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ADDIS ABABA UNIVERSITY

EiABC

(ETHIOPIAN INSTITUTE OF ARCHITECTURE BUILDING CONSTRUCTION

AND CITY DEVELOPMENT)

THESIS TITLE: CAUSES OF PRICE ESCALATION AND ITS

IMPACT ON CONSTRUCTION CONTRACTORS IN ETHIOPIA

PREPARED BY- HUNDE HAILU

MELESE MOLLAW

YINCHACHU MERSHA

ADIVISOR- MINWEYELT EJIGU (MSC.)

A Thesis Submitted To The School Of Graduate Studies Of Addis Ababa University (Ethiopian Institute

Of Architecture Building Construction And City Development) In Partial Fulfillment Of The

Requirements For The Degree Of Bachelor Science (BSC) In Construction Technology And

Management.

Addis Ababa

June 2015

ADDIS ABABA UNIVERSITY

EiABC

(ETHIOPIAN INSTITUTE OF ARCHITECTURE

BUILDING CONSTRUCTION AND CITY DEVELOPMENT)

“CAUSES OF PRICE ESCALATION AND ITS IMPACT ON CONSTRUCTION

CONTRACTORS IN ETHIOPIA”

NAME IDENTIFICATION CARD NO.

MELESE MOLLAW------------------------------------ETR/2859/03

HUNDE HAILU-------------------------------------------ETR/2847/03

YINCHACHU MERSHA-------------------------------ETR/2910/03

APPROVED BY THE BOARD OF EXAMINERS

NAME SIGNATURE

_________________________ ___________________

ADVISOR

_________________________ ___________________

EXAMINER (INTERNAL)

_________________________ ___________________

EXAMINER (EXTERNAL)

_________________________ ___________________

CHAIRPERSON

Causes Of Price Escalation And its Impacts On Construction Contractors In Ethiopia

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PREPARED By MELESE M., HUNDE H., AND YINCHACHU M. JUNE 2015

DECLARATION

We declare that this thesis entitled “CAUSES OF PRICE ESCALATION AND ITS IMPACT ON

CONSTRUCTION CONTRACTORS IN ETHIOPIA” is our original work. This thesis has not been

presented for any other university and is not concurrently submitted in candidature of any other degree, and that

all sources of material used for the thesis have been duly acknowledged.

Candidate:

Name: _______________________

Signature: __________________


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ACKNOWLEDGEMENTS

First of all, we thanks the almighty God, for giving me the opportunity to rejoin the university and helping us go

through all the course works and this research work with special enthusiasm and courage.

Our deepest gratitude goes to our advisor Ato MINWEYELT EJIGU (MSC.)For structuring the research, for

providing different research ideas and reference, helping us by printing paper for his constructive comments and

ideas as well as his precious time in reviewing this work, encouraging us to complete the research even through

the times we have faced difficulties and tolerating us with great patience when we delay in the research work.

Our special gratitude should also go to Ato SOLOMON BANTI (MSC), who supported us in providing related

thesis materials and papers that would essentially help in shaping the research in such a beautiful manner.

In addition, we would like to express our appreciation to all organizations and individuals who contributed

directly or indirectly to this thesis and provided the necessary materials and support for realization of this thesis.

Especial thanks are forwarded to contractors, consultants and clients (project owners) who sacrificed their time

in filling the questionnaires.

Last but not least, our special compliment goes to our family for their continuous support and prayer during this

work.


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TABLE OF CONTENTS

DECLARATION ............................................................................................................................................i

ACKNOWLEDGEMENTS...........................................................................................................................ii

TABLE OF CONTENTS ............................................................................................................................ iii

LIST OF TABLES........................................................................................................................................ vi

LIST OF FIGURES AND PIE-CHARTS ................................................................................................... vii

ABBREVIATIONS ....................................................................................................................................viii

ABSTRACT .................................................................................................................................................. ix

CHAPTER ONE ............................................................................................................................................ 1

1. INTRODUCTION .............................................................................................................................................. 1

1.1. The Study Overview ..................................................................................................................... 1

1.2. Statement of the problem .............................................................................................................. 2

1.3. Research objectives ...................................................................................................................... 3

1.4. Research questions ....................................................................................................................... 4

1.5. Research motivation ..................................................................................................................... 4

1.6. Significance of the research .......................................................................................................... 5

1.7. Scope of research ......................................................................................................................... 5

CHAPTER TWO........................................................................................................................................... 7

2. LITERATURE REVIEW ...................................................................................................................... 7

2.1. General ........................................................................................................................................ 7

2.2. Price escalation ............................................................................................................................ 8

2.2.1. Definition of Price escalation .................................................................................................... 8

2.2.2. Elements of construction industry prices ................................................................................... 9

2.3. Main types of construction price indices ..................................................................................... 10

2.3.1. Relation between the Input Price Index & Output price Index ................................................. 11

2.3.2. Methods of construction prices ............................................................................................... 12

2.3.3. Outline of processes in developing a construction price index ................................................. 15

2.3.4. Uses of construction price indices ........................................................................................... 16

2.3.5. Important considerations & major elements of construction price indices ................................ 17

2.3.6. Sources of information used to compile construction price indices .......................................... 18


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2.4. Causes & impacts of price escalation in construction industry ..................................................... 19

2.4.1. Causes of price escalation ....................................................................................................... 19

2.4.1.1. External causes ............................................................................................................... 19

2.4.1.2. Internal causes ................................................................................................................ 21

2.4.2. Impact of price escalation ....................................................................................................... 22

2.5. Prevention Method approach ...................................................................................................... 24

2.5.1. Purpose of Price escalation clause ........................................................................................... 24

2.5.2. Use of Price escalation clause ................................................................................................. 25

2.6. Tools used for mitigating and sharing escalation risks ................................................................. 27

2.6.1. The Owner’s Perspective .................................................................................................... 28

2.7. Contractual Provision made between contracting parties of price escalations in the cause of

Ethiopia .................................................................................................................................................. 29

2.8. Comparison of difference clauses ............................................................................................... 36

CHAPTER THREE..................................................................................................................................... 37

3. RESEARCH METHODOLOGY......................................................................................................... 37

3.1 Introduction................................................................................................................................ 37

3.2 Research Type ............................................................................................................................ 38

3.3 The Study Approach ................................................................................................................... 38

3.4 The study scope and limitation ................................................................................................... 38

3.5 Data Source and Collection ........................................................................................................ 39

3.6 The Research Population ............................................................................................................ 41

3.7 Method of Analysis .................................................................................................................... 41

3.8 Writing of the Research .............................................................................................................. 41

CHAPTER FOUR ....................................................................................................................................... 43

4. DATA ANALYSIS AND DISCUSSION ............................................................................................ 43

4.1. Introduction................................................................................................................................ 43

4.2. Questionnaire Response Rate ..................................................................................................... 43

4.3. Existence and Extent of price escalation ..................................................................................... 44

4.3.1. Data sources for pricing .......................................................................................................... 44

4.4. Assessment on the causes of price escalation and its impact on construction contractors in

Ethiopian construction industry .............................................................................................................. 45

4.4.1. Local contractors and the price escalation ............................................................................... 45

4.4.1.1. Causes of Price Escalation and Their Degree ................................................................... 45


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4.4.1.2. Major construction inputs which contributes to price escalation....................................... 47

4.5. Impact of price escalation ........................................................................................................... 50

4.5.1. Parties affected by price escalation ......................................................................................... 50

4.5.1.1. Impacts of price escalation in construction sector on contractors. .................................... 51

4.6. Tools used to mitigate or sharing price escalation risk ................................................................. 51

4.7. The Role of Parties in Managing Price Escalation ....................................................................... 55

4.7.1. Role of Contractor .................................................................................................................. 56

4.7.2. Role of Consultant .................................................................................................................. 56

4.7.3. Role of Client ......................................................................................................................... 57

CHAPTER FIVE ......................................................................................................................................... 58

5. CONCLUSION AND RECOMMENDATION .................................................................................... 58

5.1. Conclusion ................................................................................................................................. 58

5.2. Recommendation........................................................................................................................ 59

5.2.1. Contractor .............................................................................................................................. 59

5.2.2. Consultant .............................................................................................................................. 59

5.2.3. Client ..................................................................................................................................... 59

5.2.4. Regulatory Body .................................................................................................................... 60

REFERENCES ............................................................................................................................................ 61


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LIST OF TABLES

Table1.5. summary of question and answer of research motivation……………………………………………4

Table 2.3.1 relation between main types of construction price index…………………………………………12

Table 2.3.6. Types of information required for price index and possible data source …………………………18

Table 4.2. Summary of percentage questionnaire distributed and returned, and response rate……………….…44

Table 4.6. Tools used to mitigate price escalation …………………………………………………………….52


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LIST OF FIGURES AND PIE-CHARTS

Fig 3.8 Flow chart of research methodology……………...…………………………………………………….42

Fig. 4.4.1.1: External Causes of Price Escalation and Their Degree of Percentage............................................45

Pie –chart 4.4.1.1: external causes of price escalation and their degree of percentage .................................. 46

Fig. 4.4.1.1: internal causes of price escalation and their degree of percentage .............................................. 46

Pie- chart 4.4.1.1: internal causes of price escalation and their degree of percentage ..................................... 47

Fig 4.4.1.2: price escalation due to material and their degree of percentage ................................................... 49

Fig 4.4.1.2: price escalation due to construction inputs and their degree of percentage .................................. 49

Pie- chart 4.5.1: parties affected by price escalation........................................................................................... 50

Pie- chart 4.5.1.1 Impacts of price escalation in construction sector on contractors and its degrees……………51

Fig 4.6: Tools Used to Mitigate or Sharing Price Escalation Risk and its degree. .......................................... ..53

Fig 4.6. Methods of use accommodate price escalation……………………………………………………….54


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ABBREVIATIONS

BaTCoDA = Building and Transport Construction Design Authority

GDP = Gross domestic product

SCC = Standard Condition of Contract

ECCA = Ethiopian Construction Contractors Association

NCB= National competitive bidding

ICB= International competitive bidding

PPA= Public Procurement Agency

MoWUD = Ministry of Works and Urban Development

GPPB=governmental procurement policy board

PPIS=producer price indices

OECD= Organization for Economic Co-operation and Development

SNA=system of national account

EPCT=engineering, procurement and construction /turnkey

P&DB=plant and design built

CONS=condition of contract for construction

FIDIC=federation internationale des ingenieurs conseils

PE=price escalation

GC=general contractors

BC=building contractors

MS=mean score


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ABSTRACT

One of the wide ranging problems that the construction industry is facing is the price escalation of construction

inputs. This major problem is spread all over the country and domestic contractors are critically affected.

Moreover the projects’ performances are also affected against time, cost and quality.

The research is about investigating the causes of price escalation on domestic contractors from the contractor’s

perspective. The study concepts were developed through literature survey that enables to find out the variables.

Questionnaire based studies and desk studies are used to assess the problem.

The research result shows that the problem of price escalation occurs in an unpredictable manner with increase

in price by more than 27.6%. Contractors lose portion of their expected profit by at least 3.53% of contract

amount. To accommodate at least some portion of any future escalations contractors introduce some risk factors

in their pricing. The price escalation system that is in place is limited to few construction inputs. Moreover,

contractors get compensation only for portion of the price increase of inputs. Project delay, loss of profit wear

found to be the major effects of price increase and delay caused by the contractors is also affecting themselves

by making them vulnerable to effects of price increase.

Finally, based on the analysis of the results, recommendations for contractors and other stake holders have

been proposed that enables to minimize the adverse effect of price escalation on contractors and favors the

construction industry for better performances.

Key words: price escalation, cause of price escalation, impacts of price escalation, price escalation mitigation,

role of parties


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CHAPTER ONE

1. INTRODUCTION

1.1. The Study Overview

The construction industry has a great impact on the economy of all countries [1]. It is one of the

sectors that provide crucial ingredients for the development of an economy. According to Chitkara, [2].

the construction industry in many countries accounts for 6-9 % of the Gross Domestic Product (GDP);

and according to Bhimaraya, [3]. it reaches up to 10 % of the GDP of most countries. In Ethiopia its

percentage of GDP amounts to 3%, considerably lower than the sub-Saharan average of 6% [4]. But

know its percentage is 5.3%, according to [5].

The construction industry is a vital element of the economy and has a significant effect on the efficiency

and productivity of other industry sectors. One cannot think of widespread investment in manufacturing,

agriculture, or service sectors unless the construction results of buildings and infrastructure facilities are

in place. In some of the developing countries, the growth rate of construction activity outstrips that of

population and of GDP[2].

Ethiopia has a rich history of magnificent construction endeavors. The ruined palace of Queen Sheba at Yeha,

the Obelisks of Axum, the rock-hewn churches of Labella, and the castles of Gondar are few examples

of these expertise. With the advent of modern civilization, especially during the late 19th and early 20th

century, there have been some significant developments in this regard. Even though, the development of

the construction industry in Ethiopia is slow, it plays a key role in the development of the national economy.

The role the construction industry plays in socio-economic development is significant. It provides the

basis upon which other sectors can grow by constructing the physical facilities required for the production and

distribution of goods and services. The construction industry has a significant multiplier effect on the economy

as a whole [4]. According to MoWUD, [4]. The interrelationship between the construction industry and the

broader economy largely emanates from three of the industry’s characteristics namely:

The public sector is its major client;

It’s large size, ability to produce investment or capital goods which contribute significantly to national

GDP; and

It is a major source of employment, directly and indirectly by its multiplier effect.


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Construction industries in Ethiopia are parts of the country’s development initiative. It shared considerable

amount of the country’s scarce financial resources. In Ethiopia, the construction industry is the highest

recipient of government budget in terms of government development program. Consequently, construction

industries consume an average annual rate of nearly 60%, according to MoWUD, [6].

Ethiopia is still a developing country; and there is a huge development activity yet to be undertaken. One of the

key factors to ensure a desired level of economic growth in a developing country like ours is achieving a

significant amount of investment by the private as well as the public sector. In this development activity the

construction industry is a front line role player. However the general state of the domestic construction industry

in Ethiopia is reportedly characterized by:

An inadequate capital base,

Old and limited numbers of equipment,

Low level of equipment availability and utilization

Deficiencies in technical, managerial, financial and entrepreneurial skills.

Very limited experience or participation in private sector road and bridge works and provision of related

consulting services.

