Planning Your Contingency Budget.
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 Site Alert #29 |
Do you use contingency funds to cover construction changes? Are you using an industry standard or arbitrary number as a budget? Are you interested in a more scientific way to estimate this line item?
If you answered yes to any of these questions, you may be interested in a recent study that can improve your ability to identify issues with the size of your contingency budget before your project is bid. The study used linear regression models of two hundred projects of varying type and scope to identify ways to predict cost overruns. Using this information, you can predict projects with a high risk of budget problems and more accurately plan your contingency budget, especially for larger, non-standard projects.
The problem: Contingency funds are set-aside funds to cover construction changes, unforeseen site conditions, or cost overruns incurred after a construction contract is awarded. They are often set as an arbitrary 5% of the baseline construction budget. The study referenced above, however, showed an average overrun of 11.63%. In these cases, the 5% contingency fund was not sufficient or effective in controlling total project cost. Have you had a similar experience?
The solution: A more accurate approach is to identify project components that have a high risk of cost overruns, then plan accordingly. These actions reduce unpleasant surprises and the need to find alternate funds after the fact. Here are the variables that may be predictive of construction cost overruns and the need to budget additional contingency funds.
1. Rushing to meet a hard date. Awarding to meet a fiscal year rollover, or to meet an hard opening date like a holiday shopping season, can mean a project is pushed through to meet deadlines. If this is the case, the model predicts an overrun of 1.6% over the baseline of 11.63%.
2. Design that lasts longer than 2 years. Data indicates that projects with a shorter design period have fewer overruns. Projects that exceed 2 years from concept design to letting have overruns of 15.63%, more than 4 percentage points over the baseline of 11.63%. Is this because longer projects are more complex and prone to redesign? Is it because some projects are shelved and pulled off for a quick but less accurate update prior to bidding? Do scope creep and material cost fluctuations come into play? All these are likely to contribute to overruns.
3. Normalized design time. This is the total length of the design period in days divided by the total design cost. At the higher end of this ratio, the study showed an overrun decrease of 1%. Even at the lower end, no overrun occurred. This indicates that allowing designers the budgeted design time decreases the potential for cost overruns.
4. Design costs as a percent of cost of award. The design cost of projects with poor scope, non-standard designs, schedule delays, disputes, code changes, and redesigns may exceed 10% of the construction award. If so, this is a red flag for your contingency budget. The study indicated these projects are prone to construction overruns of 13.38%.
5. High competition. The statistically significant breaking point for large projects is the presence of 10 or more bidders. This is good news, as it can decrease the baseline cost overrun by 2.25%.
6. Straightforward designs mean that contractors have good experience in bidding on and controlling the cost of these projects. Using the baseline overrun of 11.63%, the model shows that straightforward designs reduce the baseline overrun by up to 5.8%. This results in a contingency fund of 5.83%, pretty close to, but still over, the standard 5% often used.
Summary: To develop a more realistic budget for your projects, use the above items to evaluate total project cost
scenarios. These warning signs can help you during the concept and design phases, so you have the opportunity to reduce scope, use add-alternatives during bidding, or increase contingency funds. At a minimum, you’ll be forewarned of potential overruns and can plan alternate funding sources accordingly.
Portions of this article were written using “Estimating Required Contingency Funds for Construction Projects Using Multiple Linear Regression”, authorized for distribution by the Air Force Institute of Technology and located at www.dtic.mil/cgi-bin.
If you answered yes to any of these questions, you may be interested in a recent study that can improve your ability to identify issues with the size of your contingency budget before your project is bid. The study used linear regression models of two hundred projects of varying type and scope to identify ways to predict cost overruns. Using this information, you can predict projects with a high risk of budget problems and more accurately plan your contingency budget, especially for larger, non-standard projects.
The problem: Contingency funds are set-aside funds to cover construction changes, unforeseen site conditions, or cost overruns incurred after a construction contract is awarded. They are often set as an arbitrary 5% of the baseline construction budget. The study referenced above, however, showed an average overrun of 11.63%. In these cases, the 5% contingency fund was not sufficient or effective in controlling total project cost. Have you had a similar experience?
The solution: A more accurate approach is to identify project components that have a high risk of cost overruns, then plan accordingly. These actions reduce unpleasant surprises and the need to find alternate funds after the fact. Here are the variables that may be predictive of construction cost overruns and the need to budget additional contingency funds.
1. Rushing to meet a hard date. Awarding to meet a fiscal year rollover, or to meet an hard opening date like a holiday shopping season, can mean a project is pushed through to meet deadlines. If this is the case, the model predicts an overrun of 1.6% over the baseline of 11.63%.
2. Design that lasts longer than 2 years. Data indicates that projects with a shorter design period have fewer overruns. Projects that exceed 2 years from concept design to letting have overruns of 15.63%, more than 4 percentage points over the baseline of 11.63%. Is this because longer projects are more complex and prone to redesign? Is it because some projects are shelved and pulled off for a quick but less accurate update prior to bidding? Do scope creep and material cost fluctuations come into play? All these are likely to contribute to overruns.
3. Normalized design time. This is the total length of the design period in days divided by the total design cost. At the higher end of this ratio, the study showed an overrun decrease of 1%. Even at the lower end, no overrun occurred. This indicates that allowing designers the budgeted design time decreases the potential for cost overruns.
4. Design costs as a percent of cost of award. The design cost of projects with poor scope, non-standard designs, schedule delays, disputes, code changes, and redesigns may exceed 10% of the construction award. If so, this is a red flag for your contingency budget. The study indicated these projects are prone to construction overruns of 13.38%.
5. High competition. The statistically significant breaking point for large projects is the presence of 10 or more bidders. This is good news, as it can decrease the baseline cost overrun by 2.25%.
6. Straightforward designs mean that contractors have good experience in bidding on and controlling the cost of these projects. Using the baseline overrun of 11.63%, the model shows that straightforward designs reduce the baseline overrun by up to 5.8%. This results in a contingency fund of 5.83%, pretty close to, but still over, the standard 5% often used.
Summary: To develop a more realistic budget for your projects, use the above items to evaluate total project cost
scenarios. These warning signs can help you during the concept and design phases, so you have the opportunity to reduce scope, use add-alternatives during bidding, or increase contingency funds. At a minimum, you’ll be forewarned of potential overruns and can plan alternate funding sources accordingly.
Portions of this article were written using “Estimating Required Contingency Funds for Construction Projects Using Multiple Linear Regression”, authorized for distribution by the Air Force Institute of Technology and located at www.dtic.mil/cgi-bin.
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