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JR COMPANY’S TOP TEN THINGS
THAT CAN GO WRONG
ON A CONSTRUCTION PROJECT
By Michael DiMercurio
NUMBER 4: IMPROPER BUDGET, ESTIMATE, BID OR FORECASTING
Recently a project went significantly over budget and the company’s owner’s wanted answers. What went wrong? The answer was a healthy combination of the other 9 things that can go wrong on a construction project, but in this case, the company was installing things that were slightly unusual in a project that was a “one-off” installation. The geometry was complex, the areas were congested, there were retrofit scope items to complete under uncertain conditions, and worst of all, it was a crash program on a job in which the owner’s revenue depended upon on-time startup of the systems with no hiccups. The first thing that got investigated was the quality of the estimate. How did the estimators do their job, and did they capture everything in the issued-for-bid drawings?
The answer was disappointing. The estimators had put together their estimates solely on quantities. They added up widgets and using published standards (NECA and MCAA come to mind) and their own modifications to those factors, they calculated the labor manhours, multiplied by the labor rate, added in supervision and general conditions costs, and on the strength of the quantity take-off, they estimated their material costs. All of the above would have been perfect had they been building a normal project on a normal schedule. But how did they account for the fact that they were building stranger than normal systems in a crowded environment with a challenging schedule? The answer was that they didn’t. When management asked whether there were an adjustment to the contingency account for the job based on job difficulty, the answer was that there had been no adjustment made.
Why would a contractor bid a job so optimistically? The answer was that had they not, they would have lost the job, because their intelligence showed that the other contractors who were bidding the work were making no adjustments for schedule or crowded conditions.
Do you really want to win a job by the skin of your teeth?
Maybe, you answer, because even if the job is done at cost, the contractor’s staff are kept busy and employed, and there is cash flow for a comeback. There might even be resume enhancement to consider, as in the case of the first job in a new industrial sector for the contractor.
But taking a job at a price below cost is rarely justifiable. In this case, it was not recognized consciously that the estimate was such a cut rate that the contractor would overrun even if design were perfect and the project manager executed flawless field control.
Some contractors, it must be noted, do strap on their black eye patches and hoist the Jolly Roger flag as they submit a bid intentionally lower than cost. This is the infamous “lowball” bid. It is meant to win the job at 5% or 10% below the competition. Sometimes the lowball bid is based on some sort of preaward intelligence, as in the case of an owner who wants to work with Contractor A, but Contractor B has a lock on the job, so the owner’s forces leak what the award price should be. This is a dangerous gamble, because if the contractor loses money and happens to mention the preaward tipoff, the owner’s representative who leaked the bid prices is out of a job.
A lowball bid is usually a gamble that things will go wrong on the job, things that can be alleged to be the owner’s fault or the prime contractor’s fault. The lowball contractor will then benefit and recover his lost costs and profit. A lowball also has the nice effect of keeping the competition on the bench. And when a resume job is at stake, the lowball can make sense beyond the impending overrun.
Lowball bidding is more likely when there are no repeat customers, or when the one-off customers don’t talk to each other. Examples could include the kind of projects that get built infrequently. While hospitals and schools and high rise commercial office buildings are constructed every day, how often is a major league baseball stadium built, a headline amusement park, a gigantic movie studio or a new NASA spacecraft launch complex? Certainly there are experienced contractors for those projects, and somewhere there is an owner who could tell tales of how each contractor performed or misperformed. But the question is, where are those people when you need them?
Getting back to the issue of the estimate. There are generally four types:
Class Zero Estimate: This is a SWAG, a scientific wild-assed guess. Also known as a back-of-the-envelope estimate, the Class Zero is not necessarily a bad estimate, if it is based on experience with such projects as is being estimated. The figures reached might have a contingency added of 25, 30 or even 50%.
Class One Estimate: Also known as a conceptual estimate. The incoming information might include a one page plot plan and a PFD (process flow diagram) or preliminary P&ID (piping and instrumentation diagram). It might have some information on equipment related to the process, but might be lacking in information about utilities. The schedule might be sketchy. The information is poor, but it is better than the information for the Class Zero estimate. Where possible, experienced estimators and project managers fill in the blanks and make assumptions about scope. For example, perhaps from the PM’s memory of such an installation, he knew the job needed a cooling tower, and he knows the approximate size needed and has a decent idea of what such a unit would cost. Estimators sometimes make their own P&IDs or PFDs and estimate the quantities and geometry of the job themselves, filling in the holes of missing information. Finally, “line item reserves” are added to each high risk item, adding money to line items that have no information. Then a below-the-line contingency is added to the project total to establish a “safe” budget figure, since budgets always grow as information becomes better known. Contingency amounts added might be on the order of 20 to 35% depending on the situation and the risk.
Class Two Estimate: This has even more refined information, and is usually the basis of a financing budget. Line item costs are well known from experience, and the scope is well established and the unknowns are identified. The process’ P&IDs are generally well-developed. In some cases, the scope is based on a duplicate project for which “as-built” costs are available in the estimator’s database. The plot plan and site location are known, the labor market is identified and surveyed, and the schedule is established to the point that the amount of overtime can be understood. Labor manhours for directs and indirects are within 10%. There are generally no line item reserves, and the contingency for the project might be trimmed down to 10% or less. Contingency levels less than 10% can be risky, but if a project is run on a company’s balance sheet rather than from bank financing, the company’s owners may want to keep a certain level of “management reserve” so that in their expectations, the project cost may grow over and above the budget given to project managers. In some people’s viewpoints, a project budget is an authorization to spend and a level of cost expectation. If management or owners lower the expectation of cost, the theory goes, then project managers will manage more carefully to the budget. Of course, “management by budget” is a dangerous way to build a project, as the estimate so often does not anticipate everything that could happen to a job. In the case of management reserve, contingency can be lowered to the 3% level, but contingencies this low almost guarantee that an overrun will occur.
Class Three Estimate: A class 3 estimate is rarely done, and when it is, it is because the project is considered high risk and frontier technology. Examples include a large “scale-up” of a pilot plant process or a revolutionary new process done without pilot testing. In this case, an advanced design is performed and detailed estimates of major components conducted. Bids are sought, in writing, on equipment items and contractors are asked to provide budget quotes. This form of estimate is time consuming but reduces risk on megaprojects that have never been built previously.
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