered one of the main criteria for mapping the success of large projects.
What Is Cost Overrun?
In simple terms, construction cost overrun or project budget overrun can be defined as the difference between the cost estimate in the original budget of the project and the actual cost incurred on completion of the construction work.
In other words, construction project overrun refers to various unexpected costs that add up to the final cost of the project budget at the end of a construction project.
Construction is a dynamic industry that is constantly facing uncertainties from various spheres. The construction industry is impacted the most by changing trends like market conditions, regulatory frameworks, government intervention, or fluctuating demands.
Multi-party involvement in construction projects is another factor for difficulty in cost management. Besides the project owner and project manager, the general contractor, subcontractor, supplier, and vendor are involved throughout the construction process. Thus the prevailing uncertainties and involvement of many stakeholders in every construction phase make construction cost management fairly difficult. And this results in cost overruns.
Let’s understand the impact of project cost overruns in the construction sector.
Impact of cost overruns on construction projects
Both cost overruns and time overruns have become global phenomena. When the project starts without proper planning, it leads to unexpected costs because accrued and the final cost of the project goes up as high as 80%. Consequently, the project often witnesses time overruns, which ultimately impacts the delivery method.
- Over budget: The most imminent impact of cost overrun is going over budget. The project owner orphan in commerce additional expenses beyond the agreed contract sum. this results in lower ROI(return on investment).
- Time overrun: Project delay is another consequence of cost overrun. Projects often exhibit extensions in the project timelines. According to research, most construction mega projects take up to 20% longer to finish than the initial set timeline.
- Disputes and Claims: Since cost overruns directly impact the ROI and profit margin, it leads to disputes between the project owner and the construction company. Project owners often raise claims for bearing additional charges or, sometimes, losses.
- Litigation: When disputes and claims are not settled amicably among the stakeholders, they lead to court cases for arbitration and resolution. This is often the case when hundreds of millions are at stake.
Most Common Cost Overrun Causes
#1. Erroneous project cost estimation
Inaccurate cost estimations are the most common cause of project cost overrun. Several reasons can contribute to wrong project estimation, but the most prevalent cause arises when a construction company tries to underbid in the bidding stage.
Here are some of the most common (& avoidable) cost estimation mistakes.
Common estimating mistakes:
- Not fully understanding the project’s objectives and scope
- Not considering the risks that might arise during construction
- Including arbitrary predictions and assumptions
- Not fully reviewing the estimation before finalizing it
- Ignoring the estimations from subcontractors
- Not considering currency exchange rates (if applicable)
While estimate accuracy is important and may make the difference between getting awarded a job and being passed over for it, you protect your business best by slightly overestimating, then delivering the project under budget.
This will give project managers budgetary wiggle room should the project run over budget. Finally, if the additional budget is no longer needed upon timely completion, the boost in reputation will bring a firm more work and thus more money in the long run.
#2. Hidden costs
Construction projects often have many hidden costs that may remain out of the calculations while preparing the project estimates. Some of these costs, like permits, work orders, and compensation (if any), are unpredictable, and there is no fixed ratio to calculate them. They are highly project/place/situation specific. The changing market conditions may also incur hidden costs.
The number of permits and time to issue them vary greatly depending on the project location. Even the cost of getting all the permits depends upon a variety of factors, including politics. So no one can really predict the exact figure before the project starts. However, having a contingency plan to deal with such unpredictable costs can help to keep the budget under rein.
Obtaining supplies, site issues, or weather delays can all cause a project to be delayed. Events like the COVID-19 pandemic and the subsequent restrictive measures were major reasons why almost all projects were delayed in 2020 and 2021.
The condition further deteriorated due to the global supply chain crisis. Also, the project slated to start during these periods was started with considerable delays; thus, the inflation greatly impacted their budget.
Finding employees has become increasingly difficult for the construction industry. The global pandemic pushed the labor force to leave their workplaces and stay at home. However, despite the pandemic being under control, the labor market has still not reached the pre-pandemic level. As a result, the labor charges have shot up higher. And this will definitely increase the project costs.
#3. Poor planning and design
Cost overruns in building projects are sometimes caused by poor design and sloppy planning. These errors can force last-minute changes, significantly delaying your project and costing thousands of dollars.
The collapse of the Tacoma Narrows Bridge in 1940 is a classic example of poor planning and design. The bridge, built at the cost of USD 6.4 million in 1940 (equivalent to USD 1.2 – 1.5 billion), collapsed after 4 months in operation due to design flaws. It was also a wake-up call for better construction engineering design and a stringent review and approval process. It can be inferred that poor project planning and faulty design increase the cost and are fatal.
