Avoiding Overspend Issue - Essay Example

Avoiding Overspend Introduction The problems related to project management are succinctly expressedas "any collection of vaguely related activities that are ninety percent complete, over budget and late" (Zoll). Project overspend has been a growing concern in the engineering business. The management of the six key resources viz., manpower, money, equipment, facilities, materials and information technology has become so challenging in present scenario, that overrun and overspend have turned into natural consequences, leading to loss of reputation and poor project performance. "A benchmarking study of government construction projects in 1998 showed that three quarters of the projects exceeded their budgets by up to 50%" (Office of Government of Commerce p.2).Kerzner (p. 240) explains the causes of overspend as: "Escalation in raw materials and salaries Increase in union demands Pressure from stock holders Possibility of long term high inflation, accompanied by mild recession Lack of borrowing power from financial institutions" The key to effective project management therefore lies in being able to balance and foresee overspends. This paper discusses approaches to managing costs and avoiding project overspend. Managing Overspend It is becoming increasingly common that by the time leadership discovers that 60% of budget has been spent but only 20% of the work accomplished, it is too late to avoid at least a 40% cost overrun (Cappels). Whenever there is a deviation from the planned programme causing change, recovery, rework, panic that lowers the specifications for project to be completed in time, it invariably results in overrun and consequent overspend that may lead to penalties. M'pherson explains this graphically refer figure 1). The control measures adopted in project management usually aim at mapping the deviation from the defined plan. There are hardly any measures to identify areas of cost saving. The urgency to save, therefore precipitates at a near final stage which is an inappropriate time for cost saving. Cost saving needs maximum consideration at the planning and design stage itself. Once implementation begins, changes only escalate costs and cause delays. So, t he key lies in managing requirements in such a way that overspend can be avoided. Cost control is necessarily an important step towards avoiding overspend. Some strategies for cost control are discussed below: 1. Involvement of Executive Management: Project cost control manifests its effectiveness best, when the executive management is involved in the decisions at all major phases of the project. It helps if the executive management can "recognize the importance of project risk management for identifying and planning to head off at least the most obvious potential risk events" (Max). 2. Estimating Project Budget: The cost of the total work of the project needs to be estimated at the planning stage. Detailed estimating, bottom up estimating, order of magnitude, analogus or parametric estimates can be used to project the cost of all activities and the entire project. If planning is done well, overspending at a later stage can be avoided. The risk management approach to planning can also help evaluate the assumptions and environmental conditions that dominate the project plan, so that weaknesses can be identified and the effect of any risks thus identified, can be avoided. A contingency fund or reserves is usually then set aside to cope with such risks. The budget also needs to accommodate the inflation factor. For this, final estimates are arrived at and then inflation cost is added as a percentage or lump sum. The inflation allowance then gets allocated to each cost item in relation to the actual expected inflation over the period for which costs are expected to be incurred. 3. Establish baseline cost for each activity: To establish a realistic baseline, communication and integration of various types of information is extremely important. This may require robust project control procedures which will include (Hendrickson). a. Cash flow estimates and construction plan that provide the baseline for subsequent project monitoring and control. b. Progress on individual activities and the achievement of milestone completions for comparison with the project schedule to monitor the progress of activities. c. Contract and job specifications to set the criteria to assess and assure quality. d. Data on quantity of material, labour input will help in comparing actual usage to expected requirements. Thus, cost overruns or savings on particular items will be easy to identify with any changes in unit prices, labor productivity or in the amount of material consumed. The final or detailed cost estimate provides a baseline for the assessment of financial performance during the project. The baseline then needs to be modified every time there is a change in the scope of the project which impacts change in schedule or cost, and changes the sanctioned budget. 