IntroductionHow 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 but how many companies address this openly passionately and proactively with well tried tools and methods.

Putting your head in the sand is not the answer!

This paper explains the typical causes of project cost overruns and provides some insights on the use of various techniques and tips for managing and reducing costs.

According to Wikipedia Cost overrun is defined as excess of actual cost over budget. Cost overrun is also sometimes called "cost escalation," "cost increase," or "budget overrun." It is simply calculated in one of two ways: either as a percentage, namely actual cost minus budgeted cost, as a percentage of budgeted cost, or as a ratio, viz. actual cost divided by budgeted cost. For example, if the budget for a project 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.

BackgroundCost overrun is reportedly very common in infrastructure, building, and technology projects. One of the most comprehensive studies [1] of cost overrun that exists entitled Megaprojects and Risk by Bent Flyvbjerg in 2003, found that 9 out of 10 projects surveyed overran, and that overruns of 50 to 100 percent were common. For IT projects in particular, an industry study [2] by the Standish Group in 2004 found that the average cost overrun was 43 percent, and that 71 percent of projects were over budget, over time, and under scoped.

Spectacular examples of cost overruns have been well documented. For example, the Sydney Opera House had a 1,400 percent overrun and the Concorde supersonic aeroplane experienced a 1,100 percent overrun.

Cost OverrunsSo what causes projects to incur cost overruns? The fishbone diagram below highlights many of the factors that contribute to increased costs and overruns.

 

Some obvious causes of cost overruns are listed below:

project and requirements not clearly defined , agreed and prioritised e.g. as evidenced by "wish lists"

inappropriate choice of design inadequate data and hidden or unforeseen problems and 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 or not managed effectively timescales extended insufficient checking of work, waste and rework lack of project direction and weak and inexperienced project management

Less obvious ones are...

absence of a robust business case

little or no evaluation of cost drivers or understanding of direct and indirect project costs

insufficient use of planning tools and techniques e.g. little or no evaluation of the critical path and the impact of change in a critical activity on the plan

poor estimation or forecasting especially of demand and revenue 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 correct the imbalance and avoid failure inadequate account of safety, legal, regulatory and environmental factors 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 and dealt with political pressure, vested interest groups, or simply fear of lack of approval poor communication and decision making

By way of example, the Sydney Opera House overran primarily because construction was pushed ahead before technical design problems were solved leading to significant rework and rebuild. Pressure was then placed on costs and payments resulting in the resignation of the key architect and further delays.

Concorde overran primarily because it was politically led with contractors working to government, with duplicate assembly lines then established in France and the UK and high-cost high-fuel consumption aeroplanes purchased only by the respective state airlines.

Whilst culture and politics may be difficult to deal with and may be beyond the capability of a single project manager, programme and project managers can nonetheless draw on various project management methods and tools to assist them to manage and reduce costs.

The

relationship between cost drivers and project management tools is displayed in the table below.Clearly the table suggests that the above tools and techniques can have a significant impact on many potential cost drivers.

"The first step in reducing project costs overrun is to acknowledge that a substantial risk of overrun exists". Techniques and supporting measures need to be put in place to manage and reduce the risk.

These include:

initial care and attention to project initiation and set up a sound robust business case and realistic estimates and forecasts of costs and revenue a good understanding and analysis of cost drivers and direct and indirect costs analysis of critical path continual measurement of earned value.

Details on some of the above techniques and how to use them are set out below.

Project Set Up and InitiationProject set up is key to success. Getting it right from the start will help avoid unforeseen problems and

knock on effects later.

Use of accepted project management methodologies and tools such as Prince 2 or PBOK along with a good degree of common sense will go some way to getting the project setup properly.

Key factors are:

A clear project brief with defined objectives and scope plus assigned and agreed ownership of clearly defined deliverables and built in

Review mechanisms for review and sign off Detailed tasked and integrated project plan with discrete manageable stages including

sensitivity analysis and evaluation especially of the critical path, supported by a detailed agreed resource plan including unavailability e.g. holidays

Clearly defined individual team and stakeholder responsibilities and accountabilities Processes defined for identifying, recording and managing risks, issues, assumptions,

dependencies and decisions (often referred to as a RAID Log) and changes.

Finally it's important that leadership, stakeholder and risk management issues are factored into projects early and discussed openly at project board and steering group meetings. Projects should be run on the principle of "no surprises" supported by an open supportive culture, thus avoiding the practice of issues typically being discussed behind closed doors.

Business cases - costs and revenueBusiness cases drive projects. They should be seen as a living breathing model for delivering continuous benefit. However they are often seen as "One-off" exercises to get funding and then forgotten.

Fundamentally the business case must be detailed, timed, easily understood with clearly defined itemised costs and benefits and a ROI signed off and monitored by at least Finance.

In building up the business case it is also important to establish realistic estimates of costs based ideally on past experience or validated from various sources.

Identifying CostsIn identifying costs it is useful to distinguish between direct and indirect costs

Project Indirect Costs - Costs that cannot be associated with any particular work package or project activity and tends to be fixed e.g. management, administration and interest

Direct Costs -Normal costs that can be assigned directly to a specific work package or project activity e.g. labour, materials, equipment, and subcontractors

Once direct and indirect costs and key drivers have been identified it is then useful to prepare a cost duration graph to inform project timeline decisions and run sensitivity analysis to inform which critical activities and costs should be focused on.

Note reducing project duration may reduce indirect costs but may increase direct costs by having to put more resources on the project.

In assessing and reviewing costs it is useful to:

Identify lowest cost activities which could reduce project duration and cost Assess options and lower cost alternatives e.g. internal v external resources, insourcing v

outsourcing, Explore different delivery options and processes e.g. run cross functional end to end process

workshops to drive requirements, run training internally Compute the cost benefit of reducing project time and cost Perform impact assessment on risks and issues and build in a contingency factor. A project's

budgeted costs should always include cost contingency funds to cover risks (other than scope changes imposed on the project).

In summary, focus should be on what drives and adds value to desired project output (a lean principle) so benefits should also not be ignored and often can alleviate cost increases by tying them to benefit delivery.

Hence cutting the budget is not the answer as it could reduce all the value in the project!

Estimating Demand/ RevenueIt is important to establish agreed baselines of performance from which improvements and benefits can be measured. As mentioned above they should also be tied to costs where possible to inform decisions on project scope and priorities.

Spending time on benefit assessment can improve the viability of the project and identify further potential benefits as well as quick wins which help deliver early benefit and commitment. But as evidenced below calculating benefits and forecasting demand/ revenue isn't as straight forward as it seems.

The cost overrun for the Channel tunnel between the UK and France was 80 percent for construction costs and 140 percent for financing costs. This coupled with a significant shortfall in revenue projections resulted in near collapse and significant long term refinancing. Traffic forecasts were in the early years of the project wildly optimistic. This was explained by the need to preserve shareholders and banks confidence when the cost overruns became apparent. After the tunnel was completed the forecasts became more conservative. Unfortunately, this is not untypical.

For example the UK Dept of Transport is reasonably satisfied if the original forecast of traffic flow for the year after opening a section of a new road is within 20% of actual flow for that year. In a study carried out by the Dept 22 of 41 road schemes were within this limit; the other 19 had differences from forecast from -50 to +150 percent.

In summary Flyvbjerg in his book on Megaprojects and Risks argues that traffic and revenue forecasting cannot be relied on and can have serious consequences on viability. He suggests that there is a need for more institutional checks and balances, the use of performance specification, penalties for forecasting and estimating errors and the use of risk capital to deliver a stronger commitment to produce more accurate forecasts.

Critical Path AnalysisCritical Path Analysis (CPA) is a project management tool that:

Sets out all the individual activities that make up a larger project Shows the order in which activities have to be undertaken Shows which activities can only take place once other activities have been completed Shows which activities can be undertaken simultaneously, thereby reducing the overall time

taken to complete the whole project Shows when certain resources will be needed.

Thus CPA is recognised as a powerful method for assessing:

What tasks should be carried out Where parallel activity can be carried out The shortest time to complete a project Resources required Sequence of activities scheduling and timings Task Priorities The most efficient way of shortening project time and hence cost.

