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Challenges of Cost Escalations and Time Delays in

Infrastructure Projects

Challenges of Cost Escalation and Time Delays in Infrastructure Projects

Name of the Student

Nithin S

Anurag Raychaudhury




Research Thesis

MBA-IM

Batch 20011-13

Semester II

Project Guide

Prof. Vivek Date

Roll No

2011E11

2011E14

Challenges of Cost Escalations and Time Delays in 2012

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Challenges of Cost Escalation and Time Delays



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SYMBIOSIS CENTRE FOR MANAGEMENT & HUMAN RESOURCE DEVELOPMENT

[Constituent of SYMBIOSIS INTERNATIONAL UNIVERSITY (SIU)]

(Established under Section 3 of the UGC Act 1956, by notification No.F.9-12/2001 – U.3 of the Government of India)

(Accredited by NAAC with ‘A’ Grade)

RESEARCH THESIS


MBA-Infrastructure Management

Project Guide

Prof. Vivek Date



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Acknowledgement

We, Nithin Santhosh and Anurag Raychaudhury, students of MBA-Infrastructure Management,

SCMHRD, Pune, Thank Professor Vivek Date and Dr. Ajit Patwardhan, faculty, CoE

Infrastructure Management, SCMHRD, Pune, for their support and guidance provided

throughout this thesis work.

With such help, this project would not have been completed on time. We also thank our

colleagues who provided us with various inputs from their end which helped us in collection of

data and analyzing the problems and possible solutions to them.

Last but not the least, thanks to our Director K.S Subramanian, for giving us the opportunity to

do this project as part of our semester two research project.



SYMBIOSIS CENTRE FOR

HUMAN RESOURCE DEVELOPEMENT

[Constituent of

(Established under Section 3 of the UGC Act 1956, by notification No.F.9

===================================================================================

Course Name: Research

Course Status: Core (Sem II)

Credits: 1 (50 Marks, no teaching involved)

Project Description:

To Analyse the Challenges of Cost escalations and Time Delays in Infrastructure Projects.

Cost escalation is a pervasive phenomenon in Infrastructure projects across project types, geographical

location and historical periods. Cost escalation coupled with time delays cause massive losses to the entire Social Cost Benefit Outcome of an Infrastructure Project. The focus of thi

understand the various challenges faced during a Project implementation in the Infrastructure sector, that leads to cost escalation and time delay.

Project Guide:

Prof. Vivek Date

Project Member:

Nithin Santhosh

2011 E 11 Anurag Raychaudhury

2011 E 14

15th

October 2011



SYMBIOSIS CENTRE FOR MANAGEMENT & HUMAN RESOURCE DEVELOPEMENT

Constituent of SYMBIOSIS INTERNATIONAL UNIVERSITY (SIU)](Established under Section 3 of the UGC Act 1956, by notification No.F.9-12/2001 – U.3 of the Government of India)

===================================================================================

=

Research Project (subject code 020342214)

Core (Sem II)

1 (50 Marks, no teaching involved)


phenomenon in Infrastructure projects across project types, geographical

Cost escalation coupled with time delays cause massive losses to the entire Social Cost Benefit Outcome of an Infrastructure Project. The focus of this Research thesis is to

understand the various challenges faced during a Project implementation in the Infrastructure sector, that leads to cost escalation and time delay.

October 2011


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MANAGEMENT & HUMAN RESOURCE DEVELOPEMENT

] U.3 of the Government of India)

===================================================================================


phenomenon in Infrastructure projects across project types, geographical

Cost escalation coupled with time delays cause massive losses to the s Research thesis is to

understand the various challenges faced during a Project implementation in the Infrastructure sector,



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Certificate

This is to certify that Nithin Santhosh, roll number 2011E11 and Anurag Raychaudhury, roll

number 2011E14, of MBA-Infrastructure Management, Symbiosis Centre for Management and

Human Resource Development, have completed their thesis work on ‘Challenges of Cost

Escalations and Time Delays’ satisfactorily.

Professor Vivek Date

Faculty- CoE Infrastructure Management

SCMHRD, Pune



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Executive Summary

Cost escalations and time delays have become an integral and menacing part of

Infrastructure Projects not only in India but throughout the world. Factors such as Weather,

Policy changes, Inflation which may seem menial at the start but can have adverse impacts

on the larger scale have been dealt with in detail while trying to get an understanding of the

Challenges of completing projects on time and cost.

Starting with the introduction to Infrastructure projects and their needs in modern day, we

have dealt with understanding the various challenges that are faced in all domains while

implementing these projects. MOSPI reports have been of utmost priority while we dealt with

these issues.

Next we have analysed Process of Costing and Cost estimation methods so that better

conclusions regarding the hurdles faced afterwards can be dealt with. The causes and

remedies have also been enumerated.

The various facets of Time delays and the Correct process of Scheduling has also been

analysed.

The most common issues for time delays in projects throughout the world and their

suggested remedies have been looked into.

In the final section we have provided an analysis of factor causing Cost escalation and time

delays and also dealt with new ideas such as Optimism Bias.



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Contents Contents

Acknowledgement ...................................................................................................................................... 3

Certificate .................................................................................................................................................... 5

Contents ...................................................................................................................................................... 7

Chapter 1 .................................................................................................................................................. 12

Infrastructure Projects .......................................................................................................................... 12

1.1 Infrastructure Projects an Understanding .................................................................................. 12

1.2 Monitoring of Infrastructure Projects ......................................................................................... 14

1.3 Statistics in Monitoring ............................................................................................................... 14

1.4 Regulations for Monitoring ......................................................................................................... 14

1.5 Tools for Monitoring ................................................................................................................... 15

1.6 Lessons from Implementation of Infrastructure Projects........................................................... 15

Chapter 2 .................................................................................................................................................. 17

Challenges of Cost Escalation and Time Delay ..................................................................................... 17

2.1 Delays and Cost Escalation.......................................................................................................... 17

2.1.1 The Data and Summary Statistics ............................................................................................ 18

2.1.2 Interpretation from the Data ................................................................................................... 19

Chapter 3 .................................................................................................................................................. 21

Cost Escalation ...................................................................................................................................... 21

3.1 Process of Costing of Projects and Materials .............................................................................. 21

3.1.1 Cost Concepts .......................................................................................................................... 21

3.1.1.1 Historical costs ...................................................................................................................... 21

3.1.1.2 Future costs........................................................................................................................... 21

3.1.1.3 Standard costs ....................................................................................................................... 21

3.1.1.4 Direct costs ........................................................................................................................... 21

3.1.1.5 Indirect costs ......................................................................................................................... 21

3.1.1.6 Opportunity costs ................................................................................................................. 21

3.1.1.7 Joint costs.............................................................................................................................. 22

3.1.1.8 Sunk costs ............................................................................................................................. 22

3.1.1.9 Discretionary costs ................................................................................................................ 22

3.1.1.10 Differential costs ................................................................................................................. 22



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3.1.1.11 Capacity costs ..................................................................................................................... 22

3.1.1.12 Variable costs ...................................................................................................................... 22

3.2 Financing a Project ...................................................................................................................... 23

3.2.1 Elements of Finance ................................................................................................................. 23

3.2.2 Constraints arising From Financial Provisions ......................................................................... 23

Chapter 4 .................................................................................................................................................. 24

Causes of Cost Escalation ...................................................................................................................... 24

4.1 Cost Escalation an Overview ....................................................................................................... 24

4.1.1 External Cost Factors in Cost Escalation .................................................................................. 24

4.1.2 Rising Labour Cost .................................................................................................................... 25

4.1.2.1 Impacts of Migrant Labour ................................................................................................... 25

4.2 Impact of Project Cost Escalation ............................................................................................... 25

4.3 Liability and Risk .......................................................................................................................... 26

4.3.1 Impacts of Unpredictable Risks ................................................................................................ 26

4.4 Governmental Intervention ........................................................................................................ 26

4.5 Consents and Site Acquisition ..................................................................................................... 27

4.6 Key Determinants of Initial Project Costs ................................................................................... 27

4.6.1 The Project Specification ......................................................................................................... 27

4.6.2 Location .................................................................................................................................... 28

4.6.3 Forms of Procurement/ Contract............................................................................................. 28

4.6.4 Site Characteristics ................................................................................................................... 28

4.6.5 New Build or Improvements .................................................................................................... 28

4.6.6 Tax Liabilities ............................................................................................................................ 29

4.6.7 Timescale ................................................................................................................................. 29

4.6.8 Inflation .................................................................................................................................... 29

4.6.9 Optimism Bias .......................................................................................................................... 29

4.7 Increased Risk for Financial Problems ........................................................................................ 30

4.7.1 Underestimation of Financial Problems .................................................................................. 30

4.7.2 Overconfidence, locus of control, and depression .................................................................. 31

4.7.3 Optimism bias and Planning .................................................................................................... 31

4.8 Findings related to Cost Estimation ............................................................................................ 31

4.8.1 General ..................................................................................................................................... 31



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4.8.2 Project Scope Definition .......................................................................................................... 31

4.8.3 Preparing the Base Estimate .................................................................................................... 31

4.8.4 Risk and Contingency Allowances ............................................................................................ 32

4.8.5 Cash Flow ................................................................................................................................. 32

4.8.6 Review and Approval ............................................................................................................... 32

4.8.7 Change Management ............................................................................................................... 32