#4. Not including change orders
Change orders are frequent in the construction industry, yet they take some organizations by surprise. Change orders lead to design modifications. This, in turn, requires allocating resources and time to carry out the modifications. As a result, going overboard on the budget is definite.
Let us understand why this happens. Any major construction project requires various parties to coordinate and synchronize their work to get desired outcomes. Thus, the works of all parties are interlinked. Any change in one part can start a ripple effect and force other parties to change accordingly.
However, employing the right construction software like BIM (Building Information Modelling) can suitably deal with such change orders and minimize the result cost increase. Such software can prepare a 3D model and share the data with all the concerned parties in a construction project. So any change can be visualized before being implemented on the onsite construction.
#5. Poor site management
Construction projects have huge works which need huge numbers of machinery, materials, and manpower. Therefore, site management becomes crucial for the project’s success. A project manager plays a key role in managing all the parties and ensuring smooth workflow on the construction site.
On the contrary, poor site management leads to project delays, disputes, and a lack of coordination between teams. If these things are not controlled on a project site, it can result in severe loss of working output, which will cause project delays and additional expenses.
#6. Poor Communication
There are various moving parts and a continuous flow of materials in a construction project. To facilitate a smooth movement of men and materials, e robust communication channel is required.
Adding to that, various subcontractors work simultaneously on a project. So finding a single source of truth may be difficult. Hence, workers may find it difficult to coordinate with others. If that happens, it will surely impact the outcomes of the project. One of the undesirable outcomes is costly errors that will push the project’s budget overboard.
#7. Scope change
Scope change is another major contributor to cost overruns. Humans and machine both have their limitations in predicting the future accurately. There are situations that are beyond anyone’s control. So when the anticipated conditions for a project change, the project scope changes accordingly.
Therefore, some degree of reworking seems normal for a construction project. However, keeping an eye on how frequently and costly these reworks occur will help mitigate the budget going wayward.
#8. Improper resource planning
Poor resource planning is another typical cause of budget overruns. Failure to estimate the resources that will be used during the project may result in inappropriate and inadequate procurement.
Resource planning is an essential part of construction management as well as contract management. Inadequate or irrelevant contact information may result in lengthy chains of negotiations, disputes, and arbitration. The end result will almost certainly be a project delay and cost overrun.
#9. Late payments
Cost estimators and project management teams often overlook late payments, which causes significant project cost overruns. Late payments frequently result in lost or delayed work, resulting in wasted labor costs. Besides, late payments prevent critical construction materials from being delivered to a construction site, causing schedule delays.
Late payments can also harm a construction company's reputation with distributors. It is difficult for a construction company with such tarnished reputations to associate with the best contractors and subcontractors. Such companies can also suffer from higher upfront costs and less payment flexibility.
How do you prevent cost overruns in construction projects?
Meticulous project planning
Accurate project planning is one of the best ways to ensure a project’s success. The more precise your estimates and detailed your design, the more likely the project will stay within budget.
A detailed budget and risk management plan can help you cover all of your bases and keep the project on track to meet its goals.
Due diligence with vendors
Many projects necessitate working with third-party vendors. Their assistance can range from specific task completion to the supply of critical raw materials.
Before establishing these key supplier relationships, ensure that your teams have diligently verified the vendors’ backgrounds. To accomplish this, go over the following steps:
- Determine the vendor's ability to complete the specific tasks and meet the needs of the company.
- Complete detailed checks to ensure the accuracy of the quotes provided.
- Examine the vendor's track record to see if they have a history of successful projects with other companies.
According to PMI research, the early stages of a project have the greatest influence on its overall cost. You can have a more cost-effective project that meets its objectives by assembling a skilled team with optimal resources.
End users, internal teams, and other relevant parties may submit multiple change requests, resulting in project cost overruns. Before approving any scope changes, conduct a thorough review and reassign the available resources.
Project management tools
Project management tools can enhance the project’s efficiency and help in cost control. Project managers can use such tools to efficiently monitor project resources and schedule jobs to prevent resource waste.
These project management tools also facilitate seamless communication between teams and keep the project on track. The project teams have easy access to all the details required for their work, while key stakeholders get a broad overview of the project’s progress.
The bottom line
Mega construction projects often go overboard in their budget and timeline due to various factors. While some factors are unavoidable, others are avoidable by having proper mechanisms in place. Having a competent project manager and general manager is also necessary to keep the project under budget and finish it on time.
Moreover, the project owner and project management team should constantly monitor the progress of a project. It’s necessary to intervene wherever possible and rejig their strategy to maintain the momentum of the project.
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