7

PROJECT COST MANAGEMENT

The Project Cost Management section of the PMBOK® Guide is applicable to construction projects. This section of the Construction Extension presents additional considerations for planning, and monitoring and controlling cost on construction projects.

Project Cost Management in construction includes cost estimating, cost budgeting, and cost monitoring and control, and further entails managing the day-to-day project costs. This is considerably different from financial management, which deals with revenue sources for financing the construction project, its return on investment, its cash flow, and its investment payback analysis, to name a few.

For an owner, the ability to influence cost is greatest at the early stages of the project, which makes early scope definition critical. The cost management planning effort, which includes estimating and budgeting, occurs early in project planning and sets the framework for efficient and coordinated cost management. Cost control provides a mechanism to monitor and control project costs in order to deliver a project within budget. Project Cost Management is critical to a successful project as it impacts, among other important aspects, organizational profitability.

7.1 Project Cost Management in Construction

Construction estimates are different from estimates in other industries. Some differences may be subtle, while others are completely different. In construction, estimates may range from a simple estimate for pouring a small concrete foundation to an estimate for building a multibillion-dollar processing plant. Construction estimates incorporate direct and indirect costs. Direct costs are those that are directly attributable to a specific scope of work, and may include equipment costs (e.g., a backhoe that is used exclusively for excavation). Indirect costs are those costs that cannot be directly associated to a specific scope of work and are allocated equitably over multiple scopes of work on a single project (e.g., equipment and small tools).

In EPC projects, direct costs are organized by disciplines. These disciplines are specialized scopes of work such as civil, structural, mechanical, piping, electrical, and instrumentation. Indirect costs are management and supervisory costs plus general expenses for the organization that are allocated to a particular project.

Given that the construction industry is fragmented, there is no general agreement on whether to include certain categories as direct or indirect costs. The classification depends most often on the organization and its general cost management policies.

Challenges to cost management in construction include the vast number of stakeholders involved, quality and availability of skilled labor in a particular area, weather impact on productivity, transportation in remote areas, and fluctuations in material prices. Tracking and managing these costs is a complex process, which involves detailed planning, monitoring, and control.

In addition, cost estimating is a function that occurs throughout the life cycle of the project to reflect scope, design, constructability, and performance changes. The cost of the project is proportional to its scope, whether that scope is based on an owner's ability to fund it or the cost efficiency and profits for contractors to build it. Cost management is fundamentally critical to all active stakeholders.

Cost monitoring and control is proactive and is used to predict the final outcome of a project based on actual costs, which allows preventive or corrective actions to avoid variations in final cost. Cost control techniques may differ on some projects, depending on the type of contracting strategy used. It is imperative to the overall project planning effort that cost management integrates other Knowledge Areas to reflect not only the scope and resources, but also the cost management techniques used in different project delivery methods.

7.2 Project Cost Management Planning

The cost management plan in construction is primarily concerned with the cost of the multitude of resources needed to complete project activities. The cost management plan should consider the life cycle cost of a project and may include operating costs, depending on the project delivery method. The plan should be customized for the needs of the owner/sponsor with due consideration to other stakeholders’ needs. Cost management planning is a function that should be managed throughout the design process in an effort to enhance the ability to “design to cost” and determine how the bill of quantities (sometimes referred to as BoQ) will be prepared. The BoQ is a specific document of measured quantities for the work identified by the drawings and specifications. Establishing cost drivers early in the design process and continually monitoring those drivers as well as providing staged cost estimates is vital to validating the cost of the project and also the cost of design.

Together, life cycle costing, value engineering, and constructability analysis are used in early planning stages on construction projects to:

• Reduce cost and time,
• Improve quality and performance,
• Optimize design-to-cost facility performance, and
• Optimize the decision-making process.

The cost planning effort begins with estimating and transitions into budgeting. The PMBOK® Guide defines an estimate as “a quantitative assessment of the likely amount or outcome.” This definition is usually applied to project costs, resources, and durations and is usually preceded by a modifier (i.e., preliminary, conceptual, feasibility, order-of-magnitude, and definitive). Costs are estimated for all resources that will be charged to the project. This includes, but is not limited to, labor, materials, equipment, services, and facilities, as well as special categories such as inflation, cost of project insurance, and contingency costs.

7.2.1Estimating Costs and Techniques

Estimating the cost of a project involves the process of developing an approximation of the monetary resources needed to build the project. These cost estimates are a prediction based on the known information at any point in time. For example, a preliminary cost estimate (order-of-magnitude) may provide the owner with sufficient details to allocate funding to build the project. A contractor, on the other hand, may prefer a more definitive approach to substantiate the planned cost of construction, for example, details on all materials, equipment, labor resources, overhead, and profit.

The most prevalent construction estimating techniques are analogous, parametric, bottom-up, three-point estimating, and Monte Carlo simulation. Techniques that produce more accurate estimates require more detailed and more voluminous information regarding the project and take more time and resources to develop. Figure 7-1 highlights analogous, parametric, and bottom-up techniques in relation to the known project information using the WBS as the basis for reference.

A preliminary estimate is performed early in the project and is normally required for high-level decision making. It is the first deliberate estimate of the resources, cost, and schedule. It serves as the basis for measuring subsequent estimates, which generate the cost estimate baseline.

Resource histograms are developed from these estimates. Section 9 on Project Resource Management provides additional details on histograms. The estimating tools used in construction are often based on the construction sector, trade, organization, or project-specific application.

7.2.1.1Analogous (Conceptual) Estimating

Analogous estimates are also referred to as preliminary, conceptual, top-down, order of magnitude (OOM), and rough order of magnitude (ROM). Generally, analogous techniques are customized for industrial sectors through the use of industry-specific historical data. Some of the notable analogous techniques used in construction are capacity-factored and equipment-factored estimating. Industry publications provide estimating data. Industry sector historical indexes and consumer price indices should be consulted for the most up-to-date cost and pricing data.

7.2.1.2Parametric Estimating

Parametric estimating uses a statistical relationship between relevant historical data and other project-specific variables (e.g., square footage in building construction) to calculate a cost estimate. The construction industry frequently uses software applications that provide a local industry-specific cost database and/or available cost information offered by specialized publications and professional associations.

Commonly used parametric indicators are ratio of steel in concrete (average steel per cubic meter or cubic yards of concrete), percentage of reinforcement steel for different components of structure, and labor requirement for 1 m³ (35 ft³) of reinforced concrete.

7.2.1.3Bottom-Up (Detailed) Estimating

Bottom-up techniques are the estimating tool of choice when the detailed project design becomes available. The cost and accuracy of bottom-up cost estimating are typically influenced by the size and complexity of the individual activity, work package, or work component.

A prerequisite to a bottom-up estimate is a clearly defined and detailed scope including documents such as a WBS, issued for construction (IFC) drawings, and specifications. The detailed estimating technique results in a transparent and structured estimate for the project that is more accurate and reliable.

7.2.1.4Three-Point Estimating

Cost estimates based on three points with an assumed distribution provide an expected cost and help clarify the range of uncertainty around the expected cost. A project simulation model may be used, which translates the specified detailed uncertainties of the project cost into their potential impact on project objectives.

7.2.1.5Monte Carlo Simulation

The typical statistical distributions used for modeling construction costs are beta, triangular, and lognormal distributions. However, opinions differ on the practical advantages (accuracy of estimates) of using mathematical models for project cost analysis and quantitative risk analysis, which is associated with cost estimates.

7.2.2Bill of Materials (Bill of Quantities)

The bill of materials (BOM) and material take-offs (MTOs) are terms commonly used in construction for material quantity measurements. Bill of quantities (BOQ) is also a commonly used term that refers to a document that itemizes measured quantities of material, equipment, and labor. MTOs are also used as a tool for comparing the estimate with past similar projects and to determine whether the quantities are within an acceptable range. Generally, each construction discipline has a standard of quantity measurement, such as excavation and concrete quantities are measured in cubic meters or cubic yards, while electrical cable quantities are measured in linear meters or linear feet.

Many contractors have had to adopt multiple quantity take-off and estimating solutions to deal with technological advances. The use of BIM tools and techniques for quantity take-offs, estimating, and budgeting is rapidly expanding. It is important to note that metrics from previous projects such as actual cost, productivity, and labor hours are essential components for preparing estimates.

