Cost Estimates ni Project Management and Disputes

I continue to espouse the virtues and wisdom of Stevev Holloway...for professionals, his insight is good.....read his Issue No. R14 - COST ESTIMATES IN PROJECT MANAGEMENT AND DISPUTES........

"INTRODUCTION

Cost estimating is a management function common to all projects. This is true whether the project involves a high-rise office building, refinery, manufactured product, Super Fund site cleanup, or family vacation. Cost estimating is clearly not unique to the construction industry, but rather is common to a broad spectrum of capital projects in which time, cost and quality must be managed.

As its name suggests, cost estimation is the art and science of "approximation" that is not expected to predict and, in fact, rarely predicts exact future cost performance. Nevertheless, the cost estimate is often the first benchmark against which time and cost performance are measured. Since cost is often a function of time, estimates of work activity durations are developed concurrent with activity costs and schedules.

Holloway Consulting is an expert in cost estimation and damages analysis, and we and our clients understand that variances between "what should have happened" and "what actually happened" on the project is one of the most fundamental components of construction contract disputes. It is, therefore, not surprising that the dispute resolution process often involves inquiries into "why and when" actual time and cost varied from the cost estimate, bid, contract, control budget, etc.

Because cost estimates play a key role in both project management and dispute resolution, all construction industry professionals benefit from understanding the basic elements of estimating. This article provides an overview of the estimating process including:

1. Definitions

2. Terminology

3. Estimate types and applications

DEFINITIONS

A cost estimate is a compilation of all costs and markups of the elements of a project included within an agree-upon scope. To the A/E or construction contractor, this is the cost that is likely to be incurred in completing the project, as defined by the current scope documents. This cost includes internal costs and markups, as well as outside costs of subcontractors, consultants, vendors, suppliers and third parties.

The owner's costs include its costs for administering the project, the cost that its contractors charge for the work and the fees of any consultants, engineers and suppliers. Also included in an owner's project cost estimate will be the price of land, provisions for interim and permanent financing and the numerous elements of life-cycle costs associated with ownership, such as operating and maintenance costs. (Owner costs are often not included in contractor cost estimates.)

Cost estimates are prepared in sequential steps:

1. Take-off. Measuring and cataloging the quantities of work derived from the contract or scope documents.

2. Costing. Using the take-off and the information presented in the scope documents to assign labor and material and other cost values to the elements of work.

3. Pricing. Determining the amount to be charged to the owner/client, so as to fully include all direct and indirect cost items, as well as contingency, overhead and profit.

COST ESTIMATION TERMINOLOGY

Some of the basic elements of the estimating process that consistently arise in contract disputes include:

Contingency

An amount added to the total estimated cost to allow for incomplete design and/or unanticipated events that will likely be required, based on experience and statistics. Contingency is often not applied to changes in scope or unforeseeable major events such as strikes or acts of God.

Mark-up

Defined differently by general and specialty contractors in their estimates and bids, but can include corporate overhead, profit and indirect costs. When mark-up is applied to the estimated cost for a particular item, system or other construction price, any or all of the above percentage-based applications may be included.

Time-Sensitive Cost

A term applied to those elements that will be expended or incurred on a time-unit basis (i.e., hourly, weekly, monthly), and that are often a subset of indirect costs such as field overhead.

Value Engineering

A management function that is targeted at the project design itself. The objective of value engineering is to develop or design a facility or item that will yield the least life-cycle costs and/or provide the owner the greatest value while satisfying all performance, quality, esthetic and other criteria established for it.

Escalation

Addresses the actual and/or anticipated increase in the cost of goods and/or services over time. Escalation has the same effect on project cost as interest does on the value of a savings account: Each year becomes a new base for calculating escalation for the following year. Thus, cost escalation is compounded, not added, for multiple years. Therefore, one method of applying escalation to a multi-year project is to develop a project cash flow analysis and calculate escalation for each year.

TYPES AND APPLICATIONS OF INDUSTRIAL PROJECT COST ESTIMATES

Order-of-Magnitude Estimates

Are prepared without detailed engineering and design information. Examples include an estimate made from cost capacity curves, an estimate using scale-up or scale-down factors, and an approximate ratio estimate. An estimate of this type would normally be expected to be accurate within +50% or -30%.

Order-of-Magnitude estimates are generally prepared using only basic criteria such as desired plant output, total square footage, or number of units. For buildings, the typical unit of measure is square feet of floor area or cubic feet of volume. For process and power plants, the order of magnitude may be expressed in plant capacity for input and/or output. Order-of-Magnitude estimates for roadways are usually defined by mile of a particular type of surface.

Budget Estimates

The word "budget" here applies to the owner's budget, not to the contractor's budget as a project control document. Budget estimates for industrial projects are often prepared using mechanical and process flow diagrams, preliminary P&ID's, plot plans and equipment details. An estimate of this type is normally expected to be accurate within +30% or -15%.

Budget estimates are also referred to as design development, semi-detailed, appropriation, and control estimates. Since the budget estimate is more detailed than the order-of-magnitude estimate, it is better suited for determining project feasibility and establishing definitive budgets. The accuracy and usefulness of a budget estimate depends to a large extent on the amount and quality of available engineering and design information.

Definitive Estimates

These are estimates prepared from advanced engineering and design data. On industrial projects, this data often includes fairly complete plot plans and elevations, piping and instrumentation diagrams (P&IDs), one-line electrical diagrams, equipment data sheets and quotations, structural sketches, geo-technical data and sketches of major foundations, building sketches, and a complete set of specifications.

The definitive estimate category includes all types of estimates, from the minimum Order-of-Magnitude type described above to the maximum Definitive type, which would often be prepared from issued-for-construction drawings and specifications. Definitive estimates are sometimes called check, lump-sum, tender, or post-contract change estimates, and are generally expected to be accurate within +15% or -5%.

TYPES AND APPLICATIONS OF BUILDING PROJECT COST ESTIMATES

Schematic Design

Based on the findings of the predesign and research services, the architect will often prepare a schematic design that illustrates the proposed development of the project. At this time, the architect will have a statement of probable cost prepared so the owner can develop a budget for the project. From an architect’s perspective when preparing such estimates on in-house projects, a schematic design estimate would be accurate to +/- 20%.

Design Development

The final architectural design that establishes the accuracy of all major architectural features is completed during the design development phase. The statement of probable construction cost prepared during the schematic design phase should be revised to reflect documents prepared during the DD phase. From an architect’s perspective when preparing such estimates on in-house projects, a DD estimate would be accurate to +/- 10%.

Construction Documents

The purpose of construction documents or working drawings is to show clearly and concisely the information that will be required by the contractor for pricing and performing the work. From an architect’s perspective when preparing such estimates on in-house projects, a CD estimate would be accurate to +/- 5%.

CLOSING

The cost estimate is not only one of the first documents a project manager asks for when being assigned to a new project, but is also one of the first documents included in discovery requests prepared by attorneys and experts working in contract disputes. The estimate (and subsequent bid) provides the basis of the A/E and contractor's internal control budgets and performance measurement systems, and can also form part of the basis of the expert's schedule and cost variance analyses. Regrettably, the size of an email newsletter does not provide enough space (nor does our diverse readership necessarily have the interest) for HCG to address all of the permutations of the estimating, budgeting and performance measurement processes. We welcome questions and inquiries from our subscribers on these topics."