Construction contracts are very often long, complex documents. Consequently, disagreements or claim

&disputes can arise regarding contractual obligations or expectations. When one party feels that the

contractual obligations or expectations have not been met, and they feel that they deserve monetary and/or time

compensation, they may submit a claim. One of the problems which lead to claims & disputes is price escalation.

Avoiding or minimizing of claims &disputes requires understanding of the contractual terms, early no

adversarial communication improve, and understanding of the cause of price escalations, its impact on the

construction &develop possible solutions.

1.2. Statement of the problem

In Ethiopia, the present state of the construction industry falls short of meeting domestic and international

quality standards and the performance demand expected from the sector [4]. Construction projects have

problems with construction techniques and management as well as limitation of funds and time. The critical

problems are inability to complete the projects on schedule, low quality work and cost overrun. In general,

most (if not all), construction projects experience cost overruns during their execution phase. An examination

of the records of more than four thousand construction projects by Morris et al, [7] , showed that projects

were rarely finished on time or within the allocated budget. Other researchers have also observed cost overruns

are common in the construction industry worldwide [8].


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The starting point of this research is the definition of the research issue or the problem statement [9].

The problem statement is

Practically the client side consultants did not considered price escalation during engineering estimation

or extra budget is not usually allocated for such cases ,

Construction claim properly not considered as a legitimate request for additional compensation (cost

and time) on account of a change in the term of the contract.

The claimant didn‘t submit within the reasonable period(28-30days in most contracts) & not provide the

supporting substantial document and legal aspects

Checking of claim whether, it is legally or contractual supported or not( the document are valid and

reliable) & time taken

The clients do not have an accepted ways of dealing the causes of price escalation, there is not

homogeneous solution that will substantially affect decision making by creating uncertainty. All

stake affected particularly cash flow of the contractor & delay of the project to the client.

This paper therefore focuses on price escalations in constructions and will investigate its causes, impact and

possible solutions to create amicable atmosphere during construction.

In Ethiopia construction projects were often subject to price escalation. The major factors contributing to this

situation are:

Inefficiency in planning, design, and construction;

Difficulty in Obtaining Vital Resources: Materials, Equipment and Skilled Personnel - And Their High

and Fluctuating Costs;

Poor estimating and financial planning;

Inappropriate tendering and contractual procedures; and

Inefficient on-site construction. [10].

1.3. Research objectives

The objective of this study is to determine the causes and the impacts of price escalations with possible handling

mechanisms price escalation in Public Building construction.

Generally, the purpose of the Research is

To identify the main causes of price escalation on contractors of construction industry in Ethiopia.

To assess the overall impact of price escalation on contractors of construction industry in Ethiopia.


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To identify the related responsible party to the causes of price escalation and their role.

Possible treatments mechanism for price escalations.

1.4. Research questions

The research is designed in a way that it enables to collect adequate information to answer the following core

research questions:

What are causes of price escalations?

What are the impacts of price escalations on contractors of constructions?

How can we treat price escalations on contractors of constructions work?

Question was used as a research instrument to collect data. The Information obtained from respondents was

analyzed and the Summarized results are discussed. Finally, we prepared conclusions based on discussion result

and gave recommendation.

1.5. Research motivation

Table 1.5 summery of question and answers of research motivation

NO Question Answer

1 Why has the research been established? Most construction projects in our

country suffer in price escalation.

2 What does the research try to achieve? To contribute knowledge on

problems of price escalation their

causes and their overall effects.

3 What are the important issues for the research? Methodology and literature review

together with distribution of

questionnaire and desk study on

construction projects.

4 Who will benefit from or affected by this research? Stake holders in construction industries

and ourselves as well as our country.

5 How can the research to be done? Literature review, distribution

questionnaire and desk study on

construction projects.


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The imitation the study of this research is largely due to personal observation and low Performance of the

construction projects in terms of cost and time. These includes the construction projects owned by the government

and the private sectors. However, due to the limitation with regard to accessibility of data on construction proj

1.6. Significance of the research

The problem of price escalation, especially in the construction industry, is a worldwide phenomenon, and its

ripples are normally a source of friction between clients and contractors on the issue of price escalations. If this

friction is not properly handled, this could stall the progress of work and may subsequently lead to project

abandonment and the actual project will suffer with universal inflations of costs. Although the causes of

project cost escalations are well known, the methodology used in handling its evaluation, especially on

those aspects relating to price escalations, is very inadequate.

The unprecedented escalation of prices escalations in the construction industry has caused significant

financial hardships for unprepared supplier, subcontractors, contractors, and owners. Contract losses suffered,

projects delayed, or serious disputes resulting from the efforts of constructions industry players to mitigate,

shift or recoup the financial consequences of this sudden and dramatically price escalations. Yet, it is certain that

profits have been lost, relations have been damaged, projects have been impacted, and construction lawyers

have been called upon to look for ways to soften or shift the impact of price escalations on their

unprepared constructions client.

1.7. Scope of research

In implementations statistics indicate that majority of construction industries suffered with an extended

dalliance that lead to the major disputes loss of time and money, and the end user cannot use the intended

projects on the appropriate time. And in several instances the dalliance is not the intention for both the client and

contractor as it does not help both, either in the performance or in the cash flow.

Therefore solving these kinds of claim & disputes during the course of construction will automatically improve

quality of work by creating an amicable atmosphere for client, contractor and consultant and save substantial

amount of money.


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THESIS OVERVIEW

This paper has focused to contribute knowledge on causes &impact of price escalations &with their possible

treatment in public building constructions.

The study report is generally organized in four chapters &appendices.

Chapter 1.Introduction: Composed of general information and background, which gives on overview the cause

of Price escalation & the impact of price escalation in the project with related problems. It also describes in detail

the study objective, goal &methodology followed in this paper

Chapter 2.Literature review: Definitions, comparisons of literature review &quotes the various related works

in this area of the study mainly focusing on the methods of construction

Price escalation, cause &impact of price escalations, prevention approach of price escalation purpose &uses.

In addition in the case of Ethiopia the contractual provision made b/n parties involved.

Chapter 3. The research design and methodology: The basic research design was an exploratory research

methodology using both primary and secondary data. This design was chosen since it enables to assess the

magnitude, scope problems and facilitate for the suggestion of solutions.

Chapter 4.Analisis&Discussions: This includes finding through questioners collected & analyzed the

Questioners on the bases of causes &impact of price escalation with possible treatment.

Chapter 5.Conclusion &Recommendations: This coves the conclusion of the study together with

recommendations for minimizing the cause of price escalation &their imp acts in constructions project


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CHAPTER TWO

2. LITERATURE REVIEW

2.1. General

Construction project is a mission, undertaken to create a unique facility, product or service within the

specified scope, quality, time, and cost [2]. In practice, however, some construction projects encounter

price escalation, delay on completion time or poor Workmanship upon completion. Price escalation, poor

quality workmanship and delay of construction projects require an in-depth investigation to improve the

outputs of the construction industry.

It is common to see construction projects failing to achieve their mission of creating facilities within the

specified cost and time(not all). Hardly few projects get completed on time and within budget since construction

projects are exposed to uncertain environments because of such factors as construction complexity; presence

of various interest groups such as the project owners, end users, consultants, contractors, financiers; materials,

equipment, project funding; climatic environment; the economic and political environment and statutory

regulations.

The successful execution of construction projects, keeping them within estimated cost and the prescribed

schedules and expected performances or quality, primarily depends on the existence of an efficient

construction sector capable of sustained growth and development in order to cope with the requirements of social

and economic development and to utilize the latest technology in planning and execution. According to

Chalabi, et al, [11] adequate planning at the early stages of a project is crucial for minimizing delays and

cost overruns.

Price escalation is mostly common in infrastructure and building construction projects. Researches on construction

projects in some developing countries indicate that by the time a project is completed, the actual cost

exceeds the original contract price by about 30 % [12]. One of the most comprehensive studies of price

escalation that exists found that 9 out of 10 projects had price escalation or cost overrun.

According to Peter Hall, [13] the Sydney Opera House in Sydney sets some kind of a world record for

time delay and price escalation. Originally estimated in 1957 to cost just A$7.000.000.00 and to be completed

in January 1963, it was in fact finished in October 1973 at a cost of A$102.000.000.00. This makes final

costs about 14 times the original estimate.


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2.2. Price escalation

The sad truth about construction price escalation is that they have been a fact of life since Biblical times

“For which of you, intending to build a tower, sitteth not down first, and counteth the cost, whether he have

sufficient to finish it?” [14]. The problem of price escalation, especially in the construction industry, is a

worldwide phenomenon, and its ripples are normally a source of friction among clients, consultants and

contractors on the issue of project cost variation. Project price escalation create a financial risk to clients.

However, in spite of the risks involved, the history of the construction industry is full of projects that were

completed with significant price escalation [15].

2.2.1. Definition of Price escalation

Price escalation according to Guidelines for Contract Price Escalations [16] is defined as: Price escalation

is an increase in the contract price during Contract implementation on the basis of the existence of an event or

occurrence or Series of events or occurrences. These will be a contract provision in order to cater in the cost of

material, labor etc., due to continuing price changes over time [17].

For the purpose of this research cost escalation is defined as the difference between the un expected final

actual cost of a construction project at completion and the contract amount, agreed by and between the

client (the project owner) and the contractor during signing of the contract.

The following are further explained about Price Escalation:

Related to the decrease of the purchasing power of money with time; i.e. most cost estimation is

done based on the existing currency & then escalate with the time when the project will be accomplished;

[18].

Used to estimate the future cost of a project; that is, to escalate current costs into the future or to

move the cost to the future by using predictive escalation index for planning and budgeting; [19]. Used to

bring historical costs to the present; that is to compare the present cost based on the past by using

historical escalation index, it will also be associated with escalation concepts of present and future

worth.[20]

Therefore based on the above ascribed a Price Escalation can be defined as the consideration of a onetime cost or

continuing costs due to changing of Technology, Changing availability of materials and labor & changing value

of the Monetary (i.e. Inflation), rate escalations, & adjustments as they specifically related to the products and

service and also used to determine reconstruction costs, original costs, estimates for future costs &cost for

budgeting purpose.


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2.2.2. Elements of construction industry prices

The term construction covers a wide variety of activities, these include the construction of dwelling, non-residential

buildings, and civil engineering works such as roads, bridges, dams, etc. Construction activity also encompasses

repair, renovations, rehabilitations and maintenance of existing structures, etc. The diversity of construction

activity is the cause of one of the major problems in the compilation of construction price indices, that of

comparability. The items comprising an index and their relative weights are the result of different norms and

standards that apply in each country.

There are a number of difficulties in compiling construction price indices using practices followed in the

compilation of produced price indices (PPIs),[21]. These include:

The product “building” or “construction” or its components are not produced and sold by the

construction industry or its various branches alone.

Sub-contractors selling their output to establishments and enterprises of the construction industry.

The construction branch does not only produce new buildings or construction work. It is also involved

in maintenance and repair work, conversions, extensions, demolition, etc.

As a result of these factors it is difficult to combine individual series of price relatives for construction work at

new buildings in the construction industry or its individual branches, as sufficient weighting information is

seldom available. Prices have already increased several times in the past year or so, as review the evolving

market conditions underlying the present situation of the construction industry. We can see this industry from

different point of view for price change/index. From the supply side, the price of the output of construction

activity is a function of the following major four factors which is related with input price, output price &seller

price indices.

A. Direct inputs: directly rendered to the production of the work. These include materials, labor,

equipment’s or energy, etc. Direct inputs generally vary in proportion to output.

B. Indirect inputs and overheads: These include depreciation, Administrative expenses, etc. These

are generally fixed and do not vary directly with the volume of output. The project overheads are

the cost of administering a project and providing the general plant, facilities and site based services.

C. Productivity: Refers to the efficiency with which inputs are converted into outputs (e.g. through

new technical solutions, increased labor productivity, or more effective organization of work).

D. Profit: Is a residual determined by the sales price, service provided and combinations of the three

preceding items. Profit varies widely and may be Negative.


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The output price for a construction project may increase for any one or more of the following reasons:

Widening or narrowing of profit margins due to changes in market conditions (i.e. irrespective of

changes in costs);

Increases in the prices of direct inputs; and

Changes in productivity resulting in changes in the quantity of direct inputs per unit of output.

On the demand side, the price actually paid by the purchaser or final owner of the output of the construction

activity includes a number of additional cost elements paid by the purchaser. These include the price of the land,

costs of obtaining planning permission, taxes and connection fees, insurance, professional fees (legal, architects,

engineers), real estate agent fees, land registry charges, etc. Normally, the client (or Architect charged by the

client with the responsibility of supervising the construction) concludes contracts with a number of firms.

Most of these are predominantly part of the construction branch; however they may also belong to other branches

of the economy (e.g. steel construction, manufacture of fixtures, engineering, etc.) The client (or supervising

architect) invites construction contractors (who in turn may invite sub-contractors) to undertake work at a

building or construction site. From the perspective of the production performed by a construction contractor, the

price in question may be either the prices of the various inputs to the construction processes paid by the

construction contractor, or the prices received by the construction contractor from the client for the output of the

constructions contractor.

2.3. Main types of construction price indices

Three main types of construction price indices are compiled. These are input price indices, output price indices,

and seller‘s price indices [21].

1. Input Price Indices

Input price indices measure changes in the price of inputs to the construction process by monitoring separately

the cost of each factor. This generally entails the compilation of a weighted index of the costs of wages and

materials. Initially, representative object (e.g. a dwelling of a specific type, size, style, etc.) is taken and the

quantity of labor hours and materials needed for its construction calculated. These quantities are periodically

multiplied by the corresponding prices and the outcome totaled.


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Input price indices only provide a reflection of changes in the prices of construction inputs. The indices produced

are production cost rather than production price indices. These include changes in productivity, profit, and trade

margins of the construction contractor, and changes in actual market conditions.

2. Output Price Indices

Output price indices measure changes in the prices of what is produced by entities engaged in construction

activity. Output price indices cover most of the items normally built into the price paid by purchasers or clients

to entities involved in producing the completed output of the construction activity. These generally include

materials, labor, equipment hire, land preparation costs, overheads, profits, and trade margins.

Different techniques are used to include all these components. One method involves the inclusion in the index

of all (or as many as possible of) the individual factors involved in the construction of a dwelling, non-residential

building, etc. These include overheads, profits, trade margins, and any other costs paid by the client or purchaser

to the builder.

