Why are so many cost estimates inaccurate?

Written by Admin | 6/22/2017

"I think there is a world market for maybe 5 computers"
- Thomas Watson, Chairman, IBM 1943

In 1903 the president of the Michigan Savings Bank was said to have advised Henry Ford’s lawyer not to invest in the Ford Motor Company with the following statement;

“The horse is here to stay, but the automobile is only a novelty – a fad.”

It seems people are often unable to predict the future and either end up making horribly bad or wildly optimistic predictions. Why is it so hard for companies to make accurate predictions regarding their projects? And what can they do to minimize the risk that project estimates represent to their company?

Managing projects, programs, and portfolios

The CEO of a professional services company was lamenting the fact that his project managers were constantly misquoting project estimates. This led to a corporate culture of micromanagement and this in turn led to a high employee turnover rate. After auditing the organization, it was determined they had a serious “visibility problem” and they are not alone. In a study undertaken by Geoff Ashley & Associates, a small group of professional services leaders were asked to honestly admit to whether or not their companies managed projects, programs or portfolios. The universal response was (in addition to the looks of confusion) that they all manage to projects. This, in a nutshell, is why we are so bad at estimating project costs.

Consider that a project has a beginning and an end. Once it is completed, the project is closed and in many cases, it is never to be heard from again. A program approach, on the other hand, brings similar projects together which can give your organization access to critical project management KPI’s. A program approach to project management, therefore, can sometimes help you learn from one project to another similar project. If every project you take is similar to the last project, this approach can work very well.

But how often does that happen? A portfolio approach means that you have a more centralized view of all of your projects across the entire organization. In addition to seeing KPI’s, you can also develop best practices and other mission-critical metrics that can have a significant impact on your project profitability. Projects begin and end, but the portfolio continues forever (hopefully).

Portfolio management gives CEO’s and CFO’s, as well as, other senior project management staff, an aggregate of all of the costs, value and risk associated with their projects. If things are going badly in one area of the business, a manager can quickly allocate resources to bring any given project back into budget – or at least give the organization the ability to mitigate the extent to which the project goes over budget. This is especially critical when your organization has silos based on industry practices. It is often the case that one partner is unaware of the issues facing a partner in a different, unrelated practice.

Maybe even more importantly, if the organization takes a portfolio approach to project management, and their project management software solution is collecting and analyzing all of the available data, the senior management team may obtain a perspective that in some situations is counter-intuitive.

If your project accounting software provides analytics, dashboards and reports that span an entire portfolio at once, you might determine that a project that is going off the rails does not “deserve” the investment of resources required to bring it back into scope. I realize that most of us feel every client (project) is worthy of our best efforts, but sometimes this simply is not the case. A portfolio view gives you information that allows you to understand that sometimes it is more appropriate to focus in other areas in order to maximize your profitability across all of your projects. The needs of the many…

Common issues that affect estimating accuracy

This holistic view of an organization helps to eliminate some of the most common issues facing professional services organizations today:

1. Too many projects:

Are individual (or practice) goals inconsistent with company goals? This is a tough one. If I want to make partner in many firms, I have to bill a certain number of hours. If I want my bonus, I need billable time. So I am incented to approve projects that might not always be the most profitable and/or appropriate.

This is a project-focused culture instead of a portfolio-based culture. It leads to too many projects being undertaken – or too few resources being available when needed. Individual goals may not incent collaboration by managers across the company.

2. Self-fulfilling prophecy:

Because we take on too many projects, we are pulled in too many directions. We become less efficient. We lose billable time by not accounting for all of our time. In some companies, the ability to bill multiple clients for the same hour is not only encouraged, it is rewarded. We ultimately become less productive, effective, efficient and ultimately less profitable. Projects fall behind or get out of scope.

3. Data suffers:

How many companies complain about project managers not filling in their time sheets? It is a universal issue/problem. If only that were the only problem… In a study by R.G.Cooper of more than 300 organizations they stated there were “… major weaknesses in the front-end of projects: weak preliminary market assessments, barely adequate technical assessments, dismal market studies and marketing inputs, and deficient business analysis.” Why is this so? Go back to #1. Because the focus is on billable time over everything else, time spent researching and then communicating mission-critical information about the client is overlooked. Non-billable time is non-existent. Client satisfaction is compromised. Everything suffers.

4. The “Big is Better” disconnect:

This is another interesting phenomenon. I was working with a professional services company that had seen average project revenue steadily increase for three years in a row. These larger projects, of course, bring with them larger potential for risk. If you fail in a small project, it is not as potentially harmful as failing with a large project. In addition, with larger projects you tend to have “all your eggs in one basket”. This particular partner found that they were consistently ending the quarter with the “need” to close 100% of their proposals in order to meet their goals.

