Upload
dr-rupert-booth
View
308
Download
2
Embed Size (px)
Citation preview
February 2015
Dr Rupert Booth, FIET FRICS FCMA PMP CEngChief Economist
COST ESCLATION ACROSS
THE LIFECYCLE
Agenda
Pre-Tender
Government intervention
Corporate actions
Forecasting input prices
Optimism bias
Contingencies
Post-tender
Input price escalation
Pass-throughSelecting indicesDesigning indicesHedging
Cost over-runs
Baselines & stage-gatesProgram controlRegional factors
Government interventions
Price controls or subsidies. Usually backfire (reduce supply, increase
demand and deter inventory holding)
Market development: reduce regulatory barriers to entry of suppliers and
allow substitution (material and labour)
Bottleneck removal: reduce physical barriers to supply and arrange
inventory holding
Supplier development: set-up suppliers or encourage start-up via tenders,
encourage new entrants
Procurement strategies: widen pool of bidders, review contract terms
Corporate actions
Capacity planning
Matching resource supply to demand
Productivity improvement
Investment in skills and equipment
Re-engineering of program of work to avoid supply constraints
Portfolio level
Owner’s specification, e.g. Concrete vs. Steel frame
Use of pre-fabricated components, e.g. Water-proofing approaches
Global service centres
Design centres
Forecasting input prices (1)
Time series:
• Simple method for established trends (e.g. real wages)
• Construct multi-factor model
• Assumes past guide to the future
Regression models
• Links one factor (y) to another (x)
• Useful if clear relations exists (e.g. Bitumen or Fuel price link to oil price)
Leading indicator analysis
• Identify leading indicators, e.g. consumer price index, crude oil price, producer price
index, housing starts, and building permits are explanatory variables
• Adjust for events, e.g. Regulatory changes
Forecasting input prices (2)
Reference case benchmarking:
• Finding a reference case (e.g. Asian Games, Dubai Boom)
• Making adjustments (e.g. scale, supply elasticity)
Build-up Models
• Identify ‘stack’ of factors, e.g. global inflation, regional factors, local
overheating etc.
• Build up forecast by addition, but avoiding double-counting
Econometric models
• Model supply, demand, inventories, elasticity etc
• Wide range of assumptions that often cannot be verified
Optimism bias and contingencies
Classic paper: ‘Underestimating costs in public work projects: Error or
Lie?’ by Flyvbjerg et al (2002)
Subsequnet tsunami of ‘Mega-project’ publications, especially relevant to
sporting events
Practical Guidance:
At appraisal stage, optimism bias by project sponsor almost
inevitable, so independent review is required
At tender stage, need to develop into risk-based multi-level
contingencies with governance framework linked to funds, to control
escalation
Introduction to Indices
Sources & Methods:Construction Price IndicesOECD
Recent/ongoing consultations:
BIS Construction Price and Cost Indices (2014)
BCIS Price Adjustment Formulae Indices for Civil Engineering consultation (ongoing)
Post-Tender : Input Prices
Pass-through
Full transfer of risk away from contractor
No incentive to minimise cost
Can be appropriate where the principal sets prices, e.g. Government
Selecting indices
General inflation (may track wages but not materials)
Input cost (clarity of definition)
Output price (integrity of data collection)
Tender price (but sampling issues)
Designing indices
Benefit must outweigh the cost of collection, calculation and dissemination
Direct measurement or indirect calculation (e.g. collect input or output data and
infer the other)
Hedging
Relevant for larger contractors where hedge for commodity exists, e.g. fuel, steel
Post Tender: Cost Overruns
Baselines & stage-gates
1st protection: Clear baseline, e.g. London Olympic Baseline Legacy report (123pp)
2nd protection: stage-gate process for disciplined progression
3rd protection: change and configuration management control
Program control
Early detection of issues and update of risk register
Frequent, regular update of costs and earned value within agency and to fund holders
Contingency and variation management within governance/delegation framework
Regional factors (informal survey, September 2014):
1. Misallocation of risk leading to increased risk premia
2. Awarding contract to lowest bidder hoping to profit from variations
3. Late specification changes
4. Tortuous change management process
5. Poor coordination of overlapping projects
6. Inaccessibility of contract principal
7. Skill shortages worsened by visa problems
Claims Analysis (UAE)
Source: Construction claims in United Arab Emirates: Types, causes, and frequency. Essam K. Zaneldin
Views from the field: importance of causes of delay (Saudi)
Source: Causes of delay in large construction projects, Sadi A. Assaf , Sadiq Al-Hejji
Conclusions
Governments, Owners/principals, consultants, and contractors should have a
common interest in avoiding unexpected cost escalations
Escalation avoidance begins with market development, risk allocation and
procurement strategy
For market participants, pre-tender cost and price forecasting is feasible, with
some potential for risk transfer
Post-tender, escalation avoidance starts with good baselines and controls
Regional factors worsen tendency to cost escalation
Once escalation has occurred, opinions of course diverge but with a wide variety
of outcome by sector