3. Seller’s Price Indices

The term “seller‘s price” is used to distinguish it from the ‘purchasers ‘price” as defined in the System of National

Accounts SNA [22]. Which is excludes the land component in the ownership transfer. Seller‘s price indices

described the total sales price of completed construction, including not only the cost of labor and materials, but

also land, direct and indirect selling expenses, and seller‘s profit.

Seller‘s price indices measure changes in the prices of construction output paid by the purchaser or final owner

of the output of construction activity. These include both supply factors such as wage rates, material costs, and

productivity, and demand factors such as demographic changes, incomes, and the availability of mortgage

finance. These indices are the closest approximations in item coverage to the actual price paid for construction

output.

2.3.1. Relation between the Input Price Index & Output price Index

The inclusion in the index of all the cost elements paid for by the final owner of the construction (particularly

the land, finance costs, selling expenses) conceptually brings a seller‘s construction price index close to being a

consumer price index. The item imposition of the three types of construction price indices is illustrated in the

following diagram.


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Input Price Index Output price Index Seller’s Price Index

Elements Paid by Elements Paid by Elements Paid by

Contractor Client Final Owner

Table 2.3.1.relation between main type of construction prices indices

2.3.2. Methods of construction prices

There are seven main construction price index compilation methods used either currently, or in the recent past

[21]. In order to demonstrate the main principles more effectively these descriptions only contain the main

elements of each methodology and combinations of the seven compilation methodologies described.

A. Prior Breakdown Methods

The starting point for prior breakdown methods is a list of carefully specified factors or components, from which

the total input or output costs of a building or construction project are built up.

1) Standard Factors:

This method is mainly used for the compilation of input price indices. For any given year a representative

construction (or small number of projects) is selected and the quantities of each factor used to build it (e.g.

materials, labor, transport, machinery, etc.) evaluated. Changes in the costs of construction are determined by

Materials

Labor,

Plant &

Equipment

Transport

Energy

Other costs

Materials

Labor,

Plant & Equipment

Transport

Energy

Other costs

Contractors Profit

Margins Productivity

overheads

Materials

Labor,

Plant & Equipment

Transport

Energy

Other costs

Contractors Profit

Margins Productivity

overheads

VAT

Land

Consultants


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monitoring the cost of each factor. The representative building or construction chosen initially is used only to

establish the weights, which yields a construction cost index rather than a construction price index.

2) Component cost method:

This approach is used for the compilation of output price indices. It regards construction output as bundles of

standardized homogeneous components. These components correspond to the supply of standard operations.

Examples would be: the supply and lying of so many square meters of roofing tiles; installation of a hot water

tank of a given capacity; construction of so many square meters of brick wall etc. Price indices are compiled

using the prices of these homogenous components. A construction (or number of projects) is also chosen.

However, the actual work entailed in its completion is broken down into precisely defined standard services or

components.

A number of representative construction firms that have recently performed any of these services are surveyed

to determine the price they have actually agreed or invoiced for these services. A price index is then created for

each standard component. These indices are then aggregated for the buildings initially defined as the

benchmarks. The actual buildings are used only to define a selection of services and the corresponding weights.

A variant of this approach involves the re-specification of a number of the representative projects on a cyclical

basis.

The difference between an index based on input factors and one based on standard components is essentially

one of degree, since components are only factors at a more advanced stage of production. However, the standard

component cost index also incorporates productivity gains and changes in profit margins, as it reflects not only

the cost of the factors, but also the price of the finished product paid by the customers of the construction firm.

Another advantage of this method is that the prices obtained are for components which remain comparable

over time. Fluctuations due to differential quality or execution are eliminated. However, while components are

more homogeneous than completed buildings it is unlikely that they will be completely identical for different

completed buildings.

An advantage of both the standard factor and standard component cost methods is that they can produce

different indices merely by changing the weighting of the indices for each component. For example, indices

could be compiled by type of work, by trade.

B. Subsequent Breakdown Methods


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Subsequent breakdown methods involve the use of samples of either actually completed or fictitious

construction projects. They entail the collection of prices effectively charged (or what would be charged) by the

builder and incorporate changes in productivity and profit margins.

It start from the “completed” building or projects which are then broken down into component parts.

These methods are used primarily for the compilation of output price indices. The hedonic and matched model

methods outlined below are also used to compile seller‘s price indices.

1. Quoted prices

In this method the problem of comparability of components between construction projects is overcome by

having respondents quote prices for a standard construction output product (house, apartment, bridge, school,

etc.) whose specifications are kept constant from one period to the next.

The standard construction (house, apartment, bridge, school, etc.) is updated periodically to reflect changes in

materials, styles, etc. to ensure that it is typical of those being constructed at the time. A major problem with

this method is that it is difficult for firms to take the process seriously. They are not bidding for real work and

there is no bargaining involved.

2. Schedule of prices

This method entails the selection of a representative sample of construction projects either taking place, or

completed, in a given geographic area, over a specified period of time. The cost of each technical component

(derived from blueprints, work specifications, etc.) of a given construction in the sample is priced as at the

base reference date. This involves the use of a schedule of prices containing the price of each component of

the construction at the base period date.

By aggregating the prices for all the components a theoretical average price of the entire construction is obtained

as though it had been undertaken at the base reference date. The general weighting is obtained from statistics

on current construction. A price index is then obtained by calculating the ratio of the current actual price of the

sampled construction to the recalculated price at the base reference period (derived from the sum of its

components compiled from the schedule of prices).

The role of the schedule of prices is to define a price structure, not the average level of each component. The

composition of the schedule of prices may not necessarily reflect the average prices for the base period.

Obtaining such an average would require a very large sample. However, the relative structure of the prices on

the schedule reflects market conditions at the time period in question.


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3. Matched models:

This methodology is used for the calculation of price indices for standard project home construction, as in the

case of the price indices for the construction and renovation of privately built houses. The composition of the list

of construction projects or “models” to be matched against actual construction projects is subject to continuous

review, and is determined by the continued availability of price information relating to a particular model

specification. If the specification of an individual model changes significantly, or if a price is unable to be

obtained, then that model is excluded from the calculation of price movement.

Price information for the actual finished construction is obtained for each period from a sample of

builders/construction firms, real estate organizations, government agencies, etc. They relate to actual sales

transacted during the period.

2.3.3. Outline of processes in developing a construction price index

The development and compilation of price indices for construction activity is a complex procedure consisting of

a long and varied set of operations. The usefulness of the construction indices compiled also depends on having

a clear understanding of the purposes of the indices, and the characteristics of the construction industry in the

country where it is located.

These characteristics include:

The range of construction activities conducted throughout the country; construction techniques

commonly used for each type of construction activity, together with an idea of the rate of change in

techniques used;

Types of entities/organizations undertaking construction activity, and their characteristics (e.g. size,

industry concentration, etc.);

Administrative arrangements for the maintenance of building/construction standards;

Administrative arrangements for government authorization of individual construction projects.

These aspects must be determined before commencement of work on the creation of the index. Relevant

characteristics of the country external to the construction industry also need to be identified. These could be

economic, demographic, geographic, or administrative.

The major processes in the development and compilation of construction price indices using the “model price‖”

methodology outlined above are:

Selection of a small, representative group of recently constructed buildings, etc. as models.


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Specification of the hundreds of detailed tasks or component trades in the construction of these model

projects & general requirements of the main construction contractor.(Architectural drawings and

specifications ,overheads and profit margins)

Selection of a sample of components. The selection of components within each trade area is based on

both money value and the coverage of significant materials and/or products involved.

Development of specifications for each component to include quantities involved and base-weight unit

prices.

Selection of a sub-sample of subcontractors and general contractors in the appropriate geographic areas

from whom prices are collected.

Collection of periodic reports for a sample of these components from subcontractors. (Price collection

may be done by telephone or mail, generally after an initial personal visit to gain co- operation and

discuss reporting problems.

Calculation of a price index for the construction as a weighted combination of these component prices.

This is done by multiplying new price quotations by base period weights, and comparing the result to

base period mode prices.

Development and implementation of an ongoing process of index review to revise the list of model

projects, weights, component items, respondents, etc. It could take as long as year to set up the models,

enlist respondents, and begin to collect data.

2.3.4. Uses of construction price indices

Construction price indices are primarily used for analysis of price movements and price formation in the

construction industry, [23]. ) for price escalation clauses in construction contracts, and for deflation of

components of the national accounts.

More specifically, the primary uses

Measuring the changes of prices of construction materials for construction work.

In developing a program of projects, preparing estimates, comparing estimates with bids, and

scheduling projects within funding limits it is necessary to have some way of judging price movements,

[20] the aim is to express physical volumes of work needed for future construction work in value terms.

Studying the impacts of changing prices over the total construction cost and selling prices of the

construction work.

Measuring the expenditure of consumed materials at constant prices.

Estimating the short-term evolution of prices.

To determine replacement values for insurance purposes.


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Realizing price-index readjustments of construction contracts.

Planning the production of materials and checking the efficiency of entrepreneurial units.

Deflating components of the national accounts.

2.3.5. Important considerations & major elements of construction price indices

Most of the procedures involved in the development and calculation of construction price indices are similar to

those used in the compilation of CPIs and PPIs. However, listed below are a number of problem areas that are

either unique to construction activity, or where particular attention is required when construction price indices

are developed.

Diversity of Construction Activity

Changes over Time

Selection of Appropriate Prices

Range of Items for Inclusion

Ensuring Geographic Representativeness of the Index

Types of Construction Firms to Include

The major elements of construction price indices are outlined below. These elements are interrelated in the

sense that a series of trade-offs and adjustments are made between them by the organization developing the

index. These tradeoffs are largely determined by the proposed use of the index, data availability, and resources

available for developing and compiling the index. For example, in the case of a price index for house

construction, the requirement for an index encompassing both rural and urban areas of a country might for cost

reasons be traded off in favors of including only urban house construction by a decision to include price

information for a larger number work categories, materials, etc. Such a trade-off could be justified by:

Construction Type/Activity Coverage

Geographic Coverage

Items in the Index

Weights

Basis of Prices

Price Collection

Index Review


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2.3.6. Sources of information used to compile construction price indices

From the perspective of the organization responsible for compiling a construction price index the selection of

the most appropriate sources of information used depends on a number of considerations. These include the

use(s) to which the index will be put and the type of index required (input, output), data availability, and resources

(both financial and skill) available in the organization. The institutional background in which a construction price

index will be developed, will to a large extent determine the feasibility and cost of the index, and influence the

methodology Bused in its compilation.

The data required to compile an index may be in the form of price information obtained from construction

enterprises or materials suppliers. Alternatively, components of the price index may be obtained from

administrative agencies charged by law with the responsibility for compiling basic costs indices, or by

professional associations for use as benchmarks for contracts in the profession. Information may also be obtained

from the client who may be traced through building permits.

The following table summarizes possible sources of information for compiling construction price indices.

Table2.3.6 types of information required for price index & possible data sources

Input prices Data sources

Material

• Surveys of construction, building material supply, or building material

manufacturing enter prices.

• Associations of quantity surveyors

• Trade associations

• Chambers of commerce

• Other national statistical office collections (e.g. for producer price

indices

• Government agencies charged with responsibility of monitoring capital

construction works (particularly roads, dams, bridges, etc.)

Labor

• Trade unions

• Trade associations

• Collective bargaining agreements registered with government

• Government agencies charged with responsibility for regulating wages.

• Enterprise surveys of employers

• Household surveys of employees

Transport costs

• Transport associations

• Surveys of transport enterprises


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• Relevant government agencies

Weight information

• Construction branch structural enterprise surveys

• Associations of quantity surveyors

• Architectural enterprises/associations

2.4. Causes & impacts of price escalation in construction industry

2.4.1. Causes of price escalation

There are many causes of the recent material price spiking in the construction industry. They involve both

domestic and international market forces, as well as aspects of the construction industry that make it

particularly susceptible to average cost increases. All project managers understand that there is uncertainty in

contract price and duration. They also know that there is variation in the price and duration of actual task

performance. The causes of project price escalation may originate from either external or internal pressures

that are being applied to the public building project, [24].

At a more detailed level, the causes of construction project price escalation are usually generated from either

design or construction activities. The design-generated causes include design changes, design errors, omissions

and operational improvements. Construction driven causes are often linked to the unsatisfactory site conditions

that hinder good workmanship, material handling and plant operation. The design and construction issues must

be considered in combination with how the team is managed, co-ordinate and communicated with to reduce

problems resulting from insufficient work separation, insufficient construction planning and disturbance in

personnel planning, [25].

2.4.1.1. External causes

External cause may be due to technological changes, changes in the owner expectations, changes in competitor‘s

activities, changes in governmental legislation, changes in the economy and finally demographic changes in the

society. i.e.

1. Economic issues: inflation and deflation

The following points illustrate about inflation and deflation:

Production costs for the companies have risen; largely because of economic prospects have deteriorated

rapidly because of the large rise international currencies.

The market is beyond the control of the parties or an occurrence of the even,


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Larger construction programs with the same number of contractors

Increased construction market opportunities (recovery of reconstruction programs,

Change in Foreign Exchange Rates

2. Environmental issues: exceptionally adverse weather conditions those are described as follows

Localized material shortages for specific construction products

Consolidations in the construction industry (number of primer ownership of quarries,

Weather conditions (e.g. heavy rain) ,un expected ground water conditions

3. Technological issues: those technological issues are described as follows

Spot shortages of skilled labor

Increase technical requirement in contracts.

4. Regulatory issues: Government, Regulatory body those are described as follows

change in legislations

Regulatory restrictions, such as environmental permits for plants and quarries,

5. Materials

A change in the cost of raw materials is one of the main reasons for cost escalation. Raw material costs can rise

because of shortage of supplies, excessive demand or a lack of alternatives. A raw material such as coal or natural

gas may be in short supply because of production or extraction problems. Natural disasters or climate changes can

create supply shortages of materials such as food or timber. Rising demand from growing economies such as China

affects the cost of materials such as metals. Some scarce raw materials, such as precious metals, may have no

effective substitutes or alternative suppliers.

6. Compliance

Compliance with industry regulations can lead to cost escalation. In manufacturing, for example, compliance with

health and safety regulations increases labor costs, while compliance with consumer legislation may require

changes in product design or quality control, increasing manufacturing costs.


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7. Supply Chain

Changes in the supply chain can have an adverse effect on costs. If a company has to source its raw materials or

components from another country, the additional cost of transport and import duties will escalate costs. Rising

labor or production costs in the supply chain will also affect the cost of the finished product.

