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Cost overrun

Escalation of commitment Optimism bias SSRN (identifier)

A cost overrun, also known as a cost increase or budget overrun, involves unexpected incurred costs. When these costs are in excess of budgeted amounts due to an underestimation of the actual cost during budgeting, they are known by these terms.

Cost overruns are common in infrastructure, building, and technology projects. For IT projects, a 2004 industry study by the Standish Group found an average cost overrun of 43 percent; 71 percent of projects came in over budget, exceeded time estimates, and had estimated too narrow a scope; and total waste was estimated at $55 billion per year in the US alone.[1]

Many major construction projects have incurred cost overruns; cost estimates used to decide whether important transportation infrastructure should be built can mislead grossly and systematically.[2]

Cost overrun is distinguished from cost escalation, which is an anticipated growth in a budgeted cost due to factors such as inflation.

Causes

Recent works by Ahiaga-Dagbui and Smith suggests an alternative to what is traditionally seen as an overrun in the construction field.[3] They attempt to make a distinction between the often conflated causes of construction cost underestimation and eventual cost overruns. Critical to their argument is the point of reference for measuring cost overruns. Whereas some measure the size of cost overruns as the difference between cost at the time of decision to build and final completion costs, others measure the size of overruns as the difference between cost at contract award and final completion cost. This leads to a wide range in the size of overruns reported in different studies.

Three types of explanation for cost overrun exist: technical, psychological, and political-economic. Technical explanations account for cost overrun in terms of imperfect forecasting techniques, inadequate data, etc. Psychological explanations account for overrun in terms of optimism bias with forecasters. Scope creep, where the requirements or targets rises during the project, is common. Finally, political-economic explanations see overrun as the result of strategic misrepresentation of scope or budgets. Historically, political explanations for cost overrun have been seen to be the most dominant.[4] In the USA, the architectural firm Home Architects has attributed this to a human trait they call "Psychology of Construction Cost Denial", regarding the cost inflation of custom homes.[5]

A less explored possible cause of cost overruns on construction project is the escalation of commitment to a course of action. This theory, grounded in social psychology and organisation behaviour, suggests the tendency of people and organisations to become locked-in and entrapped in a particular course of action and thereby 'throw good money after bad' to make the venture succeed. This defies conventional rationality behind subjective expected utility theory. Ahiaga-Dagbui and Smith explore the effects of escalation of commitment on project delivery in construction using the case of the Scottish Parliament project.[6] Also, a recent study has suggested that principles of chaos theory can be employed to understand how cost overruns emerge in megaprojects.[7] This paper seeks to reclassify megaprojects as chaotic systems that are nonlinear and therefore difficult to predict. Using cases of cost overruns in oil and gas megaprojects, this study makes strong argument that chaos theory can indeed be a silver bullet in finding solutions to the recurring problem of cost overruns in megaprojects.

Prevention and mitigation

In IT projects (essentially meaning software development projects in this context), the traditional approach to try to control costs is the use of project management techniques, such as PRINCE2 - though the use of such techniques has not prevented cost overruns in all cases. In the 21st century, a newer family of approaches, collectively termed agile software development, have grown in popularity for IT projects - although conventional project management is still very widely used, and in some cases has merely been inaccurately "rebranded" as agile.

Agile development does not claim to guarantee perfect on-time and on-budget delivery of the original expectations (which may not be even realistic or suitable to meet user needs). It claims to be able to:

It has been claimed that agile development did not prevent cost and time overruns in the UK government's Universal Credit IT project, but there are serious doubts as to whether the Universal Credit software development project was in fact following a proper agile process in the first place.

In response to problem of cost overruns on major projects, the UK Government set up a Major Projects Authority to provide project assurance to HM Treasury and other Government departments undertaking major projects.[9] Independent review of the financial effectiveness of project assurance in reducing cost overruns found the project assurance process to be effective in reducing cost overruns and recommended an expansion of the process to cover most of the Government's project portfolio.[10] Project assurance is now also being used by private sector companies undertaking major projects.

Describing

Cost overrun can be described in multiple ways.

For example, consider a bridge with a construction budget of $100 million where the actual cost was $150 million. This scenario could be truthfully represented by the following statement

The final example is the most commonly used as it specifically describes the cost overruns exclusively whereas the other two describe the overrun as an aspect of the total expense. In any case care should be taken to accurately describe what is meant by the chosen percentage so as to avoid ambiguity.

List of projects with large cost overruns

Australia

Canada

United Kingdom

USA

Germany

Finland

Russia

See also

References

  1. ^ Standish Group (2004). CHAOS Report (Report). West Yarmouth, Massachusetts: Standish Group.
  2. ^ Flyvbjerg, Bent; Holm, Mette K. Skamris; Buhl, Søren L. (2002). "Underestimating Costs in Public Works Projects: Error or Lie?". Journal of the American Planning Association. 68 (3): 279–295. arXiv:1303.6604. Bibcode:2013arXiv1303.6604F. doi:10.1080/01944360208976273. SSRN 2278415.
  3. ^ Ahiaga-Dagbui, Dominic D.; Smith, Simon D. (2014). "Dealing with construction cost overruns using data mining". Construction Management and Economics. 32 (7–8): 682. doi:10.1080/01446193.2014.933854.
  4. ^ Cantarelli, Chantal C.; Flybjerg, Bent; Molin, Eric J. E.; van Wee, Bert (2010). "Cost Overruns in Large-Scale Transportation Infrastructure Projects: Explanations and Their Theoretical Embeddedness". European Journal of Transport and Infrastructure Research. 10 (1): 5–18. arXiv:1307.2176. Bibcode:2013arXiv1307.2176C. SSRN 2237990.
  5. ^ "Psychology of Construction Cost Denial - Mountain Home Architects, Timber Frame Architect, Custom Homes".
  6. ^ a b Ahiaga-Dagbui, Dominic; Smith, Simon (2014). "Exploring escalation of commitment in construction project management: Case study of the Scottish parliament project". Proceedings 30th Annual ARCOM Conference. Association of Researchers in Construction Management: 753–762. hdl:10059/1303. ISBN 9780955239083.
  7. ^ Olaniran, O.J.; Love, P.E.D.; Edwards, D.J.; Olatunji, O. "Chaos Theory: Implications for Cost Overrun Research in Hydrocarbon Megaprojects". ASCE Library. Retrieved 29 August 2020.
  8. ^ a b Stecklein, Jonette M.; Dabney, Jim; Dick, Brandon; Haskins, Bill; Lovell, Randy; Moroney, Gregory (2004). Error Cost Escalation Through the Project Life Cycle (Report). JSC-CN-8435.
  9. ^ "Major Projects Authority - GOV.UK".
  10. ^ "Assurance for major projects - National Audit Office (NAO)".
  11. ^ Harari, Yuval Noah (2017). Homo Deus: A Brief History of Tomorrow. New York: Harper. p. 305.