4.9 Factors which change Cost over Time ........................................................................................ 32

4.9.1 Funding Instances .................................................................................................................... 32

4.9.2 Poor Project Management ....................................................................................................... 33

4.9.3 Design Changes ........................................................................................................................ 33

4.9.4 Unexpected Ground Conditions .............................................................................................. 33

4.9.5 Inflation .................................................................................................................................... 35

4.9.6 Shortages of Material and Plant .............................................................................................. 35

4.9.7 Inappropriate Contractors ....................................................................................................... 35

4.9.8 Funding Problems .................................................................................................................... 36

4.9.9 Land Acquisition Costs ............................................................................................................. 36

4.9.10 Force Majeure ........................................................................................................................ 37

4.9.11 Other Factors ......................................................................................................................... 37

Chapter 5 .................................................................................................................................................. 38

Methods of Controlling Costs ............................................................................................................... 38

5.1 Uncertainty in Project Costing .................................................................................................... 38

5.1.1 Concept of Contingency ........................................................................................................... 38

5.1.2 Risk and Contingency Planning ................................................................................................ 38

5.1.3 Special Risks Contingency ........................................................................................................ 39

5.1.4 Design Contingency.................................................................................................................. 39

5.1.5 Construction Contingency ........................................................................................................ 39

5.1.6 Long term Contracts ................................................................................................................ 39

Chapter 6 .................................................................................................................................................. 41

Process of Correct Time Scheduling ..................................................................................................... 41

6.1 Relevance of Construction Schedules ......................................................................................... 41

6.2 Need for Time Scheduling ........................................................................................................... 41

6.3 Ways of Time Scheduling ............................................................................................................ 41



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6.5 Resource Scheduling ................................................................................................................... 42

6.6 Methods of Time Scheduling ...................................................................................................... 42

6.6.1 The Critical Path Method ......................................................................................................... 42

6.7 Presenting Project Schedules ...................................................................................................... 42

6.8 Resource Oriented Scheduling .................................................................................................... 43

6.9 Advanced Scheduling Techniques ............................................................................................... 44

6.9.1 Use of Advanced Scheduling Techniques ................................................................................ 44

6.9.2 Scheduling with Uncertain Durations ...................................................................................... 44

6.10 Crashing and Time/Cost Tradeoffs ............................................................................................ 45

Chapter 7 .................................................................................................................................................. 46

Causes of Time Delay ............................................................................................................................ 46

7.1 Client Related Factors ................................................................................................................. 46

7.2 Effects of Delay ........................................................................................................................... 47

7.3 Common Reasons for Time Delays And Remedies ..................................................................... 47

7.3.1 Inspections ............................................................................................................................... 47

7.3.2 Subcontractor delays ............................................................................................................... 47

7.3.3 Delays in shipping times .......................................................................................................... 48

7.3.4 Client change of mind .............................................................................................................. 48

Chapter 8 .................................................................................................................................................. 50

Analysis ................................................................................................................................................. 50

8.1 Analysis and Conclusions ............................................................................................................ 50

8.2 Findings ....................................................................................................................................... 50

8.3 Road Projects Case ...................................................................................................................... 50

8.4 Reducing Optimism Bias ............................................................................................................. 51

Chapter 9 .................................................................................................................................................. 53

BIBLIOGRAPHY ...................................................................................................................................... 53

9.1 References ...................................................................................................................................... 53



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Part 1

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Chapter 1


1.1 Infrastructure Projects an Understanding

Implementation of infrastructure projects in India has improved substantially. Although the complexity of infrastructure projects have increased but capacity to handle them efficiently is inadequate on many fronts that is why, time and cost overruns in projects still persists. It emerges from the analysis of the Central Sector Projects by the Ministry of Statistics and Programme Implementation that many of the projects suffer from inadequacies in project formulation and implementation, resulting in large time and cost overruns, affecting the very viability of the projects and acting as drag on the economy. The analysis has also identified several factors responsible for time and cost overruns – some within the control of the enterprises and some beyond their control.

Nature of sector specific problems are summarised in the Table 1:

Table 1: Sector Specific Problems for Time and Cost Overruns Sl.No. Sector Sector specific reasons for time and cost overrun

1. Atomic Energy

In the Atomic Energy the cost increase in projects is due to exchange rate variation and delay in supplies from foreign vendors. Delay in civil works is due to location problems.

2. Civil Aviation

Most of the projects in the Civil Aviation Sector are modernization projects. The main reasons for delay is availability of adequate land and funds causing delay in modernization of non-profit airports.

3. Coal

A number of Coal projects are under expansion and these projects are being funded from internal resources of the Coal Companies which is causing constraint in timely completion of expansion projects. Since Coal projects are location specific, the problem of land acquisition and rehabilitation is a major constraint.

4. Steel

In the Steel Sector, major modernization activities have been taken to expand the capacity of existing plants. Due to very heavy pressure on vendors and suppliers because of large construction activities all over the world, supplies



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are getting delayed. Delay in award and availability of suitable contractors for carrying out major activities is also causing delay in implementation.

5. Petroleum & Natural Gas

The Refineries which are under expansion are facing supply problems from indigenous as well as foreign vendors. The refineries which are being expanded for clean fuel production are facing constraints in redesigning their fluidized catalytic units which require shut down of their plants for a longer period. In the development of oil exploration, projects encountered delays mainly due to geological problems.

6. Power

The Power projects particularly, Hydro-electric projects are suffering delays due to law and order problems in the North East and in Kashmir. Some projects are also facing problems of geological surprises. Non-availability of contractors in difficult areas is posing a threat to timely completion of projects in Power Sector.

7. Railway

The major problem of Railway Sector is the non-availability of adequate funds for large number of New Line, Gauge Conversion, Doubling projects. A number of projects are also facing land acquisition, rehabilitation problems due to lack of proper response from the State Governments.

8. Road Transport & Highways

Projects are delayed mainly due to basic reasons like land acquisition, realignment of public utilities like water supply, power supply line etc. A number of projects have suffered due to lack of proper response from the State Government authorities. Some projects have been delayed due to delay and slow progress made by the contractors requiring award of the contract afresh.

9. Telecommunication

In the Telecommunication Sector projects are delayed due to lack of proper coordination and in some cases timely availability of equipment and material. Since Telecommunication is very technology intensive, availability of required type of experts and material is also causing delays.

10. Urban Development The Urban Development projects are mostly of civil construction nature and they are being carried out by CPWD on behalf of the



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administrative Ministries. Improper contract monitoring and follow up causes delay in civil work projects.

1.2 Monitoring of Infrastructure Projects

As an apex institution for monitoring, the Ministry of Statistics and Programme Implementation has initiated several measures in cooperation with various Ministries & PSUs to improve the system and procedures relating to project formulation, implementation and monitoring. These include 2-stage clearance, appointment of Nodal Officers, improved procedures for cost benefit analysis and approval, delegation of more powers at project level, release of project implementation manual, institution of MOU system, institution of 2-tier regular monitoring (Monthly & Quarterly), adoption of network based monitoring, extensive training of project managers, prioritization of projects matching with available resources, and several project based interventions. Amendment to Land Acquisition Act and development Standard Rehabilitation Package are important measures to reduce time and cost overruns.

1.3 Statistics in Monitoring The time and cost overruns in projects in the environment uncertainties, inadequate funding, delay in land acquisition, law and order problems, general escalation in costs and high cost of capital cannot be eliminated altogether but these can be controlled by suitable measures which have been highlighted above. The analysis of the Ministry of Statistics and Programme Implementation shows that cost overrun in projects even with respect to the original approved cost have come down from 62% in March, 1991 to 12% in March, 2008 and the increased to 21% in September 2010. This has resulted into indirect savings of more than Rs. 2,50,000 crore over a period of 10 years. This has been possible due to the dedicated effort of the Infrastructure and Project Monitoring Division of MOSPI and other Ministries. The increasing trend of in cost overruns in the recent years is mainly due to impact of high increase in the cost bulk materials such as cement and steel in 2006-07 and recent recession. The trend of cost overruns is depicted in the Figure 1.

1.4 Regulations for Monitoring

As monitoring alone cannot reduce time and cost overruns in projects, the Ministry of Statistic and Programme Implementation is continuously taking steps to strengthen implementation mechanism. One of the steps initiated by the Ministry was the adoption of modern Standard Bidding and Contract documents which has been developed jointly by this Ministry and the Construction Industry Development Council. A Project Implementation Manual has been



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prepared recently to guide the project authorities/user agencies so that the projects are formulated as per the guidelines issued by the Government of India from time to time. It has taken views from large number of studies undertaken by this Ministry with the help of consultants and their recommendations. It is a revised manual which not only concentrates groups on Industrial infrastructure but it gives a checklist of almost all the sectors of the Indian economy. This Manual now incorporates a complete check-list for preparation of project/ program proposals in the prescribed formats for Infrastructure and Utility Sectors covering Roads, Bridges, Shipping & Ports, Airports And Civil Aviation, Energy And Power Generation, Telecommunication, Water Supplies, Sewerage and Drainage etc; and Social and Community Development Sectors which includes Education, HRD, Health and Medical Services; and Economic Sectors such as Agriculture, Fisheries, Forestry, Industrial Estates and Tourism. The guidelines make reference to the latest innovations to the PPP and make a reference to the websites of the Ministry of Finance and Planning Commission where most of the guidelines can be seen. For the preparation of the revised manual Ministry utilized the services of CIDC.

1.5 Tools for Monitoring

Time is the essence of project management, therefore the system of monitoring based on the monitoring of milestones drawn from the PERT/CPM charts of projects. The Ministry is concentrating on the time management aspect of projects through resolution of problems coming in the way of implementation and providing latest information without time lag to all concerned authorities and agencies to take immediate action. MOSPI has in place On-Line Computerised Monitoring System (OCMS) since 2005 which has a unique database of its kind in the world. At present, 90% of the projects report online which can be processed in a two- week time. Reports are submitted to the higher authorities with exceptions requiring attention and supports resolution of problems to keep the projects on proper track. Besides the creation of awareness and system improvements, Ministry organises the training programmes and seminars in association with institution in the project management field to enhance knowledge of Project Managers and also share best practices experiences across sectors.

1.6 Lessons from Implementation of Infrastructure Projects

Lessons learnt from the implementation of infrastructure projects are going to lead the future strategies to improve project implementation scenario of central projects. These lessons are:

• Monitoring is not enough to ensure timely completion of projects it must be backed with action oriented solutions and also it will require improving system and procedures,

• the system must be backed up with latest management tools and techniques, • adequate financial and administrative powers be given at the enterprise and field levels, • remove constraints in obtaining multiple clearances,



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• re-engineering the process of obtaining approvals and posting of information on-line, • a system of reward and punishment is necessary to improve performance, • capacity building in the area of Project Management is vital to improve delivery and • top Management support is necessary for timely action, and • Establishment of Committees at the Chief Secretary level to deal with land acquisition

and clearances required from the State Governments.



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Chapter 2

Challenges of Cost Escalation and Time Delay

2.1 Delays and Cost Escalation

Every infrastructure project has to undergo several stages: from planning of the project, to its approval, to awarding of contract(s), to actual construction/procurement, and so on. Broadly put, a project’s lifecycle has three phases; development, construction, and operation-and-maintenance phase. See Figure 1.

FIGURE 1:

Project Development Phase

Construction/ Procurement Phase

Operation and Maintenance Phase

t= 0 t=1 t=2

In the beginning of the development phase, the project sponsoring department prepares estimates of time and cost (funds) needed to complete the project. An expected date of completion is also announced. The actual date of completion is invariably different from the expected date. We define ‘time overrun’ as the time difference between the actual and the initially planned (i.e, expected) dates of completion.5 The time difference is measured in months. A related term used in the paper is the ‘implementation phase’ or ‘implementation period’. It is defined as the duration in which a project is planned to be completed, i.e., the duration between the date of approval of the project and its expected date of completion. Therefore, for each project we can define percentage time overrun as the ratio of the time overrun and the implementation phase for the project (multiplied by one hundred). Clearly, the time overrun and therefore the percentage time overrun can be positive, zero or even negative. Similarly, we define ‘cost overrun’ as the difference between the actual cost and the initially projected (i.e., expected) cost of the projects. The initially expected cost is called the initial project cost. This is the estimated cost of project works. It is estimated when a project is planned and generally is arrived at using current input prices. The actual cost becomes known only at the time of completion at the end of phase two. Percentage cost overrun for a project is defined as the ratio of the cost overrun and the initially projected cost of the project (multiplied by one hundred). Again, percentage cost overrun can be positive, zero or negative.

t=3



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2.1.1 The Data and Summary Statistics

The programme implementation division of the MOSPI publishes quarterly reports on the ongoing projects. Each quarterly report also provides some information about the projects that get completed in that quarter. According to these reports, during April 1992-March 2009, a total of 1035 projects belonging to seventeen infrastructure sectors have been completed. Most of these are publically funded and managed projects; only few road projects are PPPs. Each project is worth at least Rs 20 Crore.

Summary Statistics: Delays and cost overruns in infrastructure projects during April 1992-March 2009

% Cost Overrun % Time Overrun

Sector

Number Of Project

Mean

Std. Dev.

% of projects with positive Cost overru

Mean

Std. Dev.

% of projects with positive Time overru

Projects with cost but not time overrun

Atomic Energy 12 15.05 113.12 25.00 301.02 570.48 91.67 8.33

Civil Aviation 47 -2.27 40.52 42.55 68.52 58.15 91.49 0.00 Coal 95 -19.90 73.85 22.11 31.05 69.28 61.05 3.16

Fertilizers 16 -12.57 28.92 25.00 26.53 41.80 62.50 12.50

Finance 1 132.91 0 100.00 302.78 0 100.00 0.00 Health and family Welfare

2

302.30

92.96

100.00

268.04

208.63

100.00

0.00

I & B 7 14.00 62.97 42.86 206.98 140.57 100.00 0.00 Mines 5 -33.16 20.65 0.00 42.44 36.23 80.00 0.00

Petrochemicals 3 -12.22 25.92 33.33 74.43 3.05 100.00 0.00 Petroleum 123 -16.10 28.96 20.33 37.57 49.60 79.67 2.44

Power 107 51.94 272.50 46.73 33.57 55.15 60.75 5.61

Railways 122 94.84 178.86 82.79 118.08 141.71 98.36 0.00 Road Transport and Highways

157

15.84

62.46

54.14

50.21

56.86

85.35

6.37

Shipping and Ports

61

-1.35

84.35

31.15

118.64

276.79

95.08

1.64

Steel 43 -15.88 47.78 18.60 49.91 60.67 81.40 4.65 Telecommunica tion

69

-32.09

57.59

15.94

238.24

259.34

91.30

0.00

Urban Development

24

12.31

50.27

41.67

66.44

44.58

100.00

0.00

Total 894 15.17 132.2 40.72 79.25 153.5 82.33 3.13 Source: MOSPI data.



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2.1.2 Interpretation from the Data

As is evident from Table 1, there are wide-ranging variations across sectors in terms of average delays, cost overruns, and standard deviations. Within each sector also there are large variations with respect to the magnitude of time and cost overruns. Similar is the case with respect to the types of activities covered by projects. Again, projects are quite diverse across as well as within sectors. Yet, projects in road, railways and urban-development sectors are more homogeneous; most are construction projects. Majority of projects in civil aviation, shipping and ports, and power sectors also involve construction and the related activities. In contrast, in sectors like telecom and atomic energy, a large number of projects are for purchase and/or installation of equipments. There are some construction projects too. Similarly, project type in petroleum, petrochemicals and mining etc. is very heterogeneous. For analytical convenience, projects have been clubbed in the following five somewhat homogeneous categories: First category is of road, railways and urban- development projects; Second, civil aviation, shipping and ports, and power projects; Third, telecom and atomic energy; Fourth, petroleum and petrochemicals; Fifth, all other projects.



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Part 2

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Chapter 3

Cost Escalation

3.1 Process of Costing of Projects and Materials

3.1.1 Cost Concepts

3.1.1.1 Historical costs Actual manufacturing cost incurred during the time of say one month / year for all the units of products produced in that period. Calculated as: Direct material from material requisitions + Direct labour from time cards + Overheads from actual department overheads rates applied to direct labour from time cards.

3.1.1.2 Future costs

Future costs such as salaries of members of top management can be ignored because these will not be affected by the current decision at hand.

3.1.1.3 Standard costs

It composes of the ‘ Standard quantities x Standard cost + Standard labour time x Standard labour rates + Standard overhead services x Standard rates.’ Standards used from industry averages, past experiences, time and motion studies, counting material specifications.

3.1.1.4 Direct costs

Those costs that can be assigned directly to an organization unit or a product. Depreciation of equipment in a department or indirect labour working in a department is example of direct departmental costs. Direct material and all labour are examples o direct product costs.

3.1.1.5 Indirect costs

The costs that cannot be assigned are allocated or those small costs which can not be easily traced to the particular product. E.g. cotton waste, lubricant oils, watchman’s salary, factory overheads i.e. rent, electricity etc.

3.1.1.6 Opportunity costs

An economic resource that has been foregone as a result of accepting one alternative to another. E.g., a manufacturer sells a semi-finished product to outsider buyer for Rs 1000 ( whose cost is Rs. 800 ). He is considering a decision whether to keep it, finish it by expending additional Rs. 300, and sell it for total Rs. 1600. The profit out of the decision to complete it = Rs. 300 because the cost of semi-finished product is Rs. 1000, which is opportunity cost.



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3.1.1.7 Joint costs

The costs of manufacturing joint products prior to the split off point.. e.g. a company produces two products x and y as a result of particular joint process. After a certain operations stage say abc, x and y undergo different processes. . Therefore costs unto abc are called joint costs.

3.1.1.8 Sunk costs

Economic resources that have been already committed and which cannot be recovered e.g. amount spent on project to date that has not yielded results. These are not relevant for calculating future impact of a project.

3.1.1.9 Discretionary costs

The costs that are decided as appropriate by the management to meet the organizations goals. These costs have no relationships with the capacity or output levels. E.g. for each planning period mgt will decide how much to spend for advertisement, promotion, public relation, R&D, charitable donations, employee training etc.. These costs become fixed for next planning period.

3.1.1.10 Differential costs

The cost and only those additional costs that will be incurred as result of specific decision. Two characteristics : these are future costs that are expected to be prevalent at the time we intend to produce the product. They include only those additional costs that change as a result of the decision being analyzed . some costs like rent of the building will not change, costs previously incurred are ignored e.g. cost of Research and Development. Practically these are out of pocket cash flows resulting from the decision. Very occasionally other assets are affected i.e. additional building required.

3.1.1.11 Capacity costs

Capacity Costs are fixed costs of being able to achieve the desired level of production or to provide desired level of services . Capacity costs cannot be recovered during the down turns.

3.1.1.12 Variable costs

These costs vary directly and proportionately with volume of production and sales. Provided adequate capacity exists, range is in normal range of production.



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3.2 Financing a Project

The financing of a project involves the arrangement of adequate funds to pay for the development and operation of a clearly defined project. In some cases it is also necessary to raise finance to cover maintenance and operation.

3.2.1 Elements of Finance

For most projects, the main elements of finance will be:

• Development finance – to pay for the feasibility and initial design stages;

• Construction finance – to pay the capital expenditure;

• Contingency finance – to allow for cost overruns and delays.

The structure and form of finance will be influenced by the nature of the project. For some projects, the majority of funding will come from local or central government sources; in other cases the project will be revenue-generating and this revenue will be used to pay back loans and pay for maintenance and operation.

Some projects may also involve a private sector contribution in which the private sector aims to own and control some or all of the assets.

3.2.2 Constraints arising From Financial Provisions

The structure and timing of financial provision may impose certain constraints on the design and scheduling of the project. For some projects which apply for ERDF funding for example, very little detailed design work will have been undertaken prior to the award of grant. This may be simply because all the funding for the project is not yet in place and/or the risk is too great to commit even the design costs of a project that may not receive a grant.

In other cases, grant may not be required for the sponsor to commence a project and the design and even the construction may be started before a grant is requested. Cases of retrospective grant request also occur, where a project may be almost complete before grant is sought.



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Chapter 4

Causes of Cost Escalation

4.1 Cost Escalation an Overview

There can be various reasons for cost escalation during implementation of EPC projects like delay in start and completion of projects, ambiguity in design, wrong construction methodology, lack of coordination between availability at the source and supply of various construction materials, frequent changes in decisions of client, poor cash flow, law and order problems in the project area, land acquisition issue, non availability of labour, bad project management, local issues etc. But without doubt, the rising prices of various key material inputs along-with increasing labour cost remains one of the main reasons for project cost escalation.

4.1.1 External Cost Factors in Cost Escalation

The cost of projects is likely to increase as a result of the increase in prices of steel and cement, the two basic materials used in construction. Cement prices have gone up by around 56 per cent and steel prices have also increased by approximately 26 per cent since September 2010. Bitumen prices have also gone up. Fluctuation in bitumen prices affects road projects adversely. For example, the basic rate of bitumen (60- 70) in September 2009 was 25450/MT and now it is 31000/MT with a rise of almost 22 per cent. In June 2011 this price had touched 35990/MT which is 41 per cent higher than what it was two years ago. The market has also become very volatile.

The fluctuation in the price of diesel which is the root cause for cost escalation. Over the last one year price of the diesel has increased by 25 per cent and since Mar 2009,the increase has been nearly 40 per cent. This has impacted on the price of every construction commodity as cost of transportation has a major significance in the price of any item. The major materials that go into a civil project are cement and steel. The cost of cement in 2009 was 242 per 50-kg bag however, today the cost is 285 per bag (an increase of 17.6 per cent).Similarly, steel that was 27,850 per tonne in 2009 today is 41,500/- per tonne (an increase of 33 per cent). There has also been considerable escalation in the cost other construction materials. Natural materials like sand and aggregates have gone up by 100 per cent or more in a year due to transport cost, over loading issue, environment issue of different court orders, government ban, police harassment etc. It also depends on the type of project - if it is a project like water pipelines and irrigation then these will require land acquisition. In case of buildings or power plant projects - there may be delays due to clearances.



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4.1.2 Rising Labour Cost

Labour cost has risen rapidly in the last few years and the Mahatma Gandhi NREGA only helped to aggravate the situation further. With jobs having minimum guaranteed wages being made available closer to their home - the rural migrant worker no longer travels to the nearest town in search of work thereby leading to shortage of workforce and higher wage rates to the available workers. Labour rates are increasing day by day due to non availability of skilled workers. In the last two years, the increase in rates has been approximately 60 per cent. Construction is booming in the infrastructure sector and real estate development across the country, but the available pool of labour is limited to a few states. The demand for higher wages is increasing drastically due to labour shortage. At the same time the desired productivity is not obtained as most of the workers are not skilled but just adding in to fill the required head counts. Therefore, this trend has a double edged impact on construction cost.

4.1.2.1 Impacts of Migrant Labour

Majority of construction labours come from Jharkhand and Bihar states. In recent times, lot of development has started in these states as well, creating enough employment opportunities in their home states which in turn have created a big vacuum in the availability of labour. Also the development projects on National Levels have increased too. These factors have resulted in scarcity of labour in major construction locations thereby pushing up labour rates significantly. These factors along with inflation have pushed up the labour cost to the tune of 20-25 per cent in the recent years. There is need for a review of the government's Mahatma Gandhi NREGA, as it has created issues with respect to availability of labour

4.2 Impact of Project Cost Escalation

Project cost escalation leads to financial strain on contractors especially in the absence of 'cost escalation' clause in most current contracts. The financially burdened contractor faces lower profits or even losses which ultimately delays or even halts ongoing projects.

Rising cost does impact projects - therefore while private sector projects are going slow or postponed, public sector projects costs go up. It results in lesser projects getting executed. If the trend continues, every 3-4 years, the project cost will jump by 25 per cent. Definitely this has not brought the construction industry to a standstill but the pace has certainly slowed down and the margins have come under pressure. The situation is going to become more difficult in near future, because in FY 2011-12 NHAI has already awarded works of 21000 crore and balance 23000 crore works are lined up to be awarded, huge manpower and material will be needed to complete these projects.

Cost escalation would impact ongoing infrastructure projects - therefore projects may get delayed and completion schedule affected. But it would have a larger impact on new



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proposed projects - the rising input cost may impact new projects from viability point of view. These new projects may not find enough bidders due to rising input cost.

Construction cost is going up day by day and most of the time, the contract does not provide for escalations. This results in loss of profits or even heavy losses for the construction companies. Many of the smaller companies cannot sustain this and have to close down - as losses keep mounting due to cost escalation resulting in serious cash flow problems. Since the contractor fails to pay the vendors and labourers - sometimes work comes to stand still due to strikes and 'dharna'.

4.3 Liability and Risk

There is need to chalk out a policy for comprehensive contract document, like the internationally accepted 'FIDIC' which is well known in the consulting engineering industry for its work in defining conditions of contract for the construction industry globally. Escalation clause is a must in any contract agreement as it helps in equally distributing the risks to parties associated with any project - this must be made obligatory for all the projects.

4.3.1 Impacts of Unpredictable Risks

The effects of these significant and unpredictable increases are more severe in mega projects due to their size and the time required for completion. Often on such projects, developers remove the provisions in standard forms of contract that would entitle contractors to additional payments in respect of cost escalation thus allocating all of the risk to the contractor. The major problems with DBFOT kind of projects is that there is no escalation provisions in the concession agreement, and the developer has to account for this huge variation. All these variations are mainly due to reasons beyond control of the developer. The best possible solution to mitigate this problem is that the government should make a provision of incorporating basic rates for labour and major materials in the contracts.

4.4 Governmental Intervention

The government is instrumental in inordinate price increases as it makes different laws in the name of social welfare. This needs sensible thinking. Increase in fuel price has cascading effect on all price hikes. Besides that, Government increases taxes (state government and central government) every year either through finance bill or by circular, in some cases it is with retrospective date which makes it very difficult to run construction business. As construction is not a respected business and there is a mindset against this with the government and society, all draconian laws applicable to this sector has resulted in many companies closing their shutters.



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4.5 Consents and Site Acquisition

Before construction work can start, the necessary consents and authorisations must be in place. The time taken to obtain these is probably the most unpredictable element of a large infrastructure project and can have a significant effect on the timetable and costs. In addition to institutional approval, consents may also need to be obtained for health and safety, water, sewerage, waste disposal, fire certification, gas, electricity and highways rights.

Public consultation is a major element of the consents process in most Member States. Inadequate allowance for required consultation may lead to unforeseen delays in project implementation. Environmental Impact Assessment is now required for most large projects before consent is achieved. This also may take more time than anticipated. A project cannot proceed if the project sponsor does not own or have development rights for the land.

With projects implemented by local government authorities, the compulsory purchase of land can be undertaken. The existing owners have to be compensated for the purchase and they can usually appeal against the sum offered. Appeals can be very time consuming, although in some circumstances projects may proceed, whilst the appeals are being heard.

4.6 Key Determinants of Initial Project Costs

No two infrastructure projects will cost the same amount of money no matter how similar they are. Apart from basic technical factors, the wide range of economic and institutional conditions in different Member States will itself always lead to variations.

Nevertheless, the fundamental project costs are based on the actual cost of the land, materials, equipment and labour in the region where the project is being procured. These basic costs will vary depending upon a number of factors which are discussed below:

4.6.1 The Project Specification

The specification defines the physical attributes of a project. With a road, for example, given levels of forecast traffic will lead to specification of the required length, departmenth and width of the road pavement, the material to be used for surfacing, the number of lanes, bridges and junctions etc. For buildings, the required function and expected occupancy rate will lead to a specification of total floor space and floor plate size, height, internal and external appearance, floor loadings, heating and lighting requirements etc.Generally, the more detailed the specification and the larger the project, the more expensive it will be.



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4.6.2 Location

Location affects project costing via institutional factors and through geographical realities. Institutional factors can affect initial project cost estimates in a number of ways. Consents procedures in particular may be more arduous in some countries, affecting the time it will take to successfully implement a project. Allowance for the costs involved in sustaining a long public consultation exercise is an example. Where major projects are likely to be strongly opposed on environmental grounds, more cost may have to be allowed for environmental mitigation measures.

4.6.3 Forms of Procurement/ Contract

The form of procurement and contract used by the project sponsor can alter the estimated cost of a project. Cost savings may be made by means of lump sum contracts although these are usually marginal in relation to the total project costs. DBFO contracts, which seek to transfer most of the risk of cost overrun from project sponsor to contractor, may in some circumstances yield savings.

4.6.4 Site Characteristics

A site can be affected by soil and drainage conditions and access restrictions which can affect the original cost estimates. The amount of excavation, piling and foundation activities required are particularly affected by poor ground conditions. Where there is uncertainty about ground conditions, accurate project costing cannot be achieved unless a soil survey is undertaken. This may require the sinking of boreholes to obtain soil samples at different levels beneath the surface.

4.6.5 New Build or Improvements

Generally, the construction of new infrastructure is more expensive than improvements to existing infrastructure, or the refurbishment of buildings. This is primarily because the “non-building” costs such as land purchase, foundations, services provision etc. Do not have to be included when simply up-grading existing structures.



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4.6.6 Tax Liabilities

An organisation will be liable to pay tax on its purchases. Some organisations and types of project are not liable to pay taxes, or else these can be reclaimed. Local government projects and infrastructure for public use are examples. Some public or quasi-public sector companies, voluntary and private sector organisations can be liable and these tax costs can have a significant impact on gross construction costs.

4.6.7 Timescale

Generally, the longer a project takes, the greater the project costs will be. Project timescales are dependent on the specification of a project. Usually, the larger a project is the longer it will take to implement. This is not always the case; if substantial additional resources are used, project implementation can often be accelerated.

In some cases, work on a project may take a lot longer than expected because its phasing is dependent upon other, linking projects or public finance programmes. A project which involves non-continuous phases is usually more expensive than one undertaken without interruption because of the additional costs involved in re-mobilising plant and contractors.

4.6.8 Inflation

The longer the expected construction period, the more account will need to be taken of expected inflationary price increases over time. This is particularly important where a public authority’s expenditure programme is involved. Initial cost estimates will need to allow for the value that will need to be paid at the time the project actually goes ahead.

4.6.9 Optimism Bias

Optimism bias is the demonstrated systematic tendency for people to be overly

optimistic about the outcome of planned actions. This includes over-estimating the

likelihood of positive events and under-estimating the likelihood of negative events.

Along with the illusion of control and illusory superiority, it is one of the positive



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illusions to which people are generally susceptible. Excessive optimism can result in

cost overruns, benefit shortfalls, and delays when plans are implemented or expensive projects are built. In extreme cases these can result in defeats in military conflicts, ultimate failure of a project or economic bubbles such as market crashes.

Optimism bias can induce people to under invest in primary and preventive care and

other risk-reducing behaviors, such as abstinence from smoking. The overconfident

may also inadequately react to legal threats and incentives, undermining the

deterrent effect of liability rules.

4.7 Increased Risk for Financial Problems

Overconfidence causes many people to grossly underestimate their odds of making a payment late. Statistically, many people are quite likely to make at least one payment late due to the normal range of difficulties and delays in day-to-day life. Overconfidence bias causes these people to grossly underestimate the odds of this happening and therefore to accept grossly punitive fees and rates (e.g., an interest rate of nearly 30% on a credit card or similar line of credit) as a result of otherwise minor transgressions such as a late payment. Companies have exploited this bias by increasing interest rates to punitive rates for any late payment, even if it is to another creditor. Overconfidence bias makes these terms more acceptable to borrowers than if they were accurately calibrated.

4.7.1 Underestimation of Financial Problems

Overconfidence bias also causes many people to substantially underestimate the probability of having serious financial or liquidity problems, such as from a sudden job loss or severe illness. This can cause them to take on excessive debt under the expectation that they will do better than average in the future and be readily able to pay it off.



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4.7.2 Overconfidence, locus of control, and depression

Overconfidence bias may cause many people to overestimate their degree of control and their odds of success. This may be protective against depression—since Seligman and Maier's model of depression includes a sense of learned helplessness and loss of predictability and control. Depressives tend to be more accurate and less overconfident in their assessments of the probabilities of good and bad events occurring to others, but they tend to overestimate the probability of bad events happening to them. This has caused some researchers to consider that overconfidence bias may be adaptive or protective in some situations.

4.7.3 Optimism bias and Planning

Optimism bias arises in relation to estimates of costs and benefits and duration of tasks. It must be accounted for explicitly in appraisals if these are to be realistic. Optimism bias typically results in cost overruns, benefit shortfalls, and delays when plans are implemented.

4.8 Findings related to Cost Estimation

4.8.1 General

• All agencies acknowledge that cost estimating standards need to be improved

• Problems are exacerbated by a shortfall in resources skilled in estimating; • Volume and size of projects by the agency differs greatly from state to

state • Degree of development of a thorough estimating procedure broadly reflects

the size of the organisation and the volume of work delivered • Documented estimating procedures varied in content from state to state; • Scope for improvement and the need for more helpful material was

identified in all estimating standards

4.8.2 Project Scope Definition

• Ability to support thorough project scoping and estimate reliability at an early stage was hampered by funding constraints

• Engineering Definition not sufficiently developed for Benefit Cost Ratio phase

• Insufficient clarity of functionality and performance of the project • Variance in the quality and content of how scope is described, including

what is and isn’t included • Content of some submissions was unclear, e.g. whether property

acquisition costs were/were not included.

4.8.3 Preparing the Base Estimate

• Structure and use of estimating methods varied between agencies



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• Lower end unit rates commonly used • The level of common understanding of estimating methods was insufficient • Inconsistent estimate breakdown structures.

4.8.4 Risk and Contingency Allowances

• Contingencies generally set too low • Inconsistent use of risk assessment tools and ranges • Lack of transparency of contingencies, escalation etc.

4.8.5 Cash Flow

• Emphasis on the timing / cash flow required; • Escalation • Better techniques required for monitoring and forecasting (regional) cost

escalation indices.

4.8.6 Review and Approval

• Improvement in compliance with internal procedures is required; and • Improved rigour required in review and approval processes.

4.8.7 Change Management

• Changes in estimates from phase to phase not adequately explained; and • Inadequate methodologies to deal with change.

4.9 Factors which change Cost over Time

Once implementation begins, a project’s costs rarely remain static. As further information becomes available the costs may be further defined. Yet, even when a cost has become firmly fixed, there are numerous factors that can lead to the cost increasing.

Delays are a major factor. Whatever the reason, delays almost invariably increase budget costs. Many events may have contributed to the delay – some which could have been foreseen and others which could not.

4.9.1 Funding Instances

A key consideration in the context of funding is the time at which an application for funding is actually made. Applications can be made at three main points in time:

• Very early in the construction cycle when broad cost estimates only are available;

• On the basis of tender prices for the work to be undertaken;

• Retrospective bids where the project has been completed but grant is still required.



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The level of certainty about the final or outturn costs will vary for each of these three situations. Obviously, if an application comes forward very early in the project development cycle, then there is a much greater chance that the project will experience time and cost over-runs.

4.9.2 Poor Project Management

The role of the project manager or project management team is probably the most important element in containing the costs of a project. It is often true that a poor project with a good project manager will be completed satisfactorily. But even a good project, if combined with poor project management, will almost always face serious difficulties.

A poor project management structure will have an impact at all stages of the construction process leading to:

• A lack of planning and coordination; • Poor communication between members of the project team and the project sponsor; • Failure to identify problems and institute necessary design and programming changes; • A lack of control over time and cost inputs.

4.9.3 Design Changes

A change in a project’s design can arise for a number of reasons. It may be that the project sponsor wants additional elements to be included in the project or changes to existing ones. Usually, these design changes require additional time inputs from architects and engineers as well as the additional time and cost inputs from the contractor and for additional materials.

4.9.4 Unexpected Ground Conditions

Ground conditions can be assessed by a desk-based review of relevant published documentation and through the use of trial pits and borehole sampling onsite. However, the actual site conditions for the full extent of a project are not usually determined until construction begins. It is possible that difficult conditions are overlooked by the initial review or that conditions have changed due to adverse weather conditions or changes in sub- soil conditions.

Unexpected sub-surface conditions can, at times, require fundamental redesign of projects at great expense. Changes in surface ground conditions can lead to problems in actually moving



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machinery and supplies around the site, and in undertaking excavations and laying foundations. This can also increase the costs and add to the construction time.



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4.9.5 Inflation

As noted earlier in this section inflation can act to increase the original estimates of construction costs. Inflation may have been taken into account in the original estimates, but if the rate of inflation increases above the predicted level during the construction period, then the original cost estimate will be exceeded. Obviously any other factor that delays a project will expose the project to the risk of further inflationary cost increases. Inflation may not be the only cause of price rises. Political or technological factors may affect one or more element of costs; for example, increased labour mobility between Eastern Europe and the EU, (which may occur after the accession of the Eastern states), could in future lower the labour cost element of construction projects.

4.9.6 Shortages of Material and Plant

During periods where the level of development activity is unusually high in a particular region, there may be shortages of some construction materials, construction plant (machines and equipment used during construction) and service plant (equipment used in the operation of the infrastructure project). If this was not anticipated in the original cost estimate, delays may occur and/or the prices of these elements increase.

4.9.7 Inappropriate Contractors

Contractors are selected on the basis of price, experience in undertaking particular types of project and their track record in producing high quality work within budget and on time. Problems may arise where there is a high level of development activity being undertaken in particular region and the better contractors are not available to bid for the work at that time. Alternatively, the tender review process may not have been undertaken by the personnel with the best understanding of the services required. As a consequence, firms which are not the most experienced in that field of activity are chosen, often with implications for the quality and cost of a project.

Delays in project implementation and increases in costs can arise through the use of ineffective or inappropriate labour, or errors in calculating how productive the labour will be. This can happen especially when sub-contractors are used whose quality is not controlled in the main project contract. In most cases there is a trade-off between price, experience and track record but the desire to accept the lowest tender does not always lead to a project that is completed within time and budget.



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In most cases there is a trade-off between price, experience and track record but the desire to accept the lowest tender does not always lead to a project that is completed within time and budget.

There are cases of contractors and sub-contractors who go into liquidation during the construction period. This can lead to significant delays and extra costs arising as the project sponsor has to re-tender the remaining work. Identifying a new contractor to complete another contractor’s work is difficult because of the possible liabilities that the new contractor would have to accept for another company’s work.

4.9.8 Funding Problems

The overall lack of finance to complete a project, or delays in the payment for services by the project sponsor can lead to significant problems arising. If the costs of a project have increased significantly beyond the original estimate, then work on the project may have to stop or be delayed until additional funds can be found.

Funding problems can also arise if funds allocated to one project have been diverted to other projects within a programme of development. If the payment of invoices by a project sponsor is slow, the contractor may begin to commit fewer resources to a project, and may even cease work if cash flow becomes a problem. In some cases, even when a project is expected to be entirely profitable, project sponsors may understate the availability of local funding imply in order to maximise the level of grant. This can happen with revenue -generating projects particularly. Such practices can reduce the availability of funding for other projects.

4.9.9 Land Acquisition Costs

The land on which a project will be built is not always owned by the project sponsor. Where this is the case, local government authorities can usually compulsorily purchase the land in accordance with legal statutes. The statutes usually require that the land (and any properties on it) is valued and that compensation is paid to the owner on the basis of the valuations. Although the right to purchase and actually develop the land can be agreed relatively quickly, the amount of compensation that actually has to be paid can sometimes not be agreed until the end of the project, especially if the land owner appeals against the original valuation. The owner may have the right to appeal and it is up to a Court to agree a fair price for the land. In many cases, this may be greater than the original forecast by the project sponsor. Inevitably, long drawn out compensation cases will delay a project.



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4.9.10 Force Majeure

This term covers a range of events which are also commonly referred to as “Acts of God”. They include revolution, war, riot, extreme weather, earthquake, landslip, fire, political and economic instability.

Usually, the contractor is required to insure against such events happening. Where they do occur, they will normally lead to significant delays occurring and, consequently, cost increases

4.9.11 Other Factors

In addition to all the categories listed above, experience shows that problems also arise from premeditated under-estimation of initial costs simply in order to obtain initial approval for a project. This can lead to major projects being approved, and started, in the knowledge that actual costs will be very much higher than the “agreed” estimate. Once started, a high profile infrastructure project is often politically difficult to stop. So, when the true costs do become apparent, it is difficult for authorities to refuse the additional funding required to complete the project.



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Chapter 5

Methods of Controlling Costs

5.1 Uncertainty in Project Costing

The preparation of project cost estimates is a difficult task because construction projects are subject to risks and uncertainties, particularly in the early stages when very limited information about the project is available.

Yet, the cost estimates prepared at this stage are most important to the project sponsor because they often form the basis of the bid for funds. As a project progresses, more information becomes available to allow costs to be calculated to a greater degree of accuracy, for example the ground conditions on-site or the specific types of plant or machinery that will be provided. More reliable cost estimates become available after tenders have been received from contractors.

5.1.1 Concept of Contingency

Nevertheless, many aspects remain uncertain and normal costing practice is to include an extra element to provide “insurance” against cost over-runs. The word “contingency” is usually used to describe this additional cost element. The contingency is typically based on a “rule of thumb” calculation, as a certain percentage of the base cost estimate or a lump sum based on the experience of the estimator. A figure of 10% of gross costs is a common allowance. This risk allowance or contingency sum is often calculated only once and is not reviewed again as the project progresses. The main weakness of this simple approach to contingency costing is that individual risks are not separately evaluated. As a result, a contingency is often set too high for low risk projects, or too low for high risk projects. In addition, it is not always appropriate to carry a specific contingency allowance for the duration of a project since many of the risks become known and can then be eliminated.

5.1.2 Risk and Contingency Planning

By giving greater attention to which cost determining factors are most likely to change, and why, project sponsors should be able to develop more accurate contingency estimates. This in turn should reduce the risk of cost over-runs. Poorly managed risk affects the ability of a project to be completed within time and on budget. On the other hand, the level of risk can often be reduced if project sponsors take the time to identify, assess and manage the main factors leading to cost escalation.

Although a potentially complex subject, risk management basically involves three quite simple stages:



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• Risk identification: what could go wrong?

• Risk assessment: it is possible to quantify or at least rank any of the risks?

• Risk management: what steps can be taken to mitigate or manage these risks in order to prevent cost over-runs.

Once the risks have been identified and assessed, they must be continuously monitored until the end of the project. Although careful risk assessment typically results in an increase in initial cost estimate, it usually leads to a reduction in contingency. Risk management measures are worthwhile because they lead to a more certain final project cost.

Often it is not clear what is actually contained within a project’s contingency budget. As noted above, it could just be a general percentage estimate. In careful risk management the contingency allowance for larger projects should cover three main types of contingency:

5.1.3 Special Risks Contingency

An allowance to cover the risks arising from higher land acquisition costs, changes in external factors such as the availability of funds, statutory requirements and force majeure. It can also cover the risk of a project sponsor changing his mind about the project specification.

5.1.4 Design Contingency

An allowance for use during the technical design process to provide for the risks of changes due to design development or in estimating data.

5.1.5 Construction Contingency

An allowance for use during the construction process to provide for the risk of changes due to site conditions or as a result of changed construction methods or poor performance by contractors or sub-contractors.

The use of a better specified contingency will only be effective if suitable project control procedures are in place to control all aspects of project performance. Project control procedures should be organised and managed by the project manager. They should provide essential, coherent management information so that the project sponsor and project manager can react to changing circumstances.

5.1.6 Long term Contracts

Establishment of long term contracts with the contractors is one major way in which Cost escalation can be controlled. Although this method requires a very careful selection of the Contractor right from the very first stage of selection. But, once the selection is complete and a good rapport and long term contractual obligation is established with the contractor then the only issue will be maintaining it over a long period of time. Over a period of time the contractor will also develop a sense of obligation with the client and it will aid in developing a mechanism within the contractor aiding in cost control.



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Part 3

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Chapter 6

Process of Correct Time Scheduling

6.1 Relevance of Construction Schedules

In addition to assigning dates to project activities, project scheduling is intended to match the resources of equipment, materials and labor with project work tasks over time. Good scheduling can eliminate problems due to production bottlenecks, facilitate the timely procurement of necessary materials, and otherwise insure the completion of a project as soon as possible. In contrast, poor scheduling can result in considerable waste as laborers and equipment wait for the availability of needed resources or the completion of preceding tasks. Delays in the completion of an entire project due to poor scheduling can also create havoc for owners who are eager to start using the constructed facilities.

6.2 Need for Time Scheduling

Attitudes toward the formal scheduling of projects are often extreme. Many owners require detailed construction schedules to be submitted by contractors as a means of monitoring the work progress. The actual work performed is commonly compared to the schedule to determine if construction is proceeding satisfactorily. After the completion of construction, similar comparisons between the planned schedule and the actual accomplishments may be performed to allocate the liability for project delays due to changes requested by the owner, worker strikes or other unforeseen circumstances.

In contrast to these instances of reliance upon formal schedules, many field supervisors disdain and dislike formal scheduling procedures. In particular, the critical path method of scheduling is commonly required by owners and has been taught in universities for over two decades, but is often regarded in the field as irrelevant to actual operations and a time consuming distraction. The result is "seat-of-the-pants" scheduling that can be good or that can result in grossly inefficient schedules and poor productivity. Progressive construction firms use formal scheduling procedures whenever the complexity of work tasks is high and the coordination of different workers is required.

6.3 Ways of Time Scheduling

Formal scheduling procedures have become much more common with the advent of personal computers on construction sites and easy-to-use software programs. Sharing schedule information via the Internet has also provided a greater incentive to use formal scheduling methods. Savvy construction supervisors often carry schedule and budget information around with wearable or handheld computers. As a result, the continued development of easy to use computer programs and improved methods of presenting schedules hav overcome the practical problems associated with formal scheduling mechanisms. But problems with the use of scheduling techniques will continue until managers understand their proper use and limitations.



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6.5 Resource Scheduling

A basic distinction exists between resource oriented and time oriented scheduling techniques. For resource oriented scheduling, the focus is on using and scheduling particular resources in an effective fashion. For example, the project manager's main concern on a high-rise building site might be to insure that cranes are used effectively for moving materials; without effective scheduling in this case, delivery trucks might queue on the ground and workers wait for deliveries on upper floors. For time oriented scheduling, the emphasis is on determining the completion time of the project given the necessary precedence relationships among activities. Hybrid techniques for resource leveling or resource constrained scheduling in the presence of precedence relationships also exist. Most scheduling software is time-oriented, although virtually all of the programs have the capability to introduce resource constraints.

6.6 Methods of Time Scheduling

6.6.1 The Critical Path Method

The most widely used scheduling technique is the critical path method (CPM) for scheduling, often referred to as critical path scheduling. This method calculates the minimum completion time for a project along with the possible start and finish times for the project activities. Indeed, many texts and managers regard critical path scheduling as the only usable and practical scheduling procedure. Computer programs and algorithms for critical path scheduling are widely available and can efficiently handle projects with thousands of activities.

The critical path itself represents the set or sequence of predecessor/successor activities which will take the longest time to complete. The duration of the critical path is the sum of the activities' durations along the path. Thus, the critical path can be defined as the longest possible path through the "network" of project activities. The duration of the critical path represents the minimum time required to complete a project. Any delays along the critical path would imply that additional time would be required to complete the project.

There may be more than one critical path among all the project activities, so completion of the entire project could be delayed by delaying activities along any one of the critical paths. For example, a project consisting of two activities performed in parallel that each require three days would have each activity critical for a completion in three days.

Formally, critical path scheduling assumes that a project has been divided into activities of fixed duration and well defined predecessor relationships. A predecessor relationship implies that one activity must come before another in the schedule. No resource constraints other than those implied by precedence relationships are recognized in the simplest form of critical path scheduling.

6.7 Presenting Project Schedules

Communicating the project schedule is a vital ingredient in successful project management. A good presentation will greatly ease the manager's problem of understanding the multitude



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of activities and their inter-relationships. Moreover, numerous individuals and parties are involved in any project, and they have to understand their assignments. Graphical presentations of project schedules are particularly useful since it is much easier to comprehend a graphical display of numerous pieces of information than to sift through a large table of numbers. Early computer scheduling systems were particularly poor in this regard since they produced pages and pages of numbers without aids to the manager for understanding them. It is extremely tedious to read a table of activity numbers, durations, schedule times, and floats and thereby gain an understanding and appreciation of a project schedule. In practice, producing diagrams manually has been a common prescription to the lack of automated drafting facilities. Indeed, it has been common to use computer programs to perform critical path scheduling and then to produce bar charts of detailed activity schedules and resource assignments manually. With the availability of computer graphics, the cost and effort of producing graphical presentations has been significantly reduced and the production of presentation aids can be automated.

Network diagrams for projects have already been introduced. These diagrams provide a powerful visualization of the precedences and relationships among the various project activities. They are a basic means of communicating a project plan among the participating planners and project monitors. Project planning is often conducted by producing network representations of greater and greater refinement until the plan is satisfactory.

6.8 Resource Oriented Scheduling

Resource constrained scheduling should be applied whenever there are limited resources available for a project and the competition for these resources among the project activities is keen. In effect, delays are liable to occur in such cases as activities must wait until common resources become available. To the extent that resources are limited and demand for the resource is high, this waiting may be considerable. In turn, the congestion associated with these waits represents increased costs, poor productivity and, in the end, project delays. Schedules made without consideration for such bottlenecks can be completely unrealistic.

Resource constrained scheduling is of particular importance in managing multiple projects with fixed resources of staff or equipment. For example, a design office has an identifiable staff which must be assigned to particular projects and design activities. When the workload is heavy, the designers may fall behind on completing their assignments. Government agencies are particularly prone to the problems of fixed staffing levels, although some flexibility in accomplishing tasks is possible through the mechanism of contracting work to outside firms. Construction activities are less susceptible to this type of problem since it is easier and less costly to hire additional personnel for the (relatively) short duration of a construction project. Overtime or double shift work also provide some flexibility.

Resource oriented scheduling also is appropriate in cases in which unique resources are to be used. For example, scheduling excavation operations when one only excavator is available is simply a process of assigning work tasks or job segments on a day by day basis while insuring that appropriate precedence relationships are maintained. Even with more than one



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resource, this manual assignment process may be quite adequate. However, a planner should be careful to insure that necessary precedence is maintained.

6.9 Advanced Scheduling Techniques

6.9.1 Use of Advanced Scheduling Techniques

Construction project scheduling is a topic that has received extensive research over a number of decades. The previous chapter described the fundamental scheduling techniques widely used and supported by numerous commercial scheduling systems. A variety of special techniques have also been developed to address specific circumstances or problems. With the availability of more powerful computers and software, the use of advanced scheduling techniques is becoming easier and of greater relevance to practice.

We surveyed some of the techniques that can be employed in this regard. These techniques address some important practical problems, such as:

• scheduling in the face of uncertain estimates on activity durations, • integrated planning of scheduling and resource allocation, • scheduling in unstructured or poorly formulated circumstances.

6.9.2 Scheduling with Uncertain Durations

Unfortunately, activity durations are estimates of the actual time required, and there is liable to be a significant amount of uncertainty associated with the actual durations. During the preliminary planning stages for a project, the uncertainty in activity durations is particularly large since the scope and obstacles to the project are still undefined. Activities that are outside of the control of the owner are likely to be more uncertain. For example, the time required to gain regulatory approval for projects may vary tremendously. Other external events such as adverse weather, trench collapses, or labor strikes make duration estimates particularly uncertain.

Two simple approaches to dealing with the uncertainty in activity durations warrant some discussion before introducing more formal scheduling procedures to deal with uncertainty. First, the uncertainty in activity durations may simply be ignored and scheduling done using the expected or most likely time duration for each activity. Since only one duration estimate needs to be made for each activity, this approach reduces the required work in setting up the original schedule. Formal methods of introducing uncertainty into the scheduling process require more work and assumptions. While this simple approach might be defended, it has two drawbacks. First, the use of expected activity durations typically results in overly optimistic schedules for completion; a numerical example of this optimism appears below. Second, the use of single activity durations often produces a rigid, inflexible mindset on the part of schedulers. As field managers appreciate, activity durations vary considerable and can be influenced by good leadership and close attention. As a result, field managers may loose



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confidence in the realism of a schedule based upon fixed activity durations. Clearly, the use of fixed activity durations in setting up a schedule makes a continual process of monitoring and updating the schedule in light of actual experience imperative. Otherwise, the project schedule is rapidly outdated.

6.10 Crashing and Time/Cost Tradeoffs

Activity durations can often vary depending upon the type and amount of resources that are applied. Assigning more workers to a particular activity will normally result in a shorter duration. Greater speed may result in higher costs and lower quality, however.

A simple representation of the possible relationship between the duration of an activity and its direct costs appears in Figure below. Considering only this activity in isolation and without reference to the project completion deadline, a manager would undoubtedly choose a duration which implies minimum direct cost, represented by Dij and Cij in the figure. Unfortunately, if each activity was scheduled for the duration that resulted in the minimum direct cost in this way, the time to complete the entire project might be too long and substantial penalties associated with the late project start-up might be incurred. This is a small example of sub-optimization, in which a small component of a project is optimized or improved to the detriment of the entire project performance. Avoiding this problem of sub-optimization is a fundamental concern of project managers.



Delays are also caused by some fundamentals and things which go wrong during the construction project. A sign of delaschedule. Delay in completion of project is also caused by equipment breakdowns and labor disputes. The major factors due to which delay occur are client problem, service provider problem, sources problem and universal problem.

7.1 Client Related Factors

The client related factors are concerned with client’s type, individuality, experience, financial status, awareness, organization, construction complexity, confidence, extent and risk dealing. The contractor related factors are concerned with the contractor’s cash flow, site management, experience, subcontractors, supervision, information flow and control system. Resource problem are more often related with dealer, late delivery of equipments, deficiency of workers, non efficient equipment use during construction, late delivery of materials, inflation, low quality material etc. General problem which faced during the project are environmental problem, weather problem, ground problem, natural disastersearthquake, flood etc. The owner makes some changes during the project delaying the project. Construction plans can be changed by change of zoning laws causing the delay. The contractor can stop the work due to late delivery of payments or payments atime. The influencing delay factors affecting the construction projects are given below.



Chapter 7

Causes of Time Delay

Delays are also caused by some fundamentals and things which go wrong during the construction project. A sign of delay in work is when contractor do not takes care of the schedule. Delay in completion of project is also caused by equipment breakdowns and labor disputes. The major factors due to which delay occur are client problem, service provider

em and universal problem.

The client related factors are concerned with client’s type, individuality, experience, financial status, awareness, organization, construction complexity, confidence, extent and

contractor related factors are concerned with the contractor’s cash flow, site management, experience, subcontractors, supervision, information flow and control system. Resource problem are more often related with dealer, late delivery of equipments,

iency of workers, non efficient equipment use during construction, late delivery of materials, inflation, low quality material etc. General problem which faced during the project are environmental problem, weather problem, ground problem, natural disastersearthquake, flood etc. The owner makes some changes during the project delaying the project. Construction plans can be changed by change of zoning laws causing the delay. The contractor can stop the work due to late delivery of payments or payments atime. The influencing delay factors affecting the construction projects are given below.


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Delays are also caused by some fundamentals and things which go wrong during the y in work is when contractor do not takes care of the

schedule. Delay in completion of project is also caused by equipment breakdowns and labor disputes. The major factors due to which delay occur are client problem, service provider

The client related factors are concerned with client’s type, individuality, experience, financial status, awareness, organization, construction complexity, confidence, extent and

contractor related factors are concerned with the contractor’s cash flow, site management, experience, subcontractors, supervision, information flow and control system. Resource problem are more often related with dealer, late delivery of equipments,

iency of workers, non efficient equipment use during construction, late delivery of materials, inflation, low quality material etc. General problem which faced during the project are environmental problem, weather problem, ground problem, natural disasters like earthquake, flood etc. The owner makes some changes during the project delaying the project. Construction plans can be changed by change of zoning laws causing the delay. The contractor can stop the work due to late delivery of payments or payments are not on time. The influencing delay factors affecting the construction projects are given below.



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7.2 Effects of Delay

Several factors cause the overall delay in the construction project such as some within contractor’s liability and some are within owner’s liability. It is hard to distinguish due to overlapping nature of the events that which party or parties are responsible and what ingredients of the delay cause. It is mostly seen that delay problems are cause of dispute, negotiation, lawsuit, total desertion, litigation and abandonment. We can say that the parties included in contract through claims agree on the additional capital and extra time linked with construction delay. The consequences of delay are different for different parties. The general consequences are the loss of wealth, time and capacity. For owner, delay means the loss of income and unavailability of facilities. For contractor, delay means the loss of money for extra spending on equipment and materials and hiring the labor and loss of time.

7.3 Common Reasons for Time Delays And Remedies

7.3.1 Inspections

The source of many headaches for contractors, inspections require careful planning and time budgeting. Calling for them before the project is ready, calling for them too late, or failing them can all cause delays. Prevention One needs to be able to tell when a job is truly ready for inspection. Acquiring at least a working knowledge of as many skills on the job as possible will serve well. In addition, spend time with subcontractors to understand more of what they do. Remembering that failure of an inspection may not only require more of contractor’s time but may also necessitate a subcontractor returning.

7.3.2 Subcontractor delays

While a general contractor has only a few projects in progress at a time, a subcontractor usually has many at a time. A delay in any one of those will likely cause a delay in job. The priority of your project may be lower with a given subcontractor because he or she has a number of active projects - some of which may be larger and more financially lucrative than this. Prevention Contractors need some clout or leverage with subcontractors. With a general contractor, that leverage is future work. For individuals serving as their own general contractors, that leverage will need to be financial. Penalties for not starting on time can help, but few subcontractors will agree to contracts with



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such clauses. One will have better success by getting to know your subcontractors, understanding what they do, and communicating frequently and clearly with them about deadlines.

7.3.3 Delays in shipping times

Windows, cabinets, appliances, and special-order items are common sources of delays. A late shipment of even one item can throw off subcontractors’ schedules. Prevention Steer clients toward in-stock items whenever possible, or use suppliers that maintain larger local stocks of needed items. Otherwise, double the estimated shipping time for your planning purposes. If a client decides to order something on his or her own, specify exact dates - with a buffer - for when project will need the items.

7.3.4 Client change of mind

Every contractor knows that once a project begins to take shape, the client can visualize better and will request changes. And, given that the client is the (paying) client, he or she can make changes - if he or she understands the consequences. Prevention Detailed, proactive communication with clients before a project begins can set the stage. While you can’t anticipate every client request, one can outline some specific examples so that they understand the time and cost consequences of changes. Clients may not realize that a seemingly simple request, for example, could require a change in design, reengineering, re-filings with the municipality, and reordering of materials. Also, explaining the “chain effect” of changes to clients, with examples. Moving a wall, door, or window just a few inches also could mean that one needs to call back a plumbing or electrical subcontractor and need to work with their schedules. 7.3.5 Weather

One standard key is always to build some degree of extra time into your project timeline. How much and where in the schedule you build this in depends on the nature of the project and the area of the country in which work is going on. Prevention If the project is primarily indoors, the added time may be minimal - but not zero. Keep in mind that one may be dependent on materials shipping from other parts of the country that could be adversely affected by weather. Should snow, rain, storms, or other factors come into play, it is likely that the project will lose some time.



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Part 4

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Chapter 8

Analysis

8.1 Analysis and Conclusions

Large construction cost escalations in transport infrastructure projects are common and exist across different project types, different continents and different historical periods. We see what causes construction cost escalation, focusing on three variables: (1) the length of the implementation phase; (2) the size of the project; and (3) the type of ownership. The database used in the tests is by no means perfect. A more robust database with more and more evenly distributed, observations across subdivisions is desirable. Such a database is not available at present, however. The database provided is the best and largest available and is a major step ahead compared with earlier databases.

8.2 Findings

First, for the length of the implementation phase the main findings are as follows: _ Cost escalation is highly dependent on the length of the project-implementation phase and at a very high level of statistical significance (p < 0.001). _ Influence of the length of the implementation phase on cost escalation is not statistically different for rail, fixed-link (bridge and tunnel) and road projects, respectively. _ for every passing year from the decision to build until operations begin, the average increase in cost escalation is 4.64%. For a project in the size range of the Channel Tunnel, this is equal to an expected average cost of delay of approximately US$1 million/day, not including financing costs. It can be concluded that decision-makers should be concerned about long implementation phases and sluggish planning and implementation of large transport infrastructure projects. Sluggishness quite simply may be extremely expensive. Consequently, before a project owner decides to proceed and build a project, every effort should be made to conduct preparation, planning, authorization and ex ante evaluation in such ways that problems are negotiated and eliminated that may otherwise resurface as delays during implementation. Similarly, after the decision to build a project, it is of crucial importance that the project organization and management are set up and operated in ways that minimize the risk of delays. If those responsible for a project fail to do this, the evidence indicates that the financiers—be they taxpayers or private investors— are likely to be severely penalized in terms of cost escalations of a magnitude that could threaten project viability. Second, for the size of the project we find the following: _ for bridges and tunnels, larger projects have larger percentage cost escalations than do smaller projects; for rail and road projects, this does not appear to be the case. _ for all project types, our data do not support that bigger projects have a larger risk of cost escalation than do smaller ones; the risk of cost escalation is high for all project sizes and types.

8.3 Road Projects Case



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Projects grow larger over time, but only significantly so for road projects. Because the same percentage cost escalation will typically cause more problems in a large project than in a small one, it can be concluded that an increase in project size translates into a need for improved planning processes and institutional setups for infrastructure development and management. Third, for the type of ownership, the data do not support the oft-seen claim that public ownership is problematic per se and private ownership a main source of efficiency in curbing cost escalation. However, this does not rule out the possibility that other reasons may exist for preferring private over public ownership; for instance, that private ownership may help protect the ordinary taxpayer from financial risk and may reduce the number of people exposed to such risk. The data show, nevertheless, that the issue of ownership is more complex than is usually assumed. The main problem in relation to cost escalation may not be public versus private ownership but a certain kind of public ownership, namely state-owned enterprises, which lack both the transparency and public control that placement in the public sector proper, would entail and the competitive pressure that placement in the private sector would bring about. We expect further research on this issue to be particularly rewarding in either falsifying or confirming this finding. It is an issue of principal significance for deciding on the institutional set-up and regulatory regime for infrastructure provision.

8.4 Reducing Optimism Bias

The “Optimism Bias Uplift” is useful to control cost underestimation before the approval of projects. If no measure is taken to control cost escalation after project approval, promoters would simply “postpone” the appearance of costs during the project construction. Therefore, to discourage cost increases during the implementation of the project, it is advised that requests for funds should include an additional risk allowance in the amount of 35% of the Optimism Bias uplift. If during the implementation phase a project requires further expenditures that are within the risk allowance, these do not require additional approval from the funding institution. It also requires promoters to construct a comprehensive Risk Register to mitigate the risk involved in the implementation of large schemes. This register lists the risks that are likely to affect the delivery and operation of the proposed infrastructure. Construction risks (e.g., timescale and cost perspectives) and operational risks (e.g., maintenance risk and revenue risk) and a share of risks associated with climate change should be included in the register. In addition, it is advised that the Risk Register “needs to identify who owns the identified risk. For example, some risks may be transferable through insurance or financial instruments.” In addition, to obtain more realistic forecasts and reduced risk, full public financing or full financing with a sovereign guarantee should be avoided. Whenever possible, the decision to go ahead with a project should be made contingent on the willingness of private financiers to participate without a sovereign guarantee for at least one-third of the total capital needs. The lower limit of a one-third share of private risk capital is based on practical experience. Contracts should be written in such a manner that risk allocation is balanced, i.e., the risk to private financiers must be real, with no comfortable



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escape clauses that return risk to the taxpayer when things get difficult. This has been beneficial in situations where the project passed the market test as well as when it did not (i.e., whether the project has been subsidized or not). Private lenders, shareholders, and stock market analysts should produce their own forecasts or should critically monitor existing ones. If they were wrong about the forecasts, they and their organizations should be held responsible for the mistakes.



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Chapter 9

BIBLIOGRAPHY

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