2.4.1.2. Internal causes

Internal cause may result from changes in management policy, changes in organizational objectives and changes

in the long-term survival strategy of the organizations involved.

1) Management

Poor cost management is an underlying cause of cost escalation. Cost estimates based on incomplete or inaccurate

information may lead to cost escalation during a project or production run. Companies also risk cost escalation if

they do not monitor costs continuously to ensure that they remain in line with original estimates. Failure to include

cost escalation clauses in a contract with a supplier leaves a company vulnerable to unforeseen cost increases

during the period of a contract.

2) Labor

Labor costs have a significant impact on manufacturing costs, particularly in companies where the production

process is labor intensive. A rise in wages or employee benefits, additional training costs or an increase in the size

of the workforce can lead to cost escalation. Falling productivity also creates cost escalation. Although labor costs

remain constant, lower productivity reduces output per employee, leading to an overall increase in production

costs.

3) Organizational level and culture. It is also another internal cause of price escalation. This include the

following points:

Ineffective decision-making

Project level

Design errors and improvements

Inadequate skills and knowledge amongst the team

Late change of client brief:-variation order

Designer change of mind:-Engineers fault

Inadequate knowledge of the site conditions:-insufficient feasibility study


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Lack of professional ethics

Contract claims:-escalation claims and EOT claims

Ambiguity in project goal, scope, and resources:-scope change

Unforeseen or uncertainty situations during executions

Any one or a combination of the above factors may result in contract price variations to the design and

construction of a building project‘s actual cost to be over the contract / planned amount [26].

Price volatility of construction material and supplies such as asphalt, fuel, cement and steel can result in

significant problems for contractors in preparing realistic bids. In many cases, prospective bidders cannot obtain

firm price quotes from material supplier for the duration of the project. This leads to price speculation and

inflated bid prices to protest against possible price increases. Price escalations are never welcome but

continuing the escalations global in the construction activity, which beginning to experience for unprecedented

construction cost.

2.4.2. Impact of price escalation

The impact on the construction industry of the recent, unprecedented price escalation has been multi-fold.

Certainly, cries have come from the contractor and subcontractor community of eroded or eliminated profit

margins, as well as significant project losses. On one large project, two prominent structural steel fabricating

companies lost the battle with steel price escalation and declared bankruptcy. In addition to lost fees, and

damaged or destroyed construction businesses, the ripple effect of this dramatic price escalation has included

numerous other impacts beyond the approved contract amounts. Public bodies are then faced with the alternatives

of putting projects on hold while supplemental funding is sought, canceling the project if additional money is

not available, or attempting to scale-down the project scope.

A. Delayed or Cancelled Projects

In the world of private development, material price escalation has been significant enough to cause many

developers to rethink the “numbers” necessary to make a private development worthwhile. Delayed projects,

reduced-in-scope projects, or cancelled projects have been the result. The same impact is being felt in the public

construction sector.


23


For public projects that must be funded by bond issues, significant project price increases present special

problems. In a number of projects, between the time a bond was approved by the voters and the time bids were

received for construction projects, material prices increased significantly and bids came in at prices much.

B. Lack of Firm Price Quotes

In the past, general contractors were able to hold subcontractors and suppliers to their quotes for 60, or 90, or

perhaps 120 days. Today, with those subcontractors and suppliers whose work is particularly sensitive to

material price escalation, it is increasingly difficult to get a firm quote for any significant period of time. Below

the extent, if any, to which traditional construction contracts and long-established legal principles may be of

assistance to contractors, subcontractors, suppliers, and owners facing material price escalation dangers.

Early contractual risk allocation was controlled by unyielding principles that began with strict observance of

the “sanctity of contracts” tempered only by “impossibility” in the absolute sense of the word. Impossibility as

an excuse for performance is an ancient legal concept, traditionally limited in application solely to those

instances where performance had been rendered actually impossible due to supervening causes. Thus, “the

mere possibility of performance, no matter how slight, has ruled out impossibility as an excuse unless caused

by Acts of god, acts of government, or the fault of the other party.” The “force majeure” clause, conceived

centuries ago and commonly found in today‘s typical construction contract, is the contractual expression of this

impossibility concept.

C. Reduced Numbers of Bidders

In part because of the current level of activity in the construction industry, but also in part because of escalation

fears, owners are finding fewer bidders for their projects. States where asphalt supplies have been impacted are

seeing fewer bidders for highway and paving projects.

Owners are seeing more “one bidder” projects and an overall reduction in the number of bidders for projects.

D. Higher Project Costs

Those projects that have not been scrapped or significantly delayed as a result of price escalation difficulties

have frequently experienced higher project costs. Contractor and supplier fears regarding potential, future price

escalation, and the absence of price escalation clauses in most construction contracts, often leads to higher

contract prices and larger project costs.


24


2.5. Prevention Method approach

Even if traditional contract clauses and equitable principles of law are not likely to provide relief to contractors,

subcontractors, and suppliers faced with fixed-price contracts and significant material price escalation, the

contractor community is not without other options in dealing with price escalation risks. In appropriate cases,

one or more of the following may be useful tools for owners, contractors, subcontractors, and suppliers.

2.5.1. Purpose of Price escalation clause

A price escalation clause allows the parties and opportunity to plan for the uncertainty and allocate how and to

what extent the additional costs will be absorbed. Another issue that usually walks hand in hand with price

escalations (i.e. supply& demand) is material shortages. The contract should also contain a companion provision

allowing for time extensions for material shortage. While many contracts allow for time extensions for

unforeseeable circumstances that cause delay, depending on the circumstances, material shortage may be

foreseeable.

If an owner cannot or will not agree to a price escalation clause, consider arranging for the advance purchase of

materials, the use of a bonded warehouse and payment by the owner for materials stored in the bonded warehouse

.If an owner cannot agree to an unrestricted price escalation clause, consider including a contingency budget in

the contract for price escalations.

Price escalation clauses are potentially important to every trade. In the recent past we have seen significant

price escalations occurring with concrete, steel, &fuel to name few. The source of these price escalations are

not going to go away. Make sure you have explored the possibilities of a price escalations begin clause while

your contract is in negotiations.

The purpose of an escalation clause is to cope with and provide some insurance for inflation in long-term sales

and purchase contracts. Escalation clauses essentially offer protection for both parties in a contract for price

fluctuation for goods, such as building materials.

Escalation clauses are also referred to as price adjustment clauses. Escalation clauses benefit owners by

eliminating the need for contractors to include large contingencies in situations where neither party can

accurately predict the economic conditions of the future. Escalation clauses, fairly negotiated, avoid the risk of

uncertainty from deciding the escalation issue in litigation or arbitration.


25


A process that creates substantial economic risk for all parties involved in a construction project. The owner

may be best able to deal with the price increases through redesign, and an owner with an escalation clause

would be in a position to consider the redesign options. Without an escalation clause, subcontractors may be

forced to make the difficult business decision of declining to bid on projects, building large contingencies into

bids, or simply walking away from jobs that become too expensive, causing delays and disruptions to projects.

Three types of clauses are recognized by the federal government for government contracts:

Escalation clauses based on established prices;

Escalation clauses based on actual costs of labor or materials; and

Escalation clauses based on cost indexes of labor or materials.

The American Institute of Steel Construction recommends that its members adopt a clause that takes one of two

forms [27].

1. Payment or credit is based on substantiated “actual” costs incurred by the party supplying goods or

services. The final cost of supplied goods would be verified from actual invoices and compared to the

original estimate or published industry prices at the time of contract. This type of clause is considered

the fairest to both parties but requires the contractor to be willing to disclose detailed purchase

documents.

2. Price escalation is tied to a published material index, either chosen from commonly accepted industry

publications or developed by a governmental agency (Like MoWUD). This type of clause is less

burdensome to administer but lacks the accuracy of the actual cost comparison.

Whether a contractor or owner is under pressure due to an existing fixed-price contract or contemplating

entering into a new construction contract, this brief overview provides potential methods available to

contractors and owners to protect themselves from cost escalation problems in construction contracts.

2.5.2. Use of Price escalation clause

The use of price escalations clause is to compare the costs of projects with differing durations, price escalation

must be considered. Since the duration of larger projects extends over years, it is necessary to have a method of

forecasting or predicting the funds that must be made available in the future to pay for the work. This is where

predictive or forecast escalation indicators are used. The current year cost estimate is, if necessary, divided into

components grouped to match the available predictive escalation index. Then each group of components is

multiplied by the appropriate predictive escalation index to produce an estimate of the future cost of the project.


26


The future costs of these components are then summed to give the total cost of the project. Escalation accuracy

for the total project increases with the number of schedule activities used in summation.

Economists indicate that the source of escalation of costs in the market is Market volatility, construction cost,

budgets, municipal, paving, treatment plants and population growth has significantly contributed for the change

in price related to construction of buildings. The situation becomes critical problem as there are no a unit of the

government (like BATCODA, MoWUD…) who follow market situation to fix appropriate coefficient for price

escalation as it is used to be 5 years ago, because of transformation from centralized government system to

decentralized and market based system.

Construction estimates have always been a critical part of the design process, but in recent years it‘s become

increasingly difficult to predict the bid outcome of construction projects. The construction industry has entered

into a period of high market volatility, and mitigating the associated risks has become a challenge for owners

and consultants alike. In the past two years many projects have bid substantially over-budget because of

construction materials escalation.

Oil prices, developing nations ‘increasing consumption of materials, natural disasters and material supply

shortfalls have combined to create the “perfect storm” of market volatility in the construction industry.

Minimizing the risk of over-budget bidding is now an imposing task. When bonds and funding are solicited at a

project‘s early stage, decisions about cost have to be made with little information and virtually no insight into

potential material price increases in the time between funding and bidding.

The construction market‘s volatility in the past two years has been unexpected and unprecedented; unexpected

by those hoping to build projects with last year‘s costs and unprecedented for those who have forgotten previous

volatile markets because of decades of good fortune.

Construction costs have been increasingly volatile in recent years, with only a short period of respite currently

and no end in sight as developing nations continue to demand more and more resources. Understanding our

global economic situation and its impacts on construction and looking for ways to mitigate impacts of

unforeseen cost increases will be crucial to managing construction contracts.


27


2.6. Tools used for mitigating and sharing escalation risks

Traditionally, contractors, subcontractors, and suppliers have employed contingencies in their bids as a hedge

against many construction project risks. Absent a price escalation clause in the contract, or some other method

for sharing escalation risks with the owner or others in the chain of contract privates, hidden bid contingencies

may continue to be employed [28]. The following tools are used to mitigate &sharing of price escalations on

the construction project:

Bid Contingencies and Contract Allowances

Value Engineering for Substitute Materials

Early Material Purchases

Early Material Supply Commitments

Early Involvement of Specialty Contractors

The Use of Surcharges

Favorable Force Majeure Clauses

Delay the Construction Project

Flow down the Risks

Bulk Material Purchases and Supplier Partnerships

Material Escalation Clauses

Index-Based Escalation Clauses

National Construction Price Indexes

Cost-Based Escalation Provisions

If an owner intends to utilize an actual cost-based escalation provision, it is suggested that the arrangement

include at least the following essential pieces:

Adequate documentation (e.g., supplier quotes and detailed bid breakdowns) establishing the base price

for the application of the escalation provision.

Documentation (e.g., additional supplier quotes) establishing that the “base price” is, in fact, a

reasonable price.

A contractual obligation that the contractor and subcontractors immediately (within a specified

timeframe after con-tract award) place orders for any material items subject to escalation.

Contract language excluding from the escalation clause operation any price escalation associated

with lack of diligence by the contractor, subcontractor, or supplier, or with the delivery of the material

after the scheduled delivery date.


28


Sworn certification by the contractor of the accuracy of, and actual reliance on, the material price in

the bid, and of the accuracy of contractor‘s representations regarding the actual material cost.

Prompt notice requirements.

Exclusion of overhead and profit mark-up on the price escalation.

Adequate assurance that the contractor‘s price does not include a hidden escalation contingency.

A system for identifying, and tracking through the fabrication or delivery phases, the specific materials

subject to escalation terms.

Certainly, an owner could employ a number of other options in structuring a cost-based escalation provision

(e.g., a maximum escalation limit, a “two-way” clause operation, etc.), but the components identified above are

fundamental features, from the owner‘s perspective, of any actual cost-based escalation provision.

The extent to which public and private owners will employ material price escalation clauses in construction

contracts is uncertain. Certainly, it cannot be expected that price escalation clauses will be adopted as a standard

long-term policy for all construction projects. Most public agencies employing escalation provisions continue

to periodically monitor the utility of such clauses, as well as the impact of those clauses on the public

pocketbook. still, faced with declining numbers of bidders on some projects and higher bid prices, with the

resulting threat of postponed or cancelled public improvements, price escalation clauses continue to be

employed by many public agencies and to be considered for use by others.

2.6.1. The Owner’s Perspective

The followings mitigation measures in respect to the owners are:

If you employ a material price escalation clause, provide that the clause will trigger both upward and

downward adjustments.

Consider an escalation clause which provides a minimum level of escalation, below which the

contractor will assume all risks, as well as a maximum limit on allowable escalation.

Another variation to the employment of limits on escalation and escalation clauses is the use of “risk

sharing” provisions i.e., the contractor and owner each share a certain percentage of any eligible

escalation, perhaps on a sliding scale.

If using an escalation clause based on actual price increases over bid amounts, insure that the

contractor is required to furnish adequate proof of the prices relied on in the bid, and proof (e.g.,

multiple quotes) that the prices in the bid are reasonable and consistent with market prices.


29


Consider the potential advantages of a design-build contract arrangement, where designers and

builders collaborate early on decisions which may affect material choices and delivery schedules.

Involve specialty contractors (e.g., steel, electrical, mechanical, and concrete subcontractors and

suppliers) in the early stages of the project development, so that you can benefit from their guidance

regarding material prices and shortages.

If you intend to have the contractor and subcontractors assume all of the risks of material price

escalation, pre-qualify contractors and subcontractors for the financial strength necessary to

withstand material price spikes while continuing to perform.

If you intend to have the contractor and subcontractors assume all of the risks of material price

escalation, consider the possible utilization of performance bonds.

As you contemplate requiring contractors and subcontractors to assume all material price escalation

risks, consider the possibility that your project costs will be higher, as a function of hidden

contingencies, bond premiums, and potential project delays or disputes.

