Business and The Difficulties of Budgeting - Research Paper Example

INTRODUCTION More often than not, construction projects make news headlines all throughout the US for being financial fiascos, as opposed to remarkable engineering accomplishments that have provided improvement of our constructed environment. In the mid-1990s, a government inspection disclosed that over one quarter of construction projects were completed over their capital cost limit (HM Treasury, 1995). Prior to this, a survey of construction industry clients discovered that nearly one-third protested that their projects would often exceed the set budget (Barrick, 1995). This issue continued during the latter part of the decade with the Construction Clients Forum (1997) noting that approximately sixty percent of clients said that cost targets were seldom being met. During the beginning of the new decade, only forty-five percent of construction enterprises were being accomplished within in the budget (DETR, 2000a). Since then, the construction industry has gained a rather negative reputation for delivering facilities over the budget. This study investigates into the problem of cost overruns in construction projects. RESEARCH METHOD Samples of construction project cost overruns were recognized and examined. Due to the small sample size of pertinent published data on such schemes, it demonstrated difficulties in drawing any constant findings from the study. It was consequently resolute to collect a great number of insight from experienced cost-estimating professionals about the possible reasons for cost overruns. A questionnaire was conducted. The experimentation then began to view how the construction industry is reacting and tending to the difficulties of precise budgeting. ACTUAL PROJECT COST OVERRUNS The Scottish Parliament has long since thoroughly examined the issues involved in construction project cost overruns on various instances. The samples of these projects include the British Library, Guys House and Portcullis House. The British Library first opened its doors in 1998 and is considered to be one of the largest public buildings ever constructed in Britain. At £511m, it was three times over the original budget (Harlow and Syal, 1995). Blame was directed towards politicians and the government agency management team who continuously changed the projects personnel and the responsibilities of individuals (Spring, 1997). There had also been a lot of condemnation of the contractual arrangement used, which espoused a cost-reimbursement approach, which meant that the consultants and contractors had very few financial stimulants to remain within the cost limits. The second example concerns the third phase of a hospital redevelopment project. At £152m, Guys House doubled its original budget (NAO, 1998). A few increases in cost were revealed as being inescapable because of the alterations in the health services statutory requirements, building laws and regulations and a new liability for tax; however, other raises in costs might have been evaded. These inclinations in cost were due to failure to freeze design, remarkable design changes, obstructions to the building works, an immense amount of arguments and claims, and the bankruptcy of major works package contractors. The NAOs suggestions included the necessity to have full and realistic costings backed up by a complete risk analysis, and to recognize the risks involved in using a distinct contract strategy and to take proper action to decrease them. The third sample of this problem is the new parliamentary office building that is opposite the Houses of Parliament in London (Barrie, 1999a). At £250m, Portcullis Houses budget doubled (Wheeler, 1998). Built on a completely difficult site entirely with a precise project brief, these characteristics have steered to this turning into one of the most expensive buildings ever erected in Britain (Barrie, 1999b). The first budget estimated was reconsidered after the cladding works package tender came in completely over the budget, and the budget had to be raised once more after issues issues had been caused by other complications, as there had been an underground station sitting directly below the site (Barrie, 1997a). A statement from a Member of Parliament set out justification for the increased costs as attributed to inflation, delay in handing over the site and for approved additional design costs (Baldock, 1999). The latter includes bronze cladding to extend the life of the building, electronic door locks, internal security measures, the incorporating of the parliamentary information systems network and increased health, safety and fire regulations. THE CURRENT POSITION At the beginning of a new decade, history sought to repeat itself with yet another new parliamentary building flagrantly exceeding its original budget. The Holyrood project in Glasgow was not to be completed until 2003 but, since the original 1998 feasibility cost estimate of £90m, it is now expected to cost £230m (Scottish Parliamentary Corporate Body, 2000; Fairs, 2001). The principle cause for the addition was the demand for extra space, which caused the project to almost double, and consequently leading to knock-on effects of raised contingency, fees, VAT, fitting-out and programme delays. Last year, the project director quit after being unable to control the costs and preventing additional design alterations. Along with this project, the new Welsh assembly building was also reported Project cost overruns and risk management to be in “chaos” (Leftly, 2001). Set to be completed in 2004, a year later than had been originally planned, the project was reported to have cost upwards of £40m, which was at least £13m over budget. This led to the project’s design contract, with one of the more famous names in architecture, to be aborted. Farther a field in Europe, the European Commission are facing difficulties with their new headquarters in Brussels (Building, 2002). It could quickly become one of the world’s most expensive buildings as costs could reach £900m, which is £800m more than the original estimate had been. Concerning the problem of a potential budget instability, a Chief Executive of a construction company said that “as long as you are capable of assessing the risk, the margins you can achieve by working in construction are ok” (Barrie, 1997b). This perception of the issue was supported by yet another head of a construction firm, stating that “if youre not going to be a risk taker in construction, you should leave the industry” (Barrie, 1997c). However, in spite of the fact that the industry has been pleased with having such busy times, there are numerous headlines about well-established contractors going into receivership (Allen, 2000). One builder said, “Banks on the whole dont like construction because it always involves too much risk” (Jones, 2000). Recently, the director of a rather significant construction company believed that in which the areas that the industry most often runs into trouble is when it fails to recognize a risk (Ernst & Young, 2002). Therefore, while risk is ingrained in the construction industry, it still gives the appearance that it is not easy to tend to. There is a dire need for a more thorough comprehension of the concepts of the formal risk management. QUESTIONNAIRE SURVEY FINDINGS The mail questionnaire method was used for industrial explorations involving the issues of project cost overruns. Quantity surveyors are the industry’s professional cost estimators. Questionnaires were mailed to quantity surveying businesses along with a cover letter. Practices were chosen from the Royal Institution of Chartered Surveyors geographical directory. The biggest town in each of the ten UK regions was selected and the questionnaire was sent to five hundred businesses. An open-style question was directed to surveyors, asking them to list up to five main reasons why they believe that building project costs sometimes tend to go over the initial budget estimate. From the 114 successful responses, 341 reasons for cost overruns were received, making it an average of roughly three answers per respondent. The analysis of the results defined fifteen categories of reasons. These are ranked in Table 1, together with percentage breakdowns. As seen in Table 1, it is viable to notice that design changes to the project is the principle characteristic for cost overruns. Flanagan and Tate (1997) have discussed how the process of change now seems to be never ending and hectic. Nevertheless, they distinctly mention that what was not changed is the vital aspect of effective budget control from the starting stages of design all the way through to the completion of the project, and that buyers value a certainty of price and projects constructed within the allotted budget. The results of the survey reveal that clients are often the lead source driving the changes that lead to a raised cost. It must also be observed that it is plausible for change to sometimes reduce costs. Table 1: Perceived reasons for causing building construction projects to finish over budget Rank Reason Number of Examples (percentage of responses in category) responses 1 Design change 52 client driven (76%); design variations (24%) 2 Design 36 incomplete design at tender (38%); too much generally development (33%); initial design inadequate or lacks detail (28%) 3 Information 32 general lack of information (44%); lack of information at availability tender stage (38%); lack of information at briefing (19%) 4 Design brief 31 lack of detail and definition, badly developed, incomplete, or incorrect (84%); client not know what they want (16%) 5 Estimating 29 poor cost advice (31%); inadequate contingency allowance or method assessment of risks (31%); base method used for calculation (21%); stubborn client attitude (17%) 6 Design team 26 designers attitude, input, whims, understanding of cost and performance value (46%); M&E estimates (25%); inadequate cost control (21%); designers awareness as to areas of cost risk and subsequent risk management (7%) 7 Project 24 design management (21%); contract and site management management (17%); control (13%); communication routes (13%); sub contractor and supplier interface and management (8%); leadership (8%); lack of value management (8%); management approach (4%); decision-making (4%) =8 Time limits 19 unrealistic design development periods (47%); delays by employer and client driven speed (32%); no time to carry out realistic budgets or cost control (11%); unrealistic construction periods (11%) =8 Site conditions 19 ground works (53%); unforeseen site conditions, constraints, restrictions, Murphy’s Law - basically things go wrong (37%); dry rot or asbestos in refurbishment’s (11%) 10 Organisation 15 general poor preparation and planning (40%); pre tender (33%); inadequate surveys and investigation of existing site conditions (27%) 11 Claims 14 aggressive or claims conscious contractors, contractors risk pressure, late information release (100%) =12 Commercial 13 fee competition (46%); tight bidding conditions (31%); pressures confrontational approach of industry (15%); corner cutting clients (8%) =12 People 13 inexperience, too optimistic, intuition, knowledge, qualifications, team, personal or practical skills (70%); consultants (23%), contractor (7%) 14 Procurement 10 wrong contract used, inappropriate allocation of risk in route contract document (100%) 15 External factors 8 changes in pricing conditions, indices, inflation, statutory factors, market trends (100%) Project cost overruns and risk management With change there is sometimes a vicious circle where innovations attempt to improve the value for money of facilities but this is then followed by increased complexity and an increased degree of uncertainty. However, when methods of mitigating this risk have been developed then further innovation again leads to new complexity and uncertainty. No matter how many times professionals look back and try to learn from the problems that have been overcome in the past, this will always be a challenge that the construction industry faces. Clients are also continuously changing the game and new means of procuring facilities are being created at an ever-increasing rate (Ernst & Young, 2002). Another key observation that can be drawn from Table 1 is the problem of incomplete design information when estimating. Design development is always going to follow an estimate but, the more complete the information is on the existing site conditions and design definition, then the more accurate an estimate will be. Clients need to invest the time to determine the needs of the proposed facility in a firm brief at the very early appraisal stages when the key design decisions are being made and the framework is set to measure the projects progress. The importance of suitably qualified and experienced design and construction teams is also highlighted by the survey findings. Attitudes, team working, knowledge and both practical and personals skills are critical to the success of a project. This requires organisation and management control to lead the various parties to communicate and make effective decisions. The project manager must help the client set realistic programme time for appraisal, design and construction to ensure that information is released in a timely fashion. Lack of time is a significant reason for cost overruns, with late delivery of information leading to claims from contractors. Although external factors are cited as a reason, it is the project specific issues that need the greatest attention when managing the risk of cost overruns. MANAGING RISK The challenge facing the construction industry is to manage the risk of cost overruns and deliver projects within budget. At the beginning of the last decade, Brandon (1990) stated that in construction the new orthodoxy is to accept risk and uncertainty. He explained that it has been recognised that the key decisions are made in the very early stages of the design process, and the task is to discover techniques, procedures and information support that will improve decision- making at this critical point. Ten years later, Brandon (2000) said “... we realise that we cannot actually forecast the future particularly well” ... “our job is to assess what the risks might be in the future but, at the same time, bring in management processes that allow us to minimise the risk or adapt to changing circumstances” ... “there is a world of difference between predicting the future and thinking intelligently about it, and I wonder whether sometimes we place too much emphasis on trying to get tools which will predict (sometimes you have to do that), but what we should be doing is thinking intelligently about it and creating the paradigms that will allow us to have an improved society in the future.” Attempts are being made to improve the construction industrys poor reputation. In 1994 Sir Michael Latham set out an agenda for action that demanded changes in culture, attitude and procedures with the objective of ensuring value for money and certainty of outcome (Latham, 1994). Latham said that “No construction project is risk free. Risk can be managed, minimised, shared, transferred, or accepted. It cannot be ignored”. This work was followed in 1998 with a report by Sir John Egan, “Rethinking Construction” (DETR, 2000b), and the Construction Best Practice Programme was subsequently set up supported the Construction Industry Board (CIB). The aim is to raise awareness of the benefits of best practice and provide guidance and advice construction and client organisations so that they have the knowledge and skills required to improve the ways that they work (CIB, 2000). The main focus is transformation of outdated management practices and business cultures. Risk management is one of fifteen business improvement themes. In addition to the above initiatives, under a corporate governance code directors of listed firms must now carry out an assessment of the way they handle risk (King, 1999). This means that they have to take a systematic look at the risks that their company faces and provide a full description of how they do this to satisfy auditors and shareholders requirements. The issues include health and safety, financial procedures, environmental risks and regulatory compliance. The code means that, for the first time, directors will have to comment on what they are doing about risk in their annual reports. A finance director of a construction company said that “the code is a heavy compliance burden for contractors in a high-risk industry”, but welcomed the idea that businesses would be more transparent and it is a good opportunity to show that the industry is “trying to put its house in order” (King, 1999). In an attempt to avoid bidding for loss-making jobs and also to examine their financial and operating controls, a major contractor has hired management consultants to examine its risk management strategy (White, 2000a). The Chief Executive said “It could well be that spending half a million pounds on a soil investigation is worth it in order to avoid a major delay at a later date”. White (2000b) also reported on how a major contractor is to invest in an Internet based knowledge management system to allow staff access to detailed information on past projects. This will contain information about where projects went well, and how problems were overcome or could have been avoided. If a company invests in risk and knowledge management systems and processes it becomes less dependent on the skills of individuals, due to a body that may be shared by the entire company (Ernst & Young, 2002). EFFORTS BY COST ESTIMATING PROFESSIONALS Seeley (1996) explained that cost management has become the most important single facet of the work undertaken by the quantity surveyor, with the prime objective of controlling construction costs and obtaining value for money set against perceived performance expectations. Recently, Chartered Surveyors have been asked by the government to provide information for construction Key Performance Indicators (KPIs) for cost predictability (Martin, 2000). This is one of ten headline KPIs that were produced by the DETR in response to Sir John Egan report (DETR, 2000c). The survey provides cost predictability both from inception (commitment to invest), and start on site (commit to construct) to final completion (available for use). In the early nineteen-nineties the Royal Institution of Chartered Surveyors (RICS) produced a report concerning the future role of the Chartered Quantity Surveyor (RICS, 1991). It emphasised the need to provide more accurate and robust forecasts of construction costs. Particularly, new services were needed in the areas of early cost advice, cost control and the market forecasting which will add value to the clients Project cost overruns and risk management business and, in doing so, raise the professions profile. Three years after this report was published a surveying practice carried out a survey and found that clients believed that they would get a more effective service from quantity surveyors with risk analysis, rather than with traditional cost control methods (Crosher & James, 1994). Several clients said that the consultants should draw attention to areas of risk at the earliest possible date. A couple of years later, the (former) Chief Executive of the RICS warned “No construction project is risk free and the industry cannot afford not to manage risk” ... “The range of construction risk - contractual, design, health and safety, site, phasing, along with political, environmental and social considerations - are potentially overwhelming” ... “No major capital project should be undertaken without a full risk assessment.” (Makin, 1996). Fortune and Lees (1996) surveyed the use of early cost advice techniques for construction cost forecasting. Within their conclusions they stated that the research did not fully identify all the risk analysis models used by practitioners. They recommended that future work in this area should address the establishment and evaluation of risk analysis strategic cost advice models currently used by practitioners – a survey was subsequently undertaken by Jackson et al (1997). Towards the end of the last decade a “QS think tank” was set up (RICS, 1998). The objective was to look forward and develop a vision of where Chartered Surveyors working in construction would be in five to ten years time. The findings identified forces driving change, looking ahead to the needs of the customers and pointing to the professional skills that must be acquired to successfully serve the market after 2000. Factors driving change included the global economy, the market and the IT revolution. When considering the needs of the customer, clients said that the things that matter to them most include, among others, setting the budget, cost certainty and risk management – which should be more than just inserting a contingency! The report concluded that if the quantity surveyor is to add value to clients projects then the skills of the profession must be re -addressed, and growth areas included initial cost advice, detailed cost planning, cost management, monitoring work (“participants will need a detailed understanding of risk management”) and project management (“risk management will probably be expected as a standard service”). One of the findings in a survey of twelve thousand quantity surveyors revealed that over half of respondents think that their traditional cost modelling role is under threat and likely to be replaced with software packages in the near future (Cavil, 1999). Three -quarters of respondents strongly believed that unless they start to offer a new range of services then other professionals, such as accountants and management consultants, would take their business away. The chairman of one leading quantity surveying practice argued, “Construction risk is what we are all about. By that, I mean we advise on what can go wrong in the process of arriving at the construction phase, in construction activity itself, and in the life-cycle of the built structure” (Ainsley, 2000). However, the approach to risk management has not evolved in the construction industry and now lags behind other industries in the sophistication of approach (Ernst & Young, 2002). The industry has acknowledged the challenge of risk, but is in danger of being overtaken by the speed of change in the markets that it serves. Clearly, considering the problem of risk in project budgets, there is a need to develop new models that will enable the industry to rise to the challenge of providing more accurate estimates. CONCLUSION In the realm of construction project budgets and risk management, two vital conclusions can be deduced from this research. First, finalized project information ushers to more precise capital cost budget estimates. One of most serious problems when a budget is being estimated is that little information is often available. The requirement is to invest more time in the early briefing stages of design to clearly define a projects scope and complexity. The secondly key conclusion is that change may be classified as the greatest risk. No matter how much design information is produced for estimating, this can be counterbalanced by any design changes that are subsequently made. However, it should be noted that change is not just a threat – if managed effectively it can be an opportunity to make savings or provide greater value for money. Future research should consider the monitoring of industrial risk trends to classify budget risk and understand how it evolves. New integrated models are also needed to help cost estimators to systematically manage risk during project appraisal. However, whilst the industry is often criticised for being inefficient, the clients must also review their driving contribution to the processes of effective risk management. REFERENCES Ainsley, D (2000) Letters - Risk is the name of the QS game, Building, 22 September, 32. Allen, P (2000) £600k row as Edwards builder goes bust, Daily Mail, 4 February, 1. Baldock, H (1999) The spin starts here, Building, 23 July, 24-25. Barrick, A (1995) Poll reveals one in three jobs late, Building, 28 July, 10. 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Latham, Sir Michael (1994) Constructing the team, HMSO, London. Leftly, M (2001) What went wrong?, Building, 19 October, 26-27. Makin, C (1996) What do surveyors know about risk, InfoRM, November, 6. Martin, J (2000) Chartered surveyors provide benchmarking data for construction, Chartered Surveyor Monthly, February, 19. .Royal Institution of Chartered Surveyors (1991) QS2000 - The future role of the Chartered quantity surveyor, RICS, London. Royal Institution of Chartered Surveyors (1998) Towards a sustainable profession, Chartered Surveyor Monthly, June, 56-65. Scottish Parliamentary Corporate Body (2000) Report on the Holyrood Project, SP Paper 99, Session 1. Viewed at: Seeley, I H (1996) Building Economics (4th Edition), Macmillan Press Limited, London. Spring, M (1997) Gentle giant, Building, 31 October, 40-45. Wheeler, C (1998) Thanks for the insight, Building, 9 January, 17. White, D (2000a) Costain turns to KPMG to cut risk - Contractors review of project risk may lead to a spend-earlier-to-save-later approach, Building, 4 February, 17. White, D (2000b) Balfour to spend £5m on project database, Building, 31 March, 19. Read More