No one can be 100% successful all the time. If you have four outstanding proposals at the end of the month, you only have to be 25% successful. This is much more likely. This partner started intentionally looking for, and winning, smaller engagements. Now they have a huge resource issue. There is a lag behind obtaining a project and hiring resources to deliver on projects. This is where a portfolio view is essential.

5. Put a bullet in it:

Sometimes you just have to kill a bad project. This is not something anyone wants to do, but in some cases, the entire organization suffers due to a lack of perspective. To keep the portfolio healthy, you might need to eliminate a bad project early – before it eats into the profits of other projects. To hit your organizational goals, you might have to sacrifice a practice goal. Should that automatically penalize everyone in the practice?

If you are able to utilize your project accounting solution to analyze your portfolio instead of just individual projects, you will be able to estimate projects more successfully as well as managing projects more profitably. Once you have the tools, all you need is the desire and the culture.

For additional information on the project accounting solution to manage and analyze your project portfolio please contact:

Nicole Holliday

866-510-7839

Construction projects are very different from products manufactured in assembly lines: each building is unique, and this applies even for groups of buildings that look similar externally. Due to this fact, construction cost estimation must be performed individually for each project. This approach is very different from assembly line manufacturing, where all products are identical and have the same cost.

Inaccurate cost estimation is detrimental for construction projects. Both overestimation and underestimation have negative consequences:

• When costs are overestimated, the owner ends up paying more than necessary or may decide not to proceed with the project. Contractors can also face negative consequences if they overestimate project costs: they are likely to lose in competitive bidding or they may be regarded as scammers, hurting their reputation.
• When costs are underestimated, there are many unforeseen expenses during the construction phase. Based on how the contract is structured, these costs may affect the owner, the contractor, or both. There have been cases where developers or contractors end up bankrupt due to drastic underestimation in a large project.

There is always some uncertainty when estimating the cost of a construction project, but accuracy can be improved if the calculation is performed by experienced professionals, using reliable data and aided by software to speed up repetitive calculations.

Cost overestimation should not be confused with over-engineering, although both are detrimental for your project. Overestimation occurs when certain project elements have unreasonably high prices, while over-engineering occurs when excessive capacity is specified - your project costs more than necessary in both cases!

Looking for high-performance MEP design for your building and an accurate construction cost estimation?

Know More

Main Challenges in Construction Cost Estimation

The construction process of a building uses a wide variety of materials, and many of them are shipped from remote locations. Some of these materials have volatile prices in the international market, and a key example is steel. Also keep in mind that construction requires a significant input of man-hours, fuel and electricity.

Another limitation when estimating construction costs is time. In theory, estimators can break the list of materials down to exact quantities of bolts, nuts and nails. However, this approach demands a prohibitive amount of time, especially in large projects. This is also an expensive approach, since it consumes many hours of work that are paid for.

In modern construction practice, cost estimators use software-aided methods to speed up the process. A common approach is using unit prices, where construction costs are calculated for a discrete amount of work and then multiplied by the project total. Competitive bidding normally has a deadline for participating contractors, which means they can lose the job for being late.

How Construction Cost Estimators Manage Uncertainty

No construction estimate is 100% accurate, even if performed by an expert using the latest software package available. The normal practice is adding contingency as a percentage of the total project budget, determined by estimators based on their experience and the perceived uncertainty in each project.

Large projects are more susceptible to cost estimation errors, especially when unit prices are used. If a project element is repeated many times in a large construction, even a slight error can be amplified. Assume a skyscraper has 20,000 windows - if the cost of one window is overestimated by $50, the project becomes more expensive by one million dollars.

The project contract may include a special clause for materials that have volatile prices, such a steel. General price inflation and yearly wage increases are also important factors to consider, since they affect the price of all project inputs. Their effect is more noticeable in large projects that are built over several years, but an experienced cost estimator will take this into account.

The American Society of Professional Estimators classifies construction cost estimates according to five levels of accuracy. The following table summarizes them, in order of increasing accuracy:

Final Recommendation

Although you cannot have complete accuracy when estimating construction costs, you should get the best possible estimate. A common error in construction is hiring the contractor with the lowest bid, if when the price is unrealistically low. The project cost is normally inflated with change orders in these cases, and the contractor may be unable to complete the job under a fixed price agreement.

Having a high-performance building design is beneficial, but you can take even better decisions if you also have an accurate cost estimate. This way, you can hire the contractor with the lowest realistic bid that meets your project requirements. New York City has the highest construction costs in the world, according to the Turner & Townsend 2018 International Construction Market Survey - accuracy pays off when estimating construction costs!

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