If you utilize a material cost escalation clause, and it is index-based, make certain that you fully

understand the nature and relevance of the specified index, as well as the mechanics of the manner

in which the index will be employed.

If your price escalation mechanism involves a comparison of bid prices to actual prices, include

adequate audit rights in your contracts.

2.7. Contractual Provision made between contracting parties of price escalations in the cause of

Ethiopia

In most case price escalations is administered in Ethiopia by using the following contractual clauses. These are:-

1. The BATCODA (1987) general conditions of contract clause 70 changes in cost and legislation, sub

clause (1) increase or decrease of costs [29].

(e) The Rates contained in the priced bill of quantities are based upon the market prices of the materials

and goods specified in the appendix to the bill of quantities and current at the date of bid pricing (hereinafter

referred to as “the Basic Prices”) the contractor shall state in the said schedule the basic prices of such

materials and goods. Such prices shall be supported by bona-fide quotation from suppliers.

(f) If the market price of any of the materials or goods specified as aforesaid shall be increased or decreased

after the said date of the bid pricing, then the net amount of the difference between the basic price and the

market price payable by the contractor and current when any such goods or materials are bought shall form


30


an addition or deduction as the case may be to or from the contract price and be paid to or allowed by the

contractor accordingly.

2. MoWUD: clause 70, sub clause (1) changes in cost and legislation [4].

The contract price shall be deemed to have been calculated in the manner set out below and shall be subject to

the adjustment in the events specified here under:-

(a) The rate contained in the priced Bill of Quantities are based upon the rates of wages and other

emoluments and expenses applicable at the site date of bid pricing (as defined in sub

clause(6)hereinafter)

(b) If the said rates of wages and other emoluments and expenses are increased or decreased by any

Act, Statute, Decree, Regulation and the like after the said date of bid pricing, then the net amount

of the increased or decreased of the emoluments and expenses shall, after due consultation by the

Engineer and shall form an addition or deduction as the case may be to or from the Contract Price

and be paid to or allowed by the Contractor accordingly.

(c) The rates contained in the priced Bill of quantities are based upon the rates of the Contractor‘s

compulsory contributions payable at the date of bid pricing under or by virtue of any Act, statute,

Decree, Regulation and the like applicable at the Site.

(d) If any of the said rates of contribution shall be increased or decreased after the said date of bid

pricing or if any new compulsory contribution becomes payable after that date, then the net amount

of the difference between what the contractor actually pays in respect of works people engaged

upon or in connection with the works and what he would have paid in respect of such persons had

any of the said rates not become payable as aforesaid shall form an addition or deduction as the case

may be to or from the contract price and be paid to or allowed by the Contractor accordingly.

Provided always that the employer and the Contractor may agree upon a sum which shall be deemed

to be the net amount of the aforesaid difference, and such sum shall be deemed for the purpose of

this Contract to be that which is to be paid to or allowed by the Contractor by virtue of this paragraph.

2. Sub contract

(a) If the Contractor shall decide, subject to clause 4 hereof, to sublet any portion of the works, he

shall incorporate in the Sub-contract provisions to the like effect as those contained in sub clause (1)

of this Clause.

(b) If the price payable under Sub- contract as aforesaid is increased or decreased by reason of the

operation of the incorporated provisions of Sub clause (1) of this Clause, then the net amount of such


31


increase or decrease shall, when determined by the Engineer, form an addition or deduction as the case

may be to or from the Contract Price and be paid to or allowed by the Contractor accordingly.

3. Notice by the Contractor

The Contractor shall, within a reasonable time, give written notice to the Engineer of the happening of any of

the events referred to in paragraphs(b) and(d)of the sub clause(1) of this Clause, or of any reduction or increase

in the Subcontract price for any portion of the Work sub-let.

4. Profit

No addition to or deduction from the Contract Price made by virtue of this Clause shall alter in any way the

amount of profit of the contractor included in the Contract price.

5. Nominated Subcontractor

This Clause shall not apply in respect of Work executed by any nominated Subcontractor (fluctuation in relation

to nominated Subcontractors shall be dealt with under provisions in relation there to which may be included in

the appropriate Subcontractor or Contract of sale)

6. Date of Bid Pricing

The expression “the date of bid Pricing” as used in this clause means the date 15 days prior to the deadline for

the submission of bids as determined by the Employer in the bidding documents.

7. Subsequent Legislation

Notwithstanding the foregoing, such additional or reduced cost shall not be separately paid or credited as

aforesaid if the same shall already have been taken into account in accordance with the provisions of sub

clause(1)through(6) of this Clause.

3. FIDIC, Clause 13 Variations and Adjustments, Sub clause 13.8 Adjustment for Changes in cost [30].

In this Sub-clause, “table of adjustment data” means the completed table of adjustment data included in the

Appendix to tender. If there is no such table of adjustment data, this Sub clause shall not apply.

If this Sub-clause applies, the amounts payable to the contractor shall be adjusted for rises or falls in the cost of

labor, Goods and other inputs to the works, by the addition or deduction of the amounts determined by the

formulae prescribed in this sub-Clause. To the extent that full compensation for any rise or fall in costs is not


32


covered by the provision as of this or other Clauses, the Accepted Contract Amount shall be deemed to have

included amounts to cover the contingency of other rises and falls in costs.

The adjustment to be applied to the amount otherwise payable to the Contractor, as valued in accordance with

the appropriate Schedule and certified in payment Certificates, shall be determined from formulae for each of

the currencies in which the Contract Price is payable. No adjustment is to be applied to work valued on the

basis of cost or current prices. The formulae shall be the following general type:

.etc

Eo

End

Mo

Mnc

Lo

LnbApn

Where:

“Pn” is the adjustment multiplier to be applied to the estimated contract value in the relevant

currency of the work carried out in period “n”, this period being month unless otherwise stated in

the Appendix to Tender;

“a” is a fixed coefficient, stated in the relevant table of adjustment data, representing the

nonadjustable portion in contractual payments;

“b”, “c”, “d”… are coefficients representing the estimated proportion of each cost element related

to the execution of the Works, as stated in the relevant table of adjustment data; such tabulated cost

elements may be indicative of resources such as labor, equipment and materials;

“Ln”, “En”, “Mn”,…are the current cost indices or reference prices for period “n”, expressed in the

relevant currency of payment, each of which is applicable to the relevant tabulated cost element on

the data 49 days prior to the last day of the period (to which the particular Payment Certificate

relates);and

“Lo”, “Eo”, “Mo”… is the base cost indices or reference prices, expressed in the relevant currency

of Payment, each of which is applicable to the relevant tabulated cost element on the Base Date.

The Cost indices or reference prices stated in the table of the adjustment data shall be used. If their source is in

doubt, it shall be determined by the Engineer. For this purpose reference shall be made to the values of the

indices at stated dates (quoted in the fourth and fifth columns respectively of the table) for the purposes of


33


clarifications of the source; although these dates (and thus these values) may not correspond to the base cost

indices.

In case where the “currency of index”(stated in the table)is not the relevant currency of payment, each index

shall be converted into the relevant currency of payment at the selling rate, established by the central bank of

the Country, of this relevant currency on the above date for which the index is required to be applicable.

Until such time as each current cost index is available, the Engineer shall determine a provisional index for the

issue of interim Payment Certificates. When a current cost index is available, the adjustment shall be

recalculated accordingly.

If the Contractor fails to complete the works within the Time for Completion, adjustment of prices thereafter

shall be made using either

(I) each index or price applicable on the date 49 days prior to the expiry of the Time for Completion

of the Works, or

(II) The current index or price: whichever is more favorable to the employer the weightings

(coefficients for each of the factors of cost stated in the table(s) so adjustment data shall only

be adjusted if they have been rendered unreasonable, Unbalanced or inapplicable, as a result of

Variations.

This Sub-Clause provides formulae to adjust the contract values to reflect escalation of costs due to inflation.

No such formulae are included in EPCT, which is intended to place greater risk on the Contractor. If an EPCT

contract is to include the formulae, the provisions in P&DB 13.8 may be incorporated, by reference, with

appropriate adjustment to the wording in respect of defined words and phrases “Engineer” and “Appendix to

tender”, for example. The remaining comments on this Sub-Clause apply to CONS and P &DB only.

Under CONS or P&DB, the formulae require data which is to be specified in a table of adjustment data for

each payment currency, the tables being included in the Appendix to Tender. For a fixed-price contract where

no adjustments are to be made for escalations of costs, it is only necessary for there to be no such table in the

Appendix to Tender. However, it is better to include a statement like “Sub- Clause 13.8 not applicable”, in

order to clarify the Parties intentions.


34


The example Appendix to Tender published at the end of CONS and P &DB illustrates the format of each table

of adjustment data. It must define the coefficients (proportions) and cost indices (reference prices) which are

to be used to adjust the other amounts included in each currency in each currency in each payment Certificate.

Typically, the Employer will have defined the fixed (non-adjustable) coefficient “a” before the tender

documents are issued to tenders, but may prefer each tendered to define the other coefficient and all the sources

of the cost indices in the table for each currency, so that they can fairly reflect:

The proportions of cost (for example, different tenders may anticipate different percentage for labor and

equipment), and the source of the cost indices (each of which should related to the currency of cost, which may

also differ between tenders). The total of the proportions (b+c+d+…etc.) in each table of adjustment data must

be checked mathematically to ensure that it does not exceed (1-a).

For each index, the source and title/definition should be stated in each table. Typically, tenders will not know

the value as at the Base Date. Unless (unusually its value is published immediately before the tender submission

date. Therefore the fourth column of the table may be used to define the value of the index at another recent

date, which is then inserted in the fifth column. This recent date does not become a substitute Base Date, and

is only used as a reference linked to the index‘s value on which is stated in the fourth column. Knowing that

the index had a certain value on a certain date, the Engineer should be able to examine the published “source

of index” and determine the index which has published “title/definition” stated in the table and had such value

on such date. This purpose is clarified in the fifth from last paragraph of the sub clause. This follows

immediately after the definitions of the expressions used in the formula.

From each index, the “Country of original” and “currency of index” should be stated in each table. Typically,

this country that of the “currency of index” but may not be the same as the particular currency of payment to

which the table relates. For example, the Contractor may incur costs in many currency but only be paid in for

foreign currency. Bearing in mind that each index reflect costs in a particular currency, it is necessary to convert

indices from the‖ currency of index‖ to the “currency of payment” (unless this currencies are the same) in

accordance with the forth from last paragraph of the sub- clause.

The adjustment multiplier “Pn” is “to be applied to the estimated contract value “Note that Pn will usually

exceed” 1” and is a multiplier in order to calculate an amount to be added as indicated in sub-clauses 14.3(b),

then the mathematical expression (Pn-1) must be multiplied by the estimated “contract value” of the work carried

out in period “n”. This “Contract value” is the value in accordance with the contract, namely the applicable part


35


of the contract period defined in sub-clause 14.1(a).The expression “contract value” is also used in sub- clause

14.3(a) and at the end of CONS/P&DB14.5.

If the contract price is to be adjusted for rises or falls in the cost of labor, Goods and other inputs to the Works,

the adjustments shall be calculated in accordance with the provisions in the Particular Conditions. (EPCT)

4. Public Procurement Agency (PPA), January 2006, Clause 47 Price Adjustments and Clause 47 of the

Conditions of Contract [31].

Prices shall be adjusted for fluctuations in the cost of inputs only if provided for in the Special Conditions

of Contract. If so provided, the amounts certified in each payment certificate, after deducting for

Advance Payment, shall be adjusted by applying the respective price adjustment factor to the payment

amounts due in each currency.

A separate formula of the type indicated below applies to each Contract currency:

etcEo

End

Mo

Mnc

Lo

LnbApn ++

Where:

“Pn” is a price adjustment factor to be applied to the amount in each specific currency for each payment

certificate;

“a” is a constant, specified in the Contractor‘s Bid, representing the nonadjustable portion in

contractual payments; b, c, d, etc., are weightings or coefficients representing the estimated proportion

of each cost element (labor, materials, equipment usage, etc.) in the Works or sections thereof, net of

Provisional Sums, as specified in the Contractor‘s Bid; the sum of A, b, c, d, etc., shall be one;

Ln, Mn, En, etc., are the current cost indices or reference prices of the cost elements in the specific

currency of origin at the date 28 days prior to the deadline for bid submission; and Lo, Mo, Eo, etc., are

the base cost indices or reference prices corresponding to the above cost elements at the date 28 days

prior to the last day of the period to which a particular Interim Payment Certificate is related.

If a price adjustment factor is applied to payments made in a currency other than the currency of the source

of the index for a particular indexed input, a correction factor Zo/Zn will be applied to the respective

component factor of pn for the formula of the relevant currency. Zo is the number of units of currency of

the country of the index, equivalent to one unit of the currency of payment on the date of the base index,

and Zn is the corresponding number of such currency units on the date of the current index.

The sources of indices shall be those listed in the Contractor‘s Bid, as approved by the


36


Engineer. Indices shall be appropriate for their purpose and shall relate to the Contractor‘s proposed source

of supply of inputs on the basis of which his Contract Price and expected foreign currency requirements shall

have been computed. As the proposed basis for price adjustment, the Contractor shall have submitted with his

bid the tabulation of Weightings and Source of Indices, which shall be subject to approval by the Engineer.

If the value of the index is changed after it has been used in a calculation, the calculation shall be corrected

and an adjustment made in the next payment certificate. The index value shall be deemed to take account of

all changes in cost due to fluctuations in costs.

Price adjustment is recommended for contracts, which provide for time of completion exceeding 18 months.

Bidders are required to propose the weightings for each cost element (labor, materials, equipment etc.) and

the sources of indices. These are subject to approval by the Engineer and should be carefully analyzed by the

PE, prior to acceptance of the Bid.

2.8. Comparison of difference clauses

Some of the followings are comparison of different clauses

BaTCoDA clearly state that the contractor should provide the market price of the material at a the date of

bid pricing (basic price) and if the price increased after the said date of bid pricing, then the difference

between the basic price and current price will be paid to the contractor.

MOWUD is not clearly stated about the submission of basic price but MOWUD provide a chart to handle

price escalation for four items which are cement, Re-bar, Asphalt and fuel.

PPA says that Price adjustment is recommended for contracts, which provide for time of completion

exceeding 18 months. Bidders are required to propose the weightings for each cost element (labor, materials,

equipment etc.) and the sources of indices. These are subject to approval by the Engineer and should be

carefully analyzed by the PE, prior to acceptance of the Bid.

If the contract price is to be adjusted for rises or falls in the cost of labor, Goods and other inputs to the

Works, the adjustments shall be calculated in accordance with the provisions in the Particular Conditions.


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CHAPTER THREE

3. RESEARCH METHODOLOGY

3.1 Introduction

The key task in research is to design research process that the information obtained permits the assessment of their

impact. The basic research design was an exploratory research methodology using both primary and secondary

data. This design was chosen since it enables to assess the magnitude, scope problems and facilitate for the

suggestion of solutions.

The research process was designed through defining the research problems, its objective and questions. To

accomplish these objectives the research was made using the following methodologies.

Review the pertinent domestic and foreign literatures, ongoing researches, books, conference proceedings,

the internet, leading construction management and engineering journals and relevant practices related to

price escalations.

Survey public-sector/Regulatory body MoWUD; Construction Company, Consulting Engineers to

determine the cause of construction price escalations &method used to handled price escalations

&mitigate. The survey was conducted by quaternary the parties involved.

Analyzed the cause of price escalation with their impacts &possible treatment mechanism through

questionnaires collected.

Generally, this research is done to be an important stepping stone for examining the various aspects of the

problem under consideration; understanding and formulating guiding principles to govern the research

procedure; and developing and/or testing theories for the enhancement of the existing situation, state or process.

Research according to, Kumar, [32], considers research as a process of collecting, analyzing and

interpreting information to provide solutions to questions. For the purpose of this thesis, research is

defined as a practical investigation or exploration to find out new facts or assemble old facts by scientific

ways for the purpose of developing existing theory or its application for real problems. Research can either be a

theory based (deductive), or a problem initiated for theory contribution (inductive), or a mixed approach to

research.

Finally, conclusions will be drawn and recommendation will be forwarded based on the finding of the study and

reviewed literature. In order to provide a more meaningful comparison among projects, all the projects chosen


38


for the analysis of variations will comprise similar type of construction project. The study will be conducted on

projects that are completed or substantial completed.

3.2 Research Type

The research is a practical problem developed from the observation of construction projects and the research

questions are oriented to investigate the cause of price escalation and their impacts. This research can be

categorized as applied, exploratory, descriptive and co-relational type and it implements more of qualitative

analysis with little quantitative approach.

It is applied and exploratory because the research was initiated from practical problems and finds whether there

exists price escalation or not. It is also descriptive and co-relational because it tried to describe the actual rate

of price escalation and the variables of price escalation and tries to draw relationship between the parties and

cause and impacts of price escalation in the Ethiopian construction projects.

3.3 The Study Approach

This study had from the beginning chosen the contractors’ perspective as the target to this study. In fact, this

can contribute a lot for the overall development of the construction sector and the country’s economy as well.

The approach that was adopted to conduct the research process was a desk study or secondary research through

surveys using both structured and non-structured questionnaire having descriptive outputs.

3.4 The study scope and limitation

Price escalation in building construction projects are caused by many factors. Each causes of cost escalation

have different rates of occurrences and their impact on the final cost of the construction project also varies.

Therefore, it is important to identify both key causes of cost overrun based on their occurrence and their impact

on building construction projects. The effects of cost overrun on the stakeholders, on the construction industry,

and on the national economy of the country will be identified.

The research work was not without its problems and limitations which were encountered throughout the

preparation of this research. Its limitations are:

Unavailability of adequate documented information in the field of the study,

The reluctance of some stakeholders in the construction industry to provide information related to cost.

Shortage of time and budget to do the research


39


Bureaucracy of some office while collected data.

Transportation problems while conducting information.

Overlapping of other course and projects with thesis.

3.5 Data Source and Collection

The study has used the data sources to produce the following basic documents: respondents’ documents

and archival documents.

The main data collection instruments are:

Questionnaires

Reviewing last documents

The respondents’ documents were collected using questionnaires from clients (project owners), contractors and

consultants. There are two basic types of survey questions from which to choose: open-ended and closed-

ended. This questionnaire survey has both open-ended and closed-ended questionnaires. The surveyed

documents were mostly from completed projects, in which contract documents, project reports, correspondence

letters and payment certificates were investigated thoroughly which were very important in identifying the

recurrent problems related to cost in the Ethiopian building construction sector. In addition, they helped

to judge how problems on causes of cost overrun arise and how they are documented.

Data collection part of the research is the most tiresome part; the most difficult one is the respondents’ reluctance

to react as per their promised schedule. The time schedule that was allocated to the research and respondents

reluctance not to respond quickly made the research stressful for the period of data collection.

Owing to the large number of public agencies that own construction projects and the large number of contracting

and consulting companies that undertake work for public agencies a survey by questionnaire was found

appropriate in addition to the desk study. The questionnaire was carefully designed in light of getting

high response rate from respondents.

The answers for the structured part of the questionnaire are based on Likert’s-scale of five ordinal measures of

agreement towards each statement (from 0 to 4) as shown in the following sections. The reasons for

adopting this simple scale are:

To provide simplicity for the respondent to answer, and

To make evaluation of collected data easier


40


Likert’s-scale is important to know respondents' feelings or attitudes about something. The respondents must

indicate how closely their feelings match with the question or statement on a rating scale.

After the variables of cost overrun in building construction projects are identified; respondents are asked

about their agreement on these variables in causing price escalation.

Accordingly the respondents choose one of the following based on their feeling.

0- I strongly disagree

1- I don’t agree

2- Neutral

3- I agree

4- I strongly agree

After expressing their agreement and/or disagreement on the variables of cost overrun

respondents are asked about the chances of occurrences of these variables based on the following choices.

0- Not at all = 0% probability to happen

1- Unlikely = 0% - 25%

2- Likely = 26% - 50%

3- Almost certain = 51% - 99%

4- Certain = 100% probability to happen

After identifying the chances of occurrence of the cost overrun variables respondents were asked about the

impacts of each causes of cost overrun based on the following choices.

0- No significance

1- Minor significance

2- Average significance

3- High significance

4- Extreme significance

After data is gathered on causes of cost overrun, the responsible party from stakeholders in the construction

industry has to be identified for the cause of cost overrun; the questionnaires are prepared in such a way

that detailed information can be gathered in a systematically prepared matrix table.


41


3.6 The Research Population

The research samples are taken from stake holders in the construction industry which are clients (project

owners), contractors and consultants, that are selected depending on their direct exposure to building

construction activities. Consultants were selected based on their class categories, such as consultants above

category 3 are selected. Their lists were taken from MoWUD office and the research samples were selected

randomly from the list. Contractors were also selected based on their grade categories, General contractors (GC)

and Building Contractors (BC) above grade GC/BC 3. Their lists were taken from MoWUD office and the

research samples were selected randomly from the list. Building projects with contract amount greater than

or equal to two million birr are surveyed in the desk study.

3.7 Method of Analysis

Both descriptive and qualitative statistics are employed in the data analysis. In the analysis the “Mean Score”

method is adopted to establish the relative importance of the causes of price escalation for construction projects

in Ethiopia. As discussed earlier Likert’s scale of five ordinal measures of agreement towards each statement

(0, 1, 2, 3 and 4) is used to calculate the mean score for each factor that is used to determine the relative ranking.

The mean score (MS) for each variables of cost overrun is computed by using the following formula;

MS = ∑ (f x S)

N

Where:

MS – Mean Score

f– Frequency of responses for each score

S– Scores given to each factor (from 0 to 4)

N– Total number of responses concerning each factor

3.8 Writing of the Research

The research contains four main parts. These are the research proposal, the literature review part, the research

methodology and analysis, and the final research writing. The research proposal writing was already taken

place. The literature review part took the longest period of the research. During this period, different

documents were collected and tested against the research objectives and the relevant information were taken.

Finally all the notes taken down were linked to produce a document; the differences in perceptions between

authors being noted down. The final research part was written after analyzing all primary and other support


42


documents to test the actual existing situation of the construction industry towards the research objectives.

Finally, the conclusions and recommendations part was written.

Fig 3.8 Flow chart of research methodology

Literature review

Distribute the questioner

Desk study

Analysis

Conclusion & Recommendation

Survey /collection data


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CHAPTER FOUR

4. DATA ANALYSIS AND DISCUSSION

4.1. Introduction

This part of the research deals with the analysis and discussion of the data gathered from the desk study and

questionnaire survey. It includes the identification of the existence and extent of price escalation, main causes

of price escalation, rate of occurrences of variables of price escalation, and the impact of the various price

escalation on the final/total cost of the project. Finally, the effects of price escalation on the various

stakeholders, on the construction industry, and on the national economy in general will be dealt.

The procedure used in analyzing the results was aimed at establishing the relative importance of the

various factors responsible for price escalation and their effects. The questionnaire gave each respondent an

opportunity to identify the factor that was likely to cause price escalation by giving the response “I strongly

disagree”, “I disagree”, “I agree”, etc…; frequency occurrence of the variables of price escalation ; and the

impacts of each price escalation variables on the final cost of the project. For each variables of price escalation,

the percentages of respondents’ response were ranked for analysis purpose. On the basis of the ranking of the

variables by the various groups, it was possible to identify the most important factors that influenced

price escalation in construction projects in Ethiopia.

From the desk study a variety of completed construction projects throughout Ethiopia were surveyed.

During the desk study all the documents of each project such as correspondence letters, project report,

payment certificate, the contract amount, contract time during signing of the contract actual cost and actual

completion time at completion of the project were thoroughly investigated. These help to understand the

reasons behind each project for price escalation, and to investigate how the actual cost at completion

deviates from the contract amount.

4.2. Questionnaire Response Rate

Detailed questionnaires were designed and distributed for the assessment of price escalation on construction

projects in Ethiopia, for this purpose the questionnaires were distributed to major stakeholders in the construction

industry; these are Contractors, Consultants and Clients (project owners). To make the analysis more

comprehensive a total of 25 questionnaires were distributed to consultants, contractors and clients (project

owners) out of which 18 questionnaires were filled and returned. Table 4.2 below shows the number of


44


questionnaires distributed to clients, consultants and contractors and the number of questionnaires returned

from these stakeholders including their percentage response rate.

Table 4.2: summary of number and percentage of questionnaires distributed and returned; and response rate

No. Respondent Questionnaire distributed Questionnaire

Returned

Response Rate

No. (%) No. (%) (%)

1 Client 2 8 1 5.6 50

2 Consultant 3 12 2 11.1 66.67

3 Contractor 20 80 15 83.3 75

Total/average 25 100 18 100 72

4.3. Existence and Extent of price escalation

The first step in this research is to check whether price escalation in construction projects in Ethiopia had been

found existent or not. On the basis of data gathered from the desk study, out of 15 building construction projects

investigated 14, (93.3%), building projects suffered by price escalation. From this result, the number of construction

projects that suffered price escalation in Ethiopia are more than the number of projects that suffered price escalation

in other countries, as indicated in the literature review part of this thesis [33], found that 9 out of 10 projects

experienced price escalation.

The total price escalation ranges from the minimum amount of 0% to the maximum amount of 124.6% of the contract

amount for individual projects; and the mean rate of price escalation was found to be about 27.68% of the contract

amount. These results show that the rate of price escalation in Ethiopian construction projects is less than the values

found by other researchers in different parts of the world. For example, Al-Momani, [12], found that at project

completion the actual cost exceeds the original contract price by about 30%.

4.3.1. Data sources for pricing

The first step in pricing is to collect reliable market data from market and other data sources. Similarly the surveyed

contractors have also agreed that they conduct price data collection to be used for pricing. To this end, from the

survey, it can be seen that all the surveyed contractors conduct simple market survey to collect price data for the

inputs of the particular project they are giving their price.


45


4.4. Assessment on the causes of price escalation and its impact on construction contractors in Ethiopian

construction industry

The first step in this research was to assess the cause and impact of price escalation on construction contractors in

relation to construction inputs, in the past three years and this year, from 2004 to 2007 Ethiopian Calendar. In this

part of the research, the price escalation of construction inputs like materials, labor, equipment, etc., was studied.

4.4.1. Local contractors and the price escalation

In the recent years in Ethiopia, as a result of the successive economic growth, the price of materials on market is

observed to be very unstable. Price of everything has greatly increased and is being increased. The construction sector

is one of the victims of this high price rise of inputs. And the main actors of construction are contractors who are

sustaining the damage at the front line. From all contractors, it’s the domestic contractors who are most affected. This

is because of two reasons: one is the poor compensation they receive in such situations and the other is because of

their relatively lower technical capacity to deal with such situations.

4.4.1.1. Causes of Price Escalation and Their Degree

From the response of the contractors who responded to the questionnaire survey, it can be seen that the causes of price

escalation and their degrees are identified as follow.

External cause of price escalation and their degree

Fig. 4.4.1.1 external causes of price escalation and their degree of percentage

0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%45.00%50.00%

inflation weatherconditions technological

issue

change inlegislations

change inthe cost of raw

materials

Compliance

48.30%

10.50%15.60%

23.30%

48.30%

18%

per

centa

ge(

%)

External cause of price escalation (%)


46


The above graph is external cause of price escalation from the respondents’ direct percentage as we collected

for construction escalation. And also the following pi- chart indicates the external cause of price escalation from

100% of existed price escalation.

Pie –chart 4.4.1.1 external causes of price escalation and their degree of percentage

a) Internal cause of price escalation and their degree

Fig 4.4.1.1 internal causes of price escalation and their degree of percentage

30%

6%

10%14%

29%

11%

External cause of price escalation percentage (%)

inflation

weather conditions

technological issue

change in legislations

change in the cost of raw

materials

Compliance

24.00%

26.00%

28.00%

30.00%

32.00%

34.00%

management labor organazational level

and culture

34.00%

28.60%

31.60%

per

centa

ge(

%)

Internal cause of price escalation (%)


47


The above graph is internal cause of price escalation from the respondents’ direct percentage as we collected

for construction escalation. And also the following pie- chart indicates the internal cause of price escalation from

100% of existed price escalation.

Pie- chart 4.4.1.1 internal causes of price escalation and their degree of percentage

From the above finding, it can be seen that the causes of price escalation and their degree of contribution is

clearly identified. Among these causes, change in material cost is the leading.in addition there are also another

construction inputs which contribute to the price escalation. Here is the more detailed investigation from

respondents on the contribution of construction inputs to price escalation.

4.4.1.2. Major construction inputs which contributes to price escalation

The inputs required to undertake a certain construction project can be divided into four major categories:

Material

Labor

Equipment

Technical (overheads)

The table and figure below represents the summary of the responses of the surveyed contractors on the

contribution of construction inputs to price escalation.

36%

30%

34%

Internal cause of price escalation percentage (%)

management

labor

organazational level and

culture


48


Fig 4.4.1.2 price escalation due to material and their degree of percentage

The above graph is cause of price escalation due to some lists of construction materials from the respondents’

direct percentage as we collected for construction escalation. Construction materials is the leading components

for price escalation especially imported material from abroad. And others from desk study including above lists

are basic inputs and include simple materials such as cement, sand, and reinforcement steel as well as

manufactured products such as concrete, fired clay products and plywood. This category may also include

composite products such as window units comprising frames, glazing and fittings such as hinges and locks and

products like these include not only basic material inputs but other manufactured products and the labor involved

in assembling them.

A particular problem area in international comparisons is materials, products and assemblies for mechanical

including, lifts and heating, ventilating and air conditioning installations and electrical and other power and

utility installations. In developed countries, mechanical and electrical installations can represent one third or

more of the total cost of construction, particularly building, projects so they cannot be ignored. Material price

escalation has rapidly increased among some key building materials during the past three years. Aside from the

obvious direct price inflation, material price escalation has had the flow on effect of exacerbating general

industry nervousness Considerable material price risk is forcing subcontractors in some key trades to factor this

into their pricing. This is also affecting main contractors and tenderers generally.

0.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00% 31.40%

25.70%

37.90%

5.70% 5.70% 5.70%8.60%

21.80%

per

cen

tag

e (%

)Materials(%)


49


Fig 4.4.1.2 price escalation due to construction inputs and their degree of percentage

The above graph is cause of price escalation due to construction inputs from the respondents’ direct percentage

as we collected for construction escalation. Construction inputs are the leading components for price escalation

especially imported material from abroad. And also the following pie- chart indicates the cause of price

escalation from 100% of existed price escalation.

Pie-chart 4.4.1.2 price escalation due to construction inputs and their degree of percentage

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

materials labor equpment over head

20.90%

14.60%

17.14%18.30%

pe

rcen

tage

(%)

Price escalation duto construction inputes (%)

29%

21%24%

26%

Price escalation due to construction inputes percentage(%)

materials

labor

equpment

over head


50


From the finding list of causes for price escalation according to our analysis result shown in the above tables

about 21.5% of respondent says, change in legislation, regulatory restriction, origination level, and organizational

culture have no significance for cause of price escalation. On average 14.3% of respondent express that

consolidation in the construction industry, spot shortage of skilled labor, increase technical requirement in

contractor, organizational level and organizational culture have low significances and 42.9% of respondent

express that un expected weather condition also have low significance. From 9%-48.5% of respondent argue

that almost all lists of causes have average significance. Similarly 5%-35% of respondent says all are high

significance impact but 40% - 51% of respondent express market is beyond the control of the parties and

localized material shortages are high significances impact of price escalation respectively.

It has been found from the desk study and questioner survey that the most common causes of price escalation

are regulation change, inflation, price increment of construction materials particularly cement, reinforcement

bar, fuel, asphalt and internal management, unexpected or unforeseeable ground condition, mistakes during

planning, design and contract documents preparation, etc. as we can see from the above tables and pie-charts

data describes the leading cause of price escalations are inflation and construction material price increment

which are from external causes, and from internal causes of price escalation factors are managements and

organizational level and culture.

4.5. Impact of price escalation

4.5.1. Parties affected by price escalation

In construction sector there are many parties participates. Those are contractors, consultant, client, end user and

regulatory bodies. But among those lists in construction sectors most affected by price escalation are contractor’s

consultant, Client and End user. Regulatory bodies are insignificantly affected by price escalation. According to

the information gathered questioner survey from respondent and desk study we get the following out puts

Pie- chart 4.5.1 parties affected by price escalation

31%

16%35%

18%

degree of impacts(%)

contractors

consultant

Client

End user


51


The above pi-chart & table shows that, clients of Construction Company is highly affected by price escalation

and followed by contractor, end user and consultant respectively.

4.5.1.1. Impacts of price escalation in construction sector on contractors.

Pie- chart 4.5.1.1 Impacts of price escalation in construction sector on contractors and its degrees

Price escalation has an impact on construction sectors on contractor, consultant, and client. From the analysis

of the collected data and from desk study, we have found that (tables) 64.28% of respondent confirm that

loss of profit, project delay and additional cost are high impacts on contractor. About 60.7% of respondent

explained that claim, lack of firm price quotes, prevention from owing, project cancelation and damaged of good

relation are also high impact. On average 62.5% of respondent say loss of profit, cost incurred due to

dispute, project delay, wastage of time to handle price escalation claim ,additional cost and damage of

good relation are average impact of price escalation.

4.6. Tools used to mitigate or sharing price escalation risk

For most parties use so many methods to mitigate price escalation. We try to summarize as follows:

Good will for the accomplishment of the project in all parties can be taken as the first priority. I e. all

should work on the success of the planed project. Any solution for escalations should be seen from the

beginning as much as possible. If the worst case happens, the parties must develop an agreed tool to solve the

problem. Series attention should be given on selection of contractor and consultant based on capacity,

management condition, work experience and other related issue .By preparing appropriate cost efficient

18%

12%

16%

13%

11%

15%

13% 2%

Degree of impact on contractor (%) Loss of profit

Project cancelation

Project delay

Lack of firm price quotes

Prevention from owing

projectAdditional cost

Claim

others


52


design and method of construction and by helping the contractor to have sufficient amount of material

on site helps to minimize price escalation.

As we can see from the figures and tables the early material supply commitment, early material purchase, early

involvement special contractors are the main mitigate methods of price escalation on contractors of construction

industries. But small numbers of contractors use favorable force majeure clauses, value engineering for substitute

of materials and delay the constructions projects to mitigate the price escalation in construction industries.

Majority of our respondent suggests similar idea in order to minimize price escalation and its impact.

Table 4.6 tools used to mitigate price escalation

Tools used to mitigate price escalation Percentage

Bid Contingencies and Contract Allowances 28.70%

Value Engineering for Substitute Materials 23.40%

Early Material Purchases 46.60%

Early Material Supply Commitments 55.40%

Early Involvement of Specialty Contractors 48.30%

The Use of Surcharges 25.14%

Favorable Force Majeure Clauses 19.70%

Delay the Construction Project 25%

Flow down the Risks 30.60%

Bulk Material Purchases and Supplier Partnerships 37.60%

Material Escalation Clauses 37.70%

Index-Based Escalation Clauses 41.30%

National Construction Price Indexes 32.30%

Cost-Based Escalation Provisions 29%


53


Fig 4.6 Tools Used to Mitigate or Sharing Price Escalation Risk and its degree

Most respondents give emphasis on, the government should play a big role in managing price escalation by

minimize imported material whose cost is affected by international market, build factories and invite local and

foreign investors to construct plants such as cement , rein bars …factory to fulfill the shortage of inputs,

increase quality of labor by extending training center, increase percentage of advance payment by change the

regulation ,arrange to get material supply from the main source to the contractor.

Here also another question arises, which asks: “How contractors who tried to anticipate the price escalation to

handle the anticipated price escalation during pricing?” To this end the respondents were asked and their

response is presented in Figure 4.6. From the surveyed contractors, it was found that 56.7% of them convert the

result of their prediction into percentage risk factor which is then applied on top of the result of their pricing.

Here they adopt a simple process that they study the trend of the escalation, if any, and use their own subjective

decision to reach to the risk factor to be applied. This risk factor is meant to accommodate any possible price

escalation, after the work is started, without affecting the planned project budget and profit margin. In fact, this

risk factor is not such a huge percentage which exaggerates the overall price.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

28.70%23.40%

46.60%55.40%

48.30%

25.14%19.70%

25%30.60%

37.60%37.70%

41.30%

32.30% 29%

Per

cen

tag

e(%

)Tools used to mitigate price escalation(%)


54


Fig 4.6 methods of use accommodate price escalation

Reflection on the compensation provisions in SCC

The price change provisions in the pertaining standard contract conditions have been described in literature

review. In this section, the opinions of the respondent contractors on these provisions will be discussed. The first

step to assess through this issue was to see how the surveyed contractors feel about the application of the

Clause 70 of the MoWUD SCC, December 1994 version. To this end, 64% of the respondents agreed that it is

not well applied.

The reason was that, there are only four construction materials allowed to be considered in cases of price

escalation while there are many construction inputs whose prices can escalate unpredictably. Also, the nature of

the market in some particular country together with the economic policy directly governs whether prices of

inputs are controlled centrally or not. In a country where free market led economy is established, it may be

difficult to control and regulate prices of inputs centrally. Rather the demand and supply relation strongly governs

the prices of materials, especially the price escalation.

Therefore, since the Ethiopian economic policy is free market economic policy, the prices of inputs cannot be

easily controlled centrally. And since the application of the clause under consideration requires action from

legislative bodies it becomes difficult to apply it.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

Introducing risk factor Conducting risk

analysis for planning

Adopting high profit

margin

56.70%

21.30%25.80%

per

cen

tag

e (%

)Methods use accommodate price escalation percentage(%)


55


It can also be seen that it may be for same reason that the Ethiopian government has limited the inputs that are

allowed for compensation. Those materials whose prices can be easily set by government factories like for

cement and steel; and those whose prices are set by government agencies like fuel and asphalt.

Here, it is not only these four materials that their prices can be obtained from government factories, there are

many different materials like electrical materials, sanitary materials, paint and many others. But all are not

subject to price escalation compensation except the four. And material is not the only input in construction.

Labor has a considerable share in the cost of a construction project. Literatures show that labor consists 17-21%

of the cost in building projects and 7-10% in road projects.

But the clause under consideration completely ignores fluctuation in the labor market. Therefore, generally the

Ethiopian SCC Clause 70 was said to be not well applied as it should to be.

On the other hand, regarding the newly established price adjustment provision of PPA, some of the respondents

witnessed that they are not well familiar with it but have positive expectations. Among the surveyed contracts,

50% have agreed that the pertaining Clause 70 of MoWUD SCC should not be avoided, rather it should be

amended to encompass wide range of inputs to be considered for compensation in cases of unpredicted price

escalation. Others, 38% of them, have said the new method is good because it doesn’t exclude inputs from being

considered for compensation in cases of unpredicted price escalation. Moreover, it does not need the market

prices to be changed by Act or Decree or Regulation or the like.

Even though most of the surveyed contractors opted for the improvement on the pertaining SCC of MoWUD,

they have exhibited their positive expectation on the application of the newly established price adjustment

provision.

In addition, some were good to indicate growth areas that need to be developed in line with the application of

the said provision he points indicated by the respondents were: since the most part of its application can be

subjective, there must be uniformly applied coefficients for the work items of the construction projects. Also

there must be a mechanism to cross check the base price and the current price indices.

4.7. The Role of Parties in Managing Price Escalation

Since price escalation cannot avoid totally, the contractual parties should play roll for minimize and managing

the claim raise due to price escalation. According to our respondents the role of contractor, consultant and client

describe below:


56


4.7.1. Role of Contractor

First the entire contractor has to assess the market price before he fixes the rate and attach necessary document

as per the contract regarding price escalation like basic price index. After awarding the project he has to

provide the necessary material, manpower & equipment to execute the project within the given time

frame and has to manage properly his resources by hiring professional personnel in all level.

The contractor should have to use advance payment only for a project. During construction contractor should

keep all the necessary data which used to treating escalation then request the escalation clime on time, when

price is increase. .Beside he has to strictly follow up the schedule to prevent price escalation due to delay of the

project and if there is any problem in design or other, ask solution immediately to the client, consultant

or responsible body.

Provide methods to minimize materials wastage to prevent quantity of highly purchases materials, Maintain

equipped (qualified Net worked organized staff) built up capacity and update method of construction are

also additional roll of contractor to minimize price escalation. The contractors should organize themselves

in an association as a result of this they can fix their own labor employment cost and they should also

work with government to control the material cost.

4.7.2. Role of Consultant

Detail feasibility study prior to final design, submit complete design and specification of works to the contractor

in order to minimize variation order, preparing cost effective design, realistic selection of material , forecasting

the coming escalation, adjusting the price or(if it is material case) slouch out economical material & if it is

design case adjust it before it happened, real cost estimation, minimize ambiguities when preparing the

contract document regarding price escalation ,strictly check capacity of the contractor are roll of consultant

before construction of the work.

During construction strictly follow up the project and quick response for any inquiries and immediate practical

solution for problems coming from contractor no delay to occur, prepare price index table for all construction

material and labor, properly treat and quickly approve the clime, finally submit to the client and facilitate

for reimbursement of the contractor by assigning the right professional also the major roll of the consultant.

Consultants should try to get any other preferable solution to minimize the price escalations like substituting

materials with sample or available materials and give simple construction mechanism in order to speed

up the project preparing discussion between parties.


57


4.7.3. Role of Client

Client Should clear financial resource before starting the project and allocate enough budgets including

expected cost incurred due to price escalation for the intended work and set clearly their need before final

design , if there is any design change notify before the construction is started , avoid major change in the

implementation period which may lead to variation and price escalation.

Also Strictly check the capacity of the contractor, provide enough advances to contractor and make sure that the

contractor if procured material and equipment in accordance to the given advance, assist on materials purchase

to the contractor, release approved payment and price escalation clime immediately, so that the contractor

shall finish 0n time which helps to prevent price escalation claim coming from delay.

In addition willing to change material with equivalent type if necessary the design itself, Panel discussion

concerning the project to be implemented, Close project supervision and regular meeting with all concerned

bodies while the project is under construction are the major roll of client for managing price escalation

claim.


58


CHAPTER FIVE

5. CONCLUSION AND RECOMMENDATION

5.1. Conclusion

The development of construction sector is one of the most important enablers for social, political and economic

development in Ethiopia. This is mainly because the development of a country is highly dependent on the growth

of its construction and it, as an asset, is one indicator for economic growth. However there are various

obstruction draw back the development of construction. One of the main one is escalation of prices.This

thesis is aimed to see into the findings of the study and accordingly give recommendations to minimize

occurrences of price escalation and their impacts in construction projects. A survey of contractors, consultants

and owner was conducted to assess the causes of price escalation``, their impacts, the roll of responsible

party and possible treatment to accommodate of price escalation .