4. Forecast: Since the project is essentially dynamic in nature it is important to focus on future revenues, future costs and technical problems. Hence traditional accounting procedures pose limitations since their focus is only on recording routine costs and past expenditures associated with activities (qtd. in Hendrickson). Since past costs represent sunk costs and cannot be altered, they may not be relevant for the future. A job status report on all the following costs will aid in controlling the cost of the project and in forecasting future trend. It uses the percentage complete factor or the productivity estimates to arrive at forecasts. The job status report must consist of : a. Budgeted cost b. Estimated total cost in each category. This is the current estimate based on progress and any changes that have taken place. c. Cost Committed and cost exposure d. Cost to date e. Over or under budget information To ascertain these estimates, current information is required on the state of work. Riggs describes some techniques to arrive at these estimates. These are discussed below: Units of Work Completed: Measures actual proportion of completed work Incremental Milestones: Activities can be subdivided into milestones and this can be used to establish the percentage of work completed based on historical averages Opinion: Subjective judgments by supervisors or project managers are also useful in ascertaining the percentage of work completed. To ensure that subjective assessments are not overly influenced by optimism, pessimism, adequate field observations are necessary to ensure that estimators make an informed judgement Cost Ratio: Cost incurred to date can be used to estimate the work progress. "This method provides no independent information on the actual percentage complete or any possible errors in the activity budget: the cost forecast will always be the budgeted amount. Consequently, managers must use the estimated costs to complete an activity derived from the cost ratio method with extreme caution" (Riggs). In addition to effective project control for better cost control, the systems engineering approach to project management can also facilitate avoidance of overspend. INCOSE defines Systems Engineering as "an interdisciplinary approach and means to enable the realization of successful systems. It focuses on defining customer needs and required functionality early in the development cycle, documenting requirements, then proceeding with design synthesis and system validation while considering the complete problem". The approach is more holistic in nature where relationship between components is as important as the components themselves. The Vee Model used in Systems Engineering, addresses the technical aspect of the project life cycle and represents the series of project events. The left side of the Vee is a representation of the evolution of user requirements into parts and lines of code through the process of decomposition and definition. The downward iterations include engineering studies, requirements understanding modeling, feasibility demonstrations, and with-if analysis, and descend to the level of the system under investigation such as subsystem or piece parts as examples. The right side of the Vee represents the integration and verification of the system components into successive levels of assembly. The upward iterations ensure that the technical baseline, as it evolves, continues to be satisfactory to the user. (Forsberg & Mooz p.36-43) INCOSE explains that projects that are successful have the same manpower hours versus time curve. Deviations from the curve indicate lacunae in project management. INCOSE points that "there are calibrated databases of thousands of projects; which show that you cannot improve on the 'characteristic' profile after 15% of the project timescale has elapsed. 60% of your final costs are already committed by this point". Figure 3. reveals that majority of projects overspend, and that it can reduce dramatically when 6-8% of the budget is spent on systems engineering before the contract is negotiated.After this point one hits the law of of diminishing returns nevertheless, systems engineering continues through all phases. 6-8% reduction is observed when there is re use (repetition of activity). Applying systems engineering at an early stage also reduces the need for contingency funds. Sillito points out that benefits of systems engineering applied to project management are achieved by: building the right system (avoiding costs associated with investing in the wrong one) ensuring stakeholder satisfaction on delivery (and hence ensuring that the developer gets paid) following "integration by design" to avoid overspend and over-runs in the expensive phase of the lifecycle (generally integration, test and setting to work) To apply the systems engineering approach to project management INCOSE suggests the following steps: 1. Understand the problem: Identify the benefit to be achieved by the system, and how the system will be used. Ascertain the key measures of operational effectiveness (MOEs), and arrive at the improvement expected from the new system. Identify the stakeholders and agree on the system boundary. Give special attention to change in the environment when the system is ready and how the environment and end users will respond to the new system. 2. Investigate alternative solutions: Consider, model and evaluate both novel solutions and improvements to existing ones. Define a system architecture that encompasses all elements of the solution. 3. Agree and manage the requirements: It is critical not just to achieve the desired outcome but also to balance the requirements with budget and technical feasibility. It may be necessary to identify and consult relevant stakeholders, manage assumptions and assess the impact of any proposed changes and trade-offs and then test the system against its requirements. 4. Agree and manage the interfaces: Synergy needs to exist in the working relationship between all parts of the system in the operational environment. Parallel teams need to work with the confidence that all the pieces being developed will ultimately fit together. Creating accountability at each interface can help reduce the size of the project from N3 towards N2, where N is the number of requirements. 