Originally published as a CIMA Article January 2009

Avoiding Project Cost Overruns

Tips on how to reduce projects costs and avoid overruns

Dave Rochford

Introduction:

How many times do you hear about project costs overrunning and exceeding their budgets? No doubt far too many compared with the number of times you can remember a project coming in well within budget.

Keeping costs within the project budget and getting value for money and return on investment is even more important in these times of economic hardship and market competitiveness.

Putting your head in the sand is not the answer.

This article explains the typical causes of project cost overruns and provides new insights into how to spot the signs of a cost overrun and how to put measures in place to control costs and reduce them.

According to Wikipedia Cost overrun is defined as excess of actual cost over budget. Cost overrun is also sometimes referred to as “cost escalation,” “cost increase,” or “budget overrun.”

By way of background Cost overrun is very common in infrastructure, building, and technology projects. One of the most comprehensive studies [1] of cost overrun that exists found that 9 out of 10 projects had overrun, and overruns of 50 to 100 percent were common. For IT projects in particular, an industry study [2] by the Standish Group found that the average cost overrun was 43 percent, 71 percent of projects were over budget, over time, and under scope.

Spectacular examples of cost overrun are the Sydney Oprera HouseSydney Opera House with 1,400 percent, and the ConcordeConcorde supersonic aeroplane with 1,100 percent. The cost overrun of Boston’s Big DigBig Diwas 275 percent, or US$11 billion. The cost overrun for the Channel tunnel between the UK and France was 80 percent for construction costs and 140 percent for financing costs. Coupled with a significant shortfall in revenue projections this venture resulted in near collapse and significant long term refinancing

All of the explanations above can be considered a form of risk. A project’s budgeted costs should always include cost contingency funds to cover risks (other than scope changes imposed on the project). As has been shown in cost engineering research ^[1], poor risk analysis and contingency estimating practices account for many project cost overruns. Numerous studies have found that the greatest cause of cost growth was poorly defined scope at the time that the budget was established. The cost growth (overrun of budget before cost contingency is added) can be predicted by rating the extent of scope definition, even on complex projects with new technology. ^[2]

Cost Overrun Causes

So what causes projects to incur cost overruns? Some obvious ones are listed below:

• project and requirements not clearly defined and prioritised e.g. as evidenced by “wish lists”
• inadequate data and hidden or unforeseen costs
• scope creep
• absence of controls over spend e.g. accountability for spend not matched with responsibility, costs not monitored or reviewed, lack of any change control
• skills and resources not available when needed
• timescales extended
• waste and rework
• lack of project direction and weak and inexperienced project management
• poor management of resources.

Less obvious ones are…

• absence of a robust business case
• little or no evaluation of cost drivers or understanding of fixed and variable project costs
• insufficient use of planning tools and techniques e.g. little or no evaluation of the critical path and the impact of a change in a critical activity on the path; poor forecasting
• lack of option appraisal on costs, quality and time and the evaluation and impact of lower cost alternatives
• absence of a quality plan and lack of agreement on quality as evidenced by the setting of deliverables, review mechanisms and acceptance criteria
• inbuilt complexity and time delays e.g. over-engineering or inappropriate use of time buffers during or at the end of the project plan
• poorly integrated plans and imbalance between people processes and systems resulting in additional costs later to avoid failure and correct the imbalance
• lack of agreements /contracts where there are dependencies on third parties, or contracts with third parties not aligned to internal project objectives, costs and benefits
• risk averse culture or just simply issues and risks not adequately considered or dealt with effectively
• poor communication and decisions

The fishbone diagram below highlights many of the factors that contribute to increased costs:

A table showing the relationship between cost drivers and programme management tools is displayed below:

Clearly the above table suggests that many factors can contribute to increasing costs.

Listed below are some tips and techniques related to some of the above tools which enable checks and controls to be put into place and bolster confidence in managing and reducing costs:

• Project set up and initiation
• Getting the costs right in the first place and developing the business case
• Understanding costs and drivers
• Techniques that can be used to help reduce

But how does one go about ensuring that costs are set and stay within an agreed budget and are not allowed to overrun?

Project Set Up

Project set up is key to ultimate success. Use of accepted project management methodologies such as Prince 2 or PMBOK will go some way to getting the project setup properly along with a good degree of common sense.

Prepare a clear project brief with defined objectives and scope plus assigned and agreed ownership of clearly defined deliverables and built in review mechanisms to review and sign off deliverables.

Develop a robust business case which has detailed, timed costs and benefits and a ROI signed off and monitored by Finance. Ensure the business case is reviewed regularly and when there are changes to the project.

Understand the difference between direct and indirect costs (see below), identify any potential hidden costs and use estimating tools e.g. 3 point estimating (low medium, high), trend analysis, benchmarking etc

Detailed tasked and integrated project plan with discrete manageable stages including some analysis and evaluation e.g. of critical path, sensitivity supported by agreed resource plan including unavailability e.g. holidays), individual team responsibilities and accountabilities matched to skill requirements.

Processes defined for identifying, recording and managing risks, issues, assumptions, dependencies and decisions (often referred to as a RAID Log).

Also be aware of where the project aligns with strategy, and if applicable its position within a corporate portfolio. Note typically:

• Only 1 in 5 businesses’ portfolios contain high value-to-the-business projects
• Only 1 in 4 businesses effectively rank and prioritize their projects
• Only 1 in 5 has the right balance of projects in their portfolios

These are dismal results, but also typically:

• 4 out of 5 businesses have too many projects for the resources available, - which means that projects are under-resourced
• Only 1 in 5 businesses have a systematic portfolio management or project selection system in

Managing Time and Cost

How can we systematically protect the promise date and avoid rising costs of a project when faced with:

“Murphy’s law” – likelihood of something going wrong and uncertainty without nailing all the tasks to deadlines on a calendar, and

“Parkinson’s law” - expanding work to fill the time allowed

These can help:

• Build the schedule with target durations that are too tight to allow/encourage diversion of attention and multi-tasking.
• Focus on deliverable dates rather than task due
• Charge management with responsibility to protect project resources from interruptions rather than getting in their way with unnecessary

Costs

• Cost overrun is typically calculated in one of two ways. Either as a percentagepercentage, namely actual cost minus budgeted cost, in percent of budgeted cost. Or as a ratio, actual cost divided by budgeted cost. For example, if the budget for building a new bridge was $100 million and the actual cost was $150 million then the cost overrun may be expressed as 50 percent or by the ratio 1.5.

Definitions of Cost types:

Project Indirect Costs

• Costs that cannot be associated with any particular work package or project activity e.g.
  • Supervision, administration and interest

Project DirectCosts

• Normal costs that can be assigned directly to a specific work package or project activity e.g.
  • Labour, materials, equipment, and

Some tips:

• Project duration is usually driven by external factors e.g. customer requirements, contracts and competition so that optimum cost may not be achievable
• Reducing project duration reduces indirect costs but may increase direct costs
• Focus should be on what drives and adds value to desired project output (lean principle) and furthermore benefits need to be tied to costs
• Identify direct and indirect costs and key drivers and prepare cost duration graph to inform project timeline decisions and run sensitivity analysis to inform which costs should be focused on

Specifically project duration and time can be improved as follows:

• Tasks worked on in order of task-level priority
• Multi-tasking minimised
• Issues raised immediately
• Task completion reported immediately
• Task updates provided more regularly (eg daily) keeping projects on track for due date and providing predecessor completions for Task Managers
• Proactively obtain information needed to successfully accomplish tasks
• Provide Alerts on task completion and resource availability
• Consider spreading Buffers based on the critical chain of activities and not simply added to the end of the project
• Encourage Buffer recovery where necessary

Finally look for project management software that provides:

• automatic buffer application options and reduction
• project and buffer RAG status reports
• resource availability and task completion alerts/triggers
• escalation filters
• root cause analysis

This visibility will support an active management culture and better control on costs.

Conclusion

There are many factors that contribute to project cost overruns. Understanding the types of cost, what drives them and how to manage the activities that drive them are crucial to effective cost management and avoidance of cost overruns.