7.2.3Allowances, Contingency, and Management Reserve

How the terms allowances and contingency are used on a construction project can vary. Typically, allowances refer to a specific discipline or component of work, whereas contingency refers to the total project cost or an aggregated control account.

The quantity of the allowance depends on the phase of the project and scope definition. For conceptual estimates when the scope is preliminary, a higher allowance should be added. On the other hand, for a project in a detailed design phase, a lower allowance is needed. Generally, allowances are based on historical data and vary from organization to organization.

Cost estimates include contingency to account for cost uncertainty. Contingency is the category within the cost baseline that is allocated for identified risks. For example, rework for some project deliverables could be anticipated, while the amount of this rework is unknown. The amount of contingency may be a percentage of the estimated project costs or developed by using quantitative risk analysis techniques such as Monte Carlo.

Contingency is part of the cost baseline and the overall funding requirements for the project and should be clearly identified and documented. Management reserve, on the other hand, is not included in the cost baseline but is part of the overall project budget and funding requirements.

7.2.4Escalation, Inflation, and Currency Exchange

Estimates for multiyear projects should include escalation. Escalation should account for market conditions that affect pricing in addition to monetary inflation. Although extremely rare, some projects may account for de-escalation.

Inflation is a general index for the average increase of prices in an economy. There are other indexes that should be taken into account, such as price of commodities (steel, cement), which may vary in a pattern different from inflation. Many contractors follow commodity prices and try to take advantage of purchase opportunities when they arise.

The currency used for estimates and exchange rate fluctuations is an important consideration in construction projects. This can be difficult when estimating international projects, especially when allocating responsibility for currency exchange risk and taking into consideration the impact due to tax legislation in the countries involved.

7.2.5Metrics

Metrics used in estimating may include plant capacity, size of storage facilities, labor hours, direct to indirect cost ratio, and price per square feet. Different construction disciplines (electric, plumbing, etc.) have standard reference documents that provide general estimates for specific deliverables. Metrics used are primarily a combination of labor hours, equipment, and material costs. Parametric cost models used within construction rely on metrics such as square footage, location, and quality of materials to develop an estimate.

7.2.6Additional Considerations in Estimating

The accuracy of an estimate depends primarily on how well the scope is defined. The accuracy of a project estimate increases as the project progresses through the project life cycle. Figure 7-2 shows the relationship between evolution of scope and estimate accuracy. Empirical evidence suggests that project success may be directly related to the appropriate application of project estimating principles throughout the project life cycle.

Published commercial information, such as labor productivity, crew mix, location factors, country cost indexes for wages and materials, and resource cost rate information, is often available from commercial sources that track and provide standard costs for material, labor, and equipment.

The following list provides some additional factors that should be considered in construction cost estimating:

• Site conditions (a site visit is generally recommended to evaluate site conditions);
• Labor resource availability, type, and wage rates (unions or open shop);
• Site access restrictions;
• Restricted working hours;
• Proximity to facilities available;
• Equipment and material logistical requirements;
• Weather considerations;
• Local community and social group impacts;
• Health, safety, and environmental regulations; and
• Geotechnical data.

Most estimates are based on a similar project basis or on published rates from government projects wherein the projected estimate is based on an escalation or inflation index. The basis of estimate (BOE) is an important document that helps drive estimate accuracy. BOE provides supporting documentation with a clear and complete description of how the estimate was derived, including but not limited to the list of included information, for example, the level of accuracy, exclusions, and assumptions.

Past project lessons learned aid in the estimating effort for the next project by providing historical cost data. Lessons learned, especially the actual cost of activities, is one of the most valuable assets for a construction industry organization as construction costs are specific to an organization.

Table 7-1 shows a sample EPC estimate summary for an oil and gas owner/operator organization.

Table 7-2 shows a sample direct labor hours summary. These labor hours can be compared to historical data on similar past projects to ascertain whether the estimate is within acceptable range.

7.2.7Determine Budget

A project budget can be established once an estimate is approved. This involves aggregating the estimated costs of individual activities or construction work packages. The key benefit is that it determines the cost baseline in which project performance can later be monitored and controlled.

The budget should have the ability to be adjusted and fine-tuned, such that the current budget is realistic and in sync with any revised estimates. Further, construction budgets are also used to perform comparisons with subcontractor bids received through the procurement process.

Some organizational process assets that influence budgets often include organizational-related policies, procedures, guidelines, and tools; historical cost databases; and captured actual costs from each project that the construction organization undertakes, including the reporting methods.

7.2.7.1Construction Work Package (CWP)

Cost estimates are aggregated by work packages in accordance with the WBS and are often referred to as construction work packages (CWPs). These work package cost estimates are aggregated for the higher component levels of the WBS, such as control accounts, and ultimately, for the entire project. Work packages most often include all labor, material, equipment, and subcontractor costs.

7.2.7.2Cost Baseline

Figure 7-3 illustrates the various components of a project budget and cost baseline.

Each control account is assigned a unique code or account number(s) that links directly to the performing organization's accounting system. A cost breakdown structure (CBS) is sometimes developed as a mapping tool between the project WBS and the organization's designated code of accounts to aid in reporting costs.

7.3 Project Cost Management Monitoring and Control

Project cost monitoring and control includes the status of the project to update and track project costs, to manage changes to the cost baseline, and to provide a forecast for all remaining costs. The key benefit of cost control is that it provides the means to recognize in a timely manner the variance, if any, from the plan in order to take corrective and preventive actions in order to minimize project cost risk.

Many complex and ambitious megaprojects run the risk of project cost overruns due to ineffective cost control. Many companies are seeking ways to improve cost predictability and contain costs. For most, the answer may lie in integrated tools that provide visibility for proactive management such as earned value management (EVM). Much of the cost monitoring and control effort in construction involves using either true EVM or variations of EVM to analyze the relationship among all the components.

7.3.1Actual Cost

Most organizations have a set schedule (cut-off date) for capturing the actual cost at the end of a work period (weekly, biweekly, or monthly) depending on the activity or project. The project accounting system captures the actual labor, material, equipment, and subcontractor costs from that work period. The accounting report is reviewed and analyzed for completeness and accuracy by the project team.

On large and megaprojects involving many subcontractors and vendors, it can be difficult to capture actual costs for the same work period when each entity may utilize a different cut-off date. A work around that handles this issue is the use of an accrual method to capture revenue and costs as work in progress (WIP). Construction work in progress becomes a general ledger account where the asset costs that are directly associated with the construction are recorded.

Once that asset is placed in service, all costs associated with it are tracked in the construction WIP account and are shifted to the code of accounts line item that is most appropriate for that work component.

7.3.2Earned Value Management

In construction, EVM can be based on quantities to measure physical progress, which is done by measuring installed quantities and comparing them to planned quantities on a period-by-period basis.

Many government projects utilize earned value as a method in which progress payments are made to the contractor. The contractor gets paid by achieving predetermined contractual milestones or per the cost loaded schedule activity in which quantities of actual work in place are paid per the contract unit price for each quantified item.

7.3.3Progress and Performance Reviews

Progress can be measured in several ways, such as units completed, real and approved use of resources, incremental milestones, start or finish of work activities, or based on an inspector or supervisor opinion. Progress and performance reports (PPR) showing the EVM values are published for management review and, if needed, any responsive actions.

7.3.4Forecasting or Estimate at Completion

Forecasts are generated, updated, and reissued based on work performance data provided during project execution. Estimate at completion (EAC) is typically based on the actual costs incurred for work completed, plus an estimate to complete (ETC) the remaining work. It is incumbent on the project team to predict what it may encounter to perform the ETC, based on its experience to date. Where actual quantity measurements are available, ETC can be calculated based on remaining quantities.

The most common EAC forecasting approach is a manual, bottom-up summation by the project manager and project team. Project management software is often used to monitor the three EVM dimensions (PV, EV, and AC), to display graphical trends and to forecast a range of possible final project results.

As work on the project progresses, cost control captures more precise information and these contingency reserves may be used, reduced, increased, or eliminated. As changes needing the use of management reserves arise, the change control process is used to obtain approval to transfer the applicable management reserve funds to the cost baseline.