5. Prepare the test and support systems: Preparation of the test, training and support capabilities simultaneously with the "operational system" will help ensure that it is truly ready when deploying the system. 6. Track progress against a plan: In addition to tracking cost, schedule and resources, tracking skills, decisions and technical performance will give an advantage. Flexibility and the need to change, if the environment so demands is also important. Failure to agree on requirements or interfaces can snowball problems that impact all aspects of the project including the budget. Whole life cost management is another approach to avoiding overspend. "The whole-life costs of a facility (often referred to as through-life costs) are the costs of acquiring it (including consultancy, design and construction costs, and equipment), the costs of operating it and the costs of maintaining it over its whole life through to its disposal - that is, the total ownership costs" (Office of Government of Commerce 3). Whole life costing focuses on: 1. Integration of design and construction phases - This helps the Integrated Project Team (IPT) to assume ownership of cost and quality implications of the design, and incorporate useful inputs from end users. Involvement of IPT at an early stage in the project also helps in valuable inputs health and safety, speed of construction and operational efficiency of the completed project. 2. Understanding requirements of end users. 3. Evaluation of options like off-site fabrication and standardization of building components for higher cost-effectiveness and efficiency on site. 4. Ensuring "materials wastage close to zero compared with industry best practice of 10% and labour productivity of 65-70% compared with best industry rates of 54%" (Office of Government of Commerce 3) The method for whole life costing focuses on value for the end user and not just increasing profit margins. The elements of whole life cost are: In house resources Planning Costs Consultancy fees IT costs Construction cost Health & Safety Security Operations Cleaning Maintenance Utilities Alterations Disposal Risk allowance Construction cost The method to manage cost in whole life costing comprises: Establishing baseline costs: This involves establishing a quantified estimate of running, maintenance and other support costs of operating the proposed building, including the costs of disposal. Options available are based on Net Present Value Develop design: This draws the project team's involvement and focus on operational efficiency. Consideration is given to how value can also be improved. For example, ensuring faster throughput for an operating theatre if required. Assessment of proposed method of construction: Whole life costing employs value management and value engineering to minimize waste. The requirements are to be specified in output terms (based on business needs) and not mere details. For example, numbers of windows and thickness of walls should not normally be specified by the client. Establishing the baseline against which actual performance is to be measured Benchmarking the baseline: Compare capital and predicted whole-life costs with the benchmark cost for a similar facility procured in the same way. Conclusion Overall, one can say that project overspend is avoided if objectives and estimates are realistic and requirements clearly understood so that a clear project brief can be prepared and all stakeholders can be in sync. Design should meet with statutory requirements, clear risk allocation, strong leadership, intelligent controls and payment mechanisms, which can motivate the team to achieve the desired goal. This will ensure that overspend does not creep into the project. Works Cited Cappels, T.M. Financially Focused Project Management (FFPM). FL:J. Ross Publishing, 2004. Forsberg K., & Mooz, H., The Relationship Of Systems Engineering To The Project Cycle, Engineering Management Journal, 4:3 (1992) pp. 36-43. Hendrickson, C. "Project Management for Construction." Summer 2003.Civil and Environment Engineering Carnegie Mellon. 1 Feb 2006 < http://www.ce.cmu.edu/pmbook/12_Cost_Control,_Monitoring,_and_Accounting.html> INCOSE. "What is the Value of Systems Engineering." 7 Nov 2005.Leaflet prepared by UK Chapter of the International Council on Systems Engineering. 8 Feb 2006. Kerzner, H. Project Management: A Systems Approach to Planning, Scheduling, and Controlling. Hoboken ,New Jersey: John Wiley and Sons Inc., 2003. Max. "Project Cost Control: The way it works." Jan 2006.Maxwideman. 1 Feb 2006 < http://www.maxwideman.com/papers/cost_control/intro.htm> M'pherson, P.K. "Systems & Value Ltd, Project Management And Systems Engineering Need Each Other: The route to Intelligent Through-Life Acquisition", INCOSE UK Autumn Assembly, Abingdon. 11-12 November 2002. Office of Government Commerce (OGC). "Achieving Excellence in Construction Procurement Guide: Whole life Costing and Cost Management." 2003. Office of Government Commerce (OGC). 1 Feb 2006 < . Riggs, L.S. "Cost and Schedule Control in Industrial Construction." Dec 1986. Report to The Construction Industry Institute. Sillitto, H. "Systems engineering trends, vision and business benefit." 2004.INCOSE UK Assembly.INCOSE. 1 Feb 2006 < http://www.incose.org.uk/Downloads/AA04%20SE%20trends.ppt> Zoll. "Proceedings of the Seventh Conference on Electronic Computation." ASCE. Missouri. August 1979. 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