The analysis result shows Inflation, Change in cost of raw materials, Change in legislation, Compliance,

Technological issue, Weather condition are the external cause of price escalation and also Management,

Organization level and culture, Labor are the internal cause of price escalation in hierarchical order. According

to our founding, the market is beyond the control of the party because of, inflation, Change in cost of raw

materials and management problems by contractor are the main causes of price escalation.

The major impact of price escalation during construction can result loss of profit to the contractor, project delay,

shortage of finance to contractors and additional cost, delay of project to end user and damaged of relation

between parties. If the worst cases happen the contractor and in rear case the client may lead to Bankruptcy.

An important issue to the construction industry, Investigation in to this problem area is needed in order

to minimize price escalation. So it is essential to define the actual causes of price escalation in order to minimize

in construction projects. Identifying events that cause price escalation during construction stages could minimize

its impacts. This can be achieved by trying to understand and prevent the causes of price escalation

which seems or might be the potentials for a dispute to arise. Such as, risk assessment and allocation,

detailed work definition during the design phase, and setting common goal between the stakeholders to execute

the project highly minimizes the causes of price escalation and in turns its impacts on the construction industry.

There is no such a way in which one can prevent price escalation completely. Thus the other issue would

be ’how to minimize’. The main mitigation methods to minimize to the impact of price escalations are Early

Material Supply Commitments, Early Involvement of Specialty Contractors, Early Material Purchases and

Index-Based Escalation Clauses in hierarchical order.


59


5.2. Recommendation

As can be describe earlier in the literature review price escalation can occur in different cases .Due to different

uncertainty it is difficult to eliminate; however it is possible to minimize the cause and its impact. Based on the

analysis and the findings of the study, the following recommendations are forwarded.

5.2.1. Contractor

The followings recommendations are forwarded related to contractors

Professionals personal should be assigning to the construction project at all level.

Providing the necessary material, manpower & equipment to execute the project within the time

schedule.

The contractor should request price escalation on time, when price is increase on construction

materials.

Prepare and submit the basic price indices with bid document.

Invest the advance payment for the intended project

Contractor should have his own data to manage any dispute caused due to price escalation

Ask the consultants if material is escalate much more or not available to replace material with equivalent

type

5.2.2. Consultant

The followings recommendations are forwarded related to consultant

Conduct detail feasibility study prior to final design

Completed design should be submitted to the contactor

Follow up the project

Quickly approve payment and price escalation claim.

Give Quick response for any inquiries.

willing to change material with equivalent type

5.2.3. Client

The followings recommendations are forwarded related to client

Maintain enough budgets for the work having enough contingency.

Should decide their interest with respect to their budget.

Should be managing price escalation by means of discussion with consultant and from data get

from contractor.


60


The client has to pay the approved payment and price escalation claim on time.

Better advance the contractor and should make sure that the contractor if procured material and

equipment in accordance to the advance.

Close project follow up and regular meeting with all concerned bodies while the project is under

construction

Assist contractors on material purchase.

5.2.4. Regulatory Body The followings recommendations are forwarded related to regulatory body

The government should encourage local and foreign investor to invest their capital on the production of

construction material.

The government should subsidies private companies so that they can import construction material and

equipment in enough quality and quantity.

Modern technology should be introduced to contractor. The government should subsidize the contractor

to own, to rent and to lease modern construction.

Training center and institution should be opened to provide short term and long term training to

personnel in the building construction industry.

Financial institution should actively participate in the building construction industry to minimize cash

problem.

The relationship among parties should be strictly contractual and they should be governed by the

contract document.

To control change order and variation, and improper inspection approach clear and precise particular condition

of contract should be prepared for each and individual project


61


REFERENCES

1. Leibing, study aims at investigating the effect of projects physical characteristics on cost devotion on

road construction,( 2001)

2. Chitkara; Construction Project Management, Planning, Scheduling & Controlling; Tata McGraw- Hill

Publishing Company Ltd; 2004

3. Bhimaraya, development and implementation of bench marking model for construction industry, (2001)

4. Standard Conditions of Contract for Construction of Civil Work Projects; MoWUD (2006)

5. Standard Conditions of Contract for Construction of Civil Work Projects; MoWUD; (2014)

6. Standard Conditions of Contract for Construction of Civil Work Projects; MoWUD (2013)

7. Morris et al, (1998),

8. .Arditi, D., Akan, G.T. and Gurdamar, S. (1985). Reasons for delays in public projects in

Turkey.Construction Management and Economics 3

9. (Nick Moore, 2000 as quoted in Wubishet Jekale, 2004).

10. George Ofori, Managing Construction Industry Development; Lessons from Singapore’s Experience;

National University of Singapore, 1993

11. Chalabi, et al, (1984),

12. Al-Momani, A. (2000) Construction delay: a quantitative analysis. International Journal of Project

Management,

13. Peter Hall, (1982),

14. Luke’s, 14:28; quoted by L.Powers, (2006).

15. [Garry, 2005].

16. Guidelines for Contract Price Escalations

17. (http://wwwprocurement service.org /gppb/guidelines accessed on 12/11/2007).

18. GPPB Resolution(07/22/2004)

19. Ron Dubois(1993)

20. Doe Order 5700.2, Cost Estimateing, Analysis And Standeredizations


62


21. Organization for Economic Co-operation &development (OECD)(1997)Construction Prices indices

sources &methods, Eurostat, France

22. National Accounts SNA (1997)

23. Ron Dubois (1973)

24. Procurement &Contract Management from lecture noteBy Wubishet Jekale Mengesha (Dr. Eng.)

April2007

25. Price Fluctuation & Market Volatility in municipal &Treatment plant Construction project Darren

Hibbs)

26. (www.built-environment.uwe.a/uk/&and www.tawwa.org accessed on12/10/ 2007)

27. American Institute of Steel Construction clauses

28. Construction Briefings Decemeber2006By John Gallasher &Frank Riggs

29. The BATCoDA (1987) General Conditions of Contract.

30. FIDIC; Guide to the use of Condition of Contract for works of Civil Engineering Construction,1997

31. Public Procurement Agency; Standard Bidding Document for National Competitive Bidding; Addis

Ababa, January 2006

32. Ranjit Kumar, Scientific Research Methods, New Delhi, India ; 1996

33. Flyvbjerg, B., M.K.S. Holm and S.L. Buhl, 2003. How common and how large are cost overruns in

transport infrastructure projects?

34. Tadesse Yemane; M.Sc thesis, Construction Cost Estimation Guideline for Local Contractors in

Ethiopia; AAU Civil Engineering Department, November 2006.

http://www.built-environment.uwe.a/uk/&and%20www.tawwa.org%20%20accessed

http://www.built-environment.uwe.a/uk/&and%20www.tawwa.org%20%20accessed


63


APPENDIX

QUESTIONNAIRE SURVEY -

PREPARED FOR CONSTRUCTION CONTRACTORS

” CAUSES OF PRICE ESCALATION AND ITS IMPACT ON CONSTRUCTION CONTRACTORS IN

ETHIOPIA”

GENERAL INFORMATION

This research survey is designed to fulfill an academic requirement for a BSC. Program in Construction

Technology and Management at EiABC (ETHIOPIAN INSTITUTE OF ARCHITECTURE, BUILDING

CONSTRUCTION AND CITY DEVELOPMENT) campus of Addis Ababa University. I can assure you that

the research data will only be used for academic purposes. Particular mentioning of names will not be required

anywhere. Your open and prompt response is highly appreciated.

For any clarification on this questionnaire, please contact the researcher on

+251921-04-75-88 (Melese Mollaw),

+251917-44-14-26 (Yinchachu Mersha),

+251927-93-58-04 (Hunde Hailu)

Objective of the research

To identify the main causes of price escalation on contractors of construction industry in Ethiopia.

To assess the overall impact of price escalation on contractors of construction industry in Ethiopia.

Purpose of the research

The unprecedented escalation of prices escalations in the construction industry has caused significant

financial hardships for unprepared supplier, subcontractors, contractors, and owners. Contract losses suffered,

projects delayed, or serious disputes resulting from the efforts of constructions industry players to mitigate, shift

or recoup the financial consequences of this sudden and dramatically price escalations. Yet, it is certain that profits

have been lost, relations have been damaged, projects have been impacted, and construction lawyers have

been called upon to look for ways to soften or shift the impact of price escalations on their unprepared

constructions client. the research used in handling its evaluation, especially on those aspects relating to price

escalations, is very inadequate.

Any information you provide will not be disclosed and will only be used for analysis of the research.

We thank you for your willingness


64


PART 1: RESPONDENT'S ORGANISATION PROFILE

Name of organization

(Optional) : ___________________________________________________

Address : ___________________________________________________

Telephone : ___________________________________________________

E-mail address : ___________________________________________________

PART 2: GENERAL DETAILS OF RESPONDENT'S FIRM

(Please tick the appropriate answer, you also provide your own answers in the spaces provided)

1. Type of your organization

Consulting firm, please specify your grade__________________

Contractor, please specify your grade______________________

Client (project owner)_________________________________

2. When was your firm established?

More than 20 years

11-20 years

6-10 years

1-5 years

Less than one year.

PART 3: PROBLEMS RELATED TO CAUSES AND IMPACTS OF PRICE ESCALATION

1. Total cost of project currently at hand (please complete the table below)

Year

(EC)

Total contract amount

(x1000 Birr)

Net amount executed

in the year(x1000 Birr)

Remaining amount of

work(x1000 Birr)

Remark

2004

2005

2006

2. What are causes of the price change(escalation) for the above questions(no.1)


65


No

.

Cause of price change 0

%

0-

25%

26-

50%

51-99% 100

%

1. External

Inflation

unexpected weather

conditions

technological issue

government, change in legislations

change in the cost of raw materials

Compliance

2. Internal

Management

Labor

Organizational level and

culture

Design errors and

improvements

Inadequate skills and

knowledge amongst the

team

Late change of client

brief:-variation order


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Designer change of

mind:-Engineers fault

Inadequate knowledge

of the site conditions:-

insufficient feasibility

study

Lack of professional

ethics

3. What are the major construction inputs you have encountered price escalation since 2004 EC? , rate according to

the table.

S/N Description Major (>50%) Very High (30-

50%)

High (20-30%) Moderate (10-

20%)

Minor (0-10%)

Increase Decrease Increase Decrease Increase Decrease Increase Decrease Increase Decrease

1 Materials

Cement

reinforcement

bar

fuel

glazing

mechanical and

sanitary

electrical

materials

metals

Formworks and

scaffolding

2 Labor

Skilled

Unskilled

3 Equipment

4 Overheads

5 Regulation

change(task

4. Parties affected by price escalations, rate according to the table.


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Parties Degree of impacts

0% 1-25% 26-50% 51-75% 76-100%

contractors

consultant

Client

End user

Regulatory body

4.1. What are impacts of price escalation on contractors? here are some lists in the following table rate them

5. What do you suggest that contractors, consultants, clients and regulatory bodies should do, to prevent the

adverse effect contractors sustain due to price escalation?

5.1. What is the responsibility of contractors?

Obey favorable rules and struggle for change _______

Obey favorable rules and propose other rules ______

Refrain from the works in the industry _______

Build strong claiming behavior _______

Other/please specify -----------------------------------------------------------------------------------

Impact Degree of Impact in per

0% 1-25% 26-50% 51-75% 76-100%

Loss of profit

Project cancelation

Project delay

Lack of firm price quotes

Prevention from owing project

Additional cost

Claim

If there is another impact please specify and rate them

-

-

-


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5.2. What is the responsibility of client?

Always ask for firm prices _______

Be considerate in cases of price fluctuation _______

Develop their own price databases _______

Other/please specify_____

5.3. What is the responsibility of consultant?

Act mostly in favor of the contractor _______

Ti

ck

Tools used to mitigate price

escalation

0% 0-

25

%

26-

50

%

51-

99%

100

%

Bid Contingencies and

Contract Allowances

Value Engineering for

Substitute Materials

Early Material Purchases

Early Material Supply

Commitments

Early Involvement of

Specialty Contractors

The Use of Surcharges

Favorable Force Majeure

Clauses

Delay the Construction

Project

Flow down the Risks


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Act mostly in favor of the client _______

Develop and propose other rules _______

Prepare contract documents allowing for adjustment _______

Prepare contract documents not allowing for adjustment _______

Other/please specify

5.4. What is the responsibility of regulatory body?

Regularly monitor application of existing rules _______

Develop strong and reliable price database _______

Always control and regulate the market _______

Regularly review rules and regulations _______

Other/please specify

6. What tools used to mitigate or sharing price escalation risks do you use? Tick and Rate according to the

table.

7. What is your opinion on the application of Clause 70 of the Ethiopian Standard

Conditions of Contract?

a. It is well applied _______

Bulk Material Purchases and

Supplier Partnerships

Material Escalation Clauses

Index-Based Escalation

Clauses

National Construction Price

Indexes

Cost-Based Escalation

Provisions


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b. It is not well applied _______

c. It is easy to apply _______

d. It is not easy to apply _______

e. Other/please specify _____________________________________________

8. What is your opinion on the omission Clause 70 of the ESCC? And the application of the newly adopted price

adjustment method in Clause 47?

a. The omission of Clause 70 is good _______

b. Clause 70 should not be omitted _______

C. Clause 70 should have been amended_______

d. Other/please specify _____________________________________________

9. What is your opinion on the application of the newly adopted price adjustment method in Clause 47?

a. I expect better application _______

b. The method is complicated _______

c. I expect worse situation than Clause-70 _______

d. Other/please specify ______________________________________________

10. Have you ever tried to anticipate or predict price escalation of any kind and used it as an input during

pricing?

Yes ____ No ____

10.1. If yes, which of the methods do you use accommodate price escalation?

a) Introducing risk factor _______

b) Conducting risk analysis for planning _______

c) Adopting high profit margin _______

d) Other methods (please specify) _______

________________________________________________________________________

________________________________________________________________________

10.2. If No, why?

________________________________________________________________________

________________________________________________________________________


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Which of the data sources, that publish or disclose basic price information, do you use for pricing?

a. Simple market survey _______

b. Central Statistics Agency publications

c. National Construction Magazine by ECCA _______

d. Other sources (please specify) _______

_____________________________________________________

11. Describe the impact of the action you took in response to price escalation:

a. On the overall performance of the project

__________________________________________________________________

b. On the capacity of your company


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