In order to construct a CPA, it is necessary to estimate the elapsed time for each activity - that is the time taken from commencement to completion.

Then the CPA is drawn up a based on dependencies such as:

The availability of labour and other resources. Lead times for delivery of materials and other services. Seasonal factors - such as the weather.

Once the CPA is drawn up, it is possible to see the critical path - this is a route through the CPA, which has no spare time (called 'float' or 'slack') in any of the activities. In other words, if there is any delay to any of the activities on the critical path, the whole project will be delayed. The total time along this critical path is also the minimum time in which the whole project can be completed.

A simple example of a CPA is shown below where the letters represent tasks and the numbers task duration, with earliest start and latest finish times shown in the top right and bottom left respectively of the circles. Critical path is shown in red where the earliest start and latest finish times are the same.

Earned Value ManagementEarned value looks at how much value has been achieved so far. Each task in a project earns value as planned work is completed. Thus Earned value can be compared to actual cost and budgeted cost to determine variance against budget and plan. It concentrates on three basic parameters:

How much work should have been done to date - Budgeted Planned Work How much money has actually been spent to progress the project to date - Actual Spending What is the value of work that has been accomplished to date - Earned Value

The above terms are defined as:

Budgeted Planned Spending = Budgeted Cost of Planned Work (often referred to as BCPW)

Actual Spending = Actual Cost of Work PerformedEarned Value = Budgeted Cost of Work Performed. The value in terms of budget of what has been actually completed at a given point in time (or, % complete X Planned Spending)

Earned Value Analysis can also be used to predict future performance by extrapolating the above with estimates to complete based on performance to date ( assuming future performance will of course be the same as that to date- which to be fair is rarely the case).

20 Tips on Managing and Reducing Project Costs

Set out below are tips on managing and reducing project costs:

1. Clearly define and prioritise requirements 2. Identify direct and indirect costs and key cost drivers and dependencies and understand cost/time

relationships 3. Validate forecasts and estimates especially on demand 4. Match costs and benefits and link them to objectives and deliverables 5. Optimise cost / benefit ratios and ensure accountability is matched with responsibility 6. Reduce scope where little added value is evident 7. Consider lower cost alternatives 8. Continually focus on critical path and activities 9. Avoid managing by task due dates 10. Plan task durations so that they are carried out sequentially in order of priority 11. Provide timely task and predecessor task completion updates 12. Proactively obtain information and secure resources to complete tasks 13. Report on task completion and provide alerts and act on issues immediately 14. Use Agile techniques in systems projects, using joint workshops and cross functional teams of users

and developers to deliver iterative solutions 15. Use cross functional teams or hit squads to address issues 16. Use project and resource management software that provides:

· resource availability and task completion alerts/triggers· escalation filters and root cause analysis· exception reporting on tasks not started, not progressing and/or escalated

17. Continually measure earned value and alternative ways of meeting project deadlines 18. Regularly produce estimates to complete and review actual costs and revenue to date against the

original business case 19. Enforce tight discipline and adherence to agreed change and risk management approach 20. Engender an open honest "no surprises" culture and reinforcement of objectives.

ConclusionsThis article has focused on techniques for managing and reducing project costs. We should not forget that projects are run and delivered by people so stakeholder analysis, strong governance and effective communication are equally important.

References:[1] Megaprojects and risk: an anatomy of ambition, by Bent Flyvbjerg, Nils Bruzelius, Werner Rothengatter

[2] Standish Group, 2004. CHAOS Report (West Yarmouth, MA: Author)

[3] A study in project failure; Dr John McManus and Dr Trevor Wood-Harper Chartered Institute of IT

[4] Tutor2u.net and BizHelp24 CPA tutorial and example

Dave Rochford is the Managing Director of Implement CRM and is a leading exponent of effective customer service and management. He has been assisting companies to implement profitable customer service and management solutions for the past 20 years.

You can e mail him at dave.rochford@implementingcrm.com or call him on +44 (0) 7765 235912

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