Construction Phase Cost Management

by Scott Cullen
Faithful+Gould

Last updated: 01-17-2011

Introduction

Construction Phase Cost Management comprises two major efforts: bid the project and select a general contractor; and oversee costs from change orders and contractual claims. A useful by-product of this stage is that cost data can be collected to inform future cost estimates.

The Bid Process

The bidding process and the input from the cost manager can vary from very little to substantial, depending on the owner's capabilities and those of other consultants, e.g. an agency Construction Manager. At the very least the final cost estimate should be prepared in such a way as to facilitate comparison of the estimate with the bids received. Should a bid "bust" occur, this comparison can reveal what went wrong, for example all of the over-run may be in one trade, possibly indicating lack of competition or specifications that were written too restrictively.

Change Order Evaluation

Cost management in the construction phase is critical to bringing a project in on budget. Cost issues from the point of signing a lump sum or GMP contract arise with the issuance of change orders, or contract modifications, against the contract. These are either initiated by the owner for a change the owner would like to make, are a result of unforeseen conditions such as below-ground obstructions, or are a result of the contractor issuing a Request for Information (RFI), the answer to which results in a change to the contract drawings or specifications.

In the public sector, in order to properly prepare an estimate for a change order, the estimator must understand the overall objective, i.e. to reach an agreement with the contractor that is in the best interest of the government. The lowest possible price does not always meet this objective nor would a "generous" price if that price offers more payment than necessary to include sufficient incentive. The negotiation team must strive for some intermediate point, which is generally regarded as the lowest reasonable price- the amount at the bottom of the price range that the negotiator considers to be fair and reasonable. See Pre-Negotiation Objectives (XLS 150 KB) for more detail.

To arrive at this price the negotiator must at least partially rely upon an independently prepared government estimate. This estimate must be based on a detailed analysis of the change in requirements and existing job conditions. For the most part, the estimate should be prepared similar to, and take into account, those same conditions and elements occurring in the contract, as each applies to the change order scope. In lieu of better data, the government estimate for bid evaluation may be used for assistance.

It is necessary to fully understand the scope change (by, for example, a meeting with the designer and owner) and then prepare an accurate quantity takeoff for each direct item of change. Then apply a cost to each of the direct items for labor, material, and equipment costs, and sequentially apply appropriate overhead, profit, and bond costs, all in accordance with the terms of the construction contract. This formal, approved government estimate will be used to evaluate the contractor's proposal in determining reasonableness and therefore must be prepared on a comparable and realistic basis. The estimator should become familiar with the modification and claim processes as outlined in the contract. See Finding of Fact Template (XLS 150 KB) for more detail.

Preparation for Estimating

The estimator must review the change documents received and become thoroughly familiar with the scope and requirements of the changed work. This will perhaps entail detailed comparison, analysis and various discussions with the design team and owner to ensure understanding.

The estimator must determine the existing status of construction and how the changed work will fit into the construction schedule. This will require obtaining progress reports, schedules, and discussion with those closest to the work. This often requires a visit to the construction site, and shows why on large projects it is useful to have a cost estimator on site.

The estimator should become fully aware of the contractor's existing methods, capabilities, and rates of accomplishment. The estimate should not arbitrarily include methods and capabilities different from the way in which the contractor is performing existing work. Unless the Contracting Officer is willing to direct the contractor to another method of performing work and assume the responsibility, the estimator should usually base the change on existing contractor operations for similar work. When work is anticipated to be subcontracted, prepare the estimate to include costs accordingly.

The estimator must obtain valid labor rates that the contractor is incurring. The rates are usually available from labor reports or from the contractor upon request. Contact actual sources of supply for materials for quotes. The price that the contractor is expected to pay should be the basis for estimating material costs. The estimator should obtain a list of equipment on the job. Determine equipment rates by a required methodology, either as specified in the contract or as required by FAR 31.205-36. Any other applicable information that the estimator determines necessary should be obtained if available.

The estimator, through the negotiator, should attempt to agree tentatively with the contractor on scope and format before preparing the independent estimate. The intent of the agreement is not to influence the contents, price or independency of the Government estimate, but only to eliminate unnecessary wasted effort for both parties.

Preparing the Estimate

After collecting and analyzing all the information, the estimator must decide upon the presentation format unless there has been a prior agreement and discussion. Unless otherwise agreed, the format for the estimate will be MasterFormat with a level of detail as per the available detail on the Construction Documents. General guidance for the calculation of direct costs can be provided as follows:

  • For additional work, items and format should be priced similar to a new contract as performed by the known contractor. All new work should be priced at the rates anticipated to be in effect at the time the work will be performed.
  • Changed work requires a separate quantity takeoff for each item directly affected for comparable scope both before and after the change. The estimator should price each item at the rates that would be in effect at the scheduled time of accomplishment. Typically, the estimator quantifies, prices and totals each item of changed original work. Then, price at the applicable rates and total each comparable item of revised work. Obtain the net cost (or credit) by subtracting the total of the original work from the total of the revised work. It is important that the estimator maintain a comparable scope of items throughout both estimates. When an item of work will be performed identically before and after, except for a revision in quantity, the net or differential quantity may be estimated directly for that item. However, if overhead and profit rates vary between the original and revised work, difficulty may occur in application of those same rates to the net quantity.
  • For deleted work, the item and format should be priced similar to a new procurement as performed by the known contractor. Rates in effect at the time the work would have occurred should be utilized. In addition to the direct cost of the work, include variable overhead, profit (where the contract allows for recovery of profit on omitted work), and bond costs for credit on the deleted work.
  • Impact considerations of cost on the remaining unchanged work will be discussed forward. Clearly and adequately describe and identify impact related costs as a separate part to each estimate.
Exterior of Department of Commerce Washington DC

Department of Commerce, Washington, DC

Prepare an estimate for a modification in at least as much detail as the bidding estimate. Many instances will require even more detail in order to negotiate the lowest reasonable price. Each modification estimate should include a general summary sheet relating the major categories of cost of the modification, both for decreases and increases. Include the construction plan, descriptions, utilization schedules, and discussion sheets that would aid in understanding and support the estimator's judgments. The result will generally provide an estimate that can be defended and utilized as a firm basis for negotiation. Any guidance on composition for the contractor is equally applicable to the breakdown required for the government estimate. The government estimate should not rely on past generalized rates and settlements unless actually appropriate to that specific modification.

Estimators should base the estimate on the most dependable information available. The most reliable source is the data actually collected and experienced from the project. Time studies, periodic field visits, the project schedule of values, and log records can provide this data. Previous modification results as one source of feedback can also provide valuable data. Experienced cost data is often available from past audit reports on other modifications. The contract should also be referenced for the "rules of engagement" i.e. those contract provisions that govern allowable mark-ups for overhead and profit. These rules should be reviewed by the parties and clarified as to their intent at the outset of the project.

The estimate must be prepared in a timely manner. Procurement requirements stress the importance of settlement prior to commencing the work. The estimator must not be the initiator of a cost-plus settlement as a result of delay in preparation. On the other hand, the estimate should not be based on pure judgment when actual data is obtainable. Therefore, the estimator should immediately proceed to obtain the necessary data for the modification estimate and notify the appropriate contract administration specialist of the earliest date that the estimate can be completed. It is generally understood that the larger and more complex the change, the longer the time requirement for the initial preparation of dependable estimate. See Record of Independent Government Estimate (XLS 150 KB) for more detail.

Impact Cost Considerations

When a modification is directed, the settlement of that modification includes not only the cost and time change of the work directly affected but also the cost and time impact on the unchanged work. The impact portion on unchanged work of a modification is very difficult to determine. The scope of impact is very broad, intangible, and susceptible to a large variety of situations.

By far the greatest portion of impact costs results from acceleration or delays. In general, when delay effect can be minimized, impact costs are reduced. Through the present, at least, impact costs have been determined on a case-by-case basis for each particular situation. Very few claims for impact are denied in their entirety. It is, therefore, necessary that the claim be reviewed for validity by a team involving all-around expertise.

Impact costs are generally first presented by the contractor as "claimed" impact cost as part of the proposal. The support for such "claimed" cost should also be obtained and include narrative, calculations, and planned rescheduling. To determine the extent of the impact, the existing network schedule furnished by the contractor must be developed to reflect actual construction as accurately as possible. The modification work must be superimposed upon the original network schedule in such a manner to minimize delay under the given requirements. The revised network must then be thoroughly reviewed relative to the existing job plan.

This comparative review should indicate those areas that have been affected by the modification. Once identified, each construction task must be analyzed for impact and estimated judgmentally considering the influences caused by the change. Each impact cost claimed should be classified as either factual or judgmental. The factual costs are those which are fixed and established and can be determined directly from records. These include rental agreements, wage rate agreements, purchase documents, etc.

Once the item has been determined to be valid as a factual impact, the item cost may be directly calculated. The amount of cost change is either stated on the certification document or can be determined from the scheduled time change of the construction progress plan.

Impact costs considered factual:

  • Escalation of material prices
  • Escalation of labor wage rates
  • Change in equipment rates
  • Increase from extending the storage period for materials and equipment
  • Increase from extending the contract for labor cost and subsistence
  • Increase from a longer period of equipment rentals or use
  • Increase from a longer period of utilizing overhead personnel, materials, and utilities
  • Increase from a longer period of providing overhead and project office services

Judgmental costs are those that are dependent on variable factors such as performance, efficiency, or methodology and cannot be stated factually prior to actual accomplishment. These must be negotiated and be based upon experienced judgments. Judgment or costs can be challenged but cannot be found erroneous if based on reasonable judgments of the conditions. Since judgmental factors appear in the Government estimate and the contractor's proposal, results of negotiations often depends on credibility and clarity of support documentation. When each impacted activity can be analyzed for cost separately, the estimate of impact should be prepared accordingly. However, sometimes the impact items are so interrelated that it is best to develop a detailed plan for accomplishing the total remaining revised contract work.

Impact costs considered judgmental:

  • Change of efficