Cost overruns on capital projects are an ongoing and challenging issue for businesses and negatively affect the return shareholders see on capital investments. Capital project overruns occur when a project incurs unexpected or unanticipated costs above the original budget. Capital projects are seldomly derailed as a result of a single problem—typically, the cost overruns are the result of several improperly executed steps throughout a project.
Understanding how to prevent capital project overruns begins with understanding why they transpire. Overruns can be the result of late or poor scope definition, inadequate communication, design errors, scope creep, unexpected project site conditions, and issues pertaining to schedule and supply chain alignment.
Fortunately, there are several ways to reduce the likelihood of overruns, such as defining a strong scope during front-end planning, selecting the appropriate project delivery method, and choosing the right contractor.
Why Capital Project Overruns Occur
To reduce the occurrence of capital project overruns, we must first understand how and why they happen. Below we examine some of the many possible reasons for the development of cost overruns.
- Late or poor scope definition: A strong scope definition before the project starts is paramount to the success of any capital project. Poor scope definition inevitably results in change orders, scheduling issues, and scope creep.
- Inadequate communication: Clear and continuous communication is critical for capital projects. Too often, capital projects fail or are derailed due to miscommunication. Consistent communication requires good people, good systems, and documented processes.
- Design errors: Change orders from design errors can be catastrophic to a project’s budget. Owners following the Design-Bid-Build execution model should include financing to cover change orders that result from both design errors and the engineering company to construction company misalignment.
- Unexpected project site conditions: A thorough site review is necessary to evaluate all potential issues that could interfere with the project and require additional project costs. Problematic site issues can include anything from environmental and infrastructure problems to uncharted utilities and “unknowns” such as underground piping.
- Issues with schedule and supply chain alignment: Equipment and other long-lead items must be identified, fully specified, and purchase-ready at or before the start of construction. Use scheduling software such as Microsoft Project or Primavera to understand the interdependency at those critical tasks on the project schedule. Delayed and misaligned deliveries can result in additional labor costs which were not accounted for during the cost estimation process.
- Scope creep: It is important to control the scope and to not allow new project “desires” to creep in. Changes in scope definition require new resources, materials, and staff as well as schedule changes or delays and additional funding.
Tips for Reducing the Likelihood of Capital Project Overruns
Reducing the likelihood of capital project overruns can be accomplished through the following measures:
- Clear and Strong Scope Definition
- Appropriate Selection of the Project Delivery Method
- Selection of the Right Contractor
Clear and Strong Scope Definition
A well-developed, highly detailed scope will reduce the likelihood of change orders occurring during project execution. While it is unlikely to eliminate the chance of capital project overruns altogether, a strong scope definition during front-end planning can greatly reduce the likelihood. The majority of cost overruns stem from weak scope definition, resulting in many changes to the design. Good front-end planning for most industrial projects entering the execution stage will require, at a minimum, the scope of facility, the scope of supply, a detailed schedule, project P&IDs, equipment drawings, preliminary equipment layout, and infrastructure, power, and utility surveys.
Going hand in hand with scope definition, the development of an execution plan that identifies specific responsibilities can aid in this effort as well. Early stakeholder alignment, involvement, and agreement with the project scope should occur before project kickoff. Tools such as project charters are useful to identify the project goals and expectations.
Appropriate Selection of the Project Delivery Method
Unlike traditional design-bid-build (DBB) methods, turnkey or design-build methods provide a higher level of price certainty. These methods allow project owners to work with an EPC contractor to complete capital projects from detail engineering to construction. With DBB approaches, separate companies are contracted for engineering/design and construction. This separation can lead to miscommunications and inconsistencies between the engineering drawings and a project owner’s actual needs.
The EPC model acts as a collaborative approach, where all teams from engineering/design, procurement, fabrication, and construction work together as a single cohesive unit, thus reducing the likelihood of miscommunications leading to cost overruns. While project delivery methods can depend on project size, the level of the initial concept and scope development, and other project-specific factors, the EPC approach offers cost certainty as well as schedule certainty to project owners.
Other advantages of utilizing turnkey project delivery methods include:
- Reduced change management challenges
- Condensed project timelines
- Consistent quality
- Risk transference from the project owner to the contractor
- More collaborative approaches
Choosing the Right Contractor
Selecting an EPC contractor can be challenging. While it is typically a benefit that this model offers a single point of accountability, it can be a downfall if the right contractor is not selected.
Here’s what to look for in an EPC contractor as it relates to the minimization of capital project overruns:
- Your contractor, as well as their internal teams, should be familiar with the area and type of work that is being performed.
- Your contractor should perform all stages of the project in-house, including construction. Contractors who design with a focus on construction can significantly reduce overruns associated with discrepancies between engineering/design and construction.
- Your contractor should provide full transparency throughout project execution including reports regarding cost and schedule.
At H+M Industrial EPC, we value your vision, budget, and schedule and work to provide the highest level of transparency throughout the entire course of your project. From front-end planning to start-up, our fully integrated team works to complete your project on time and within budget while meeting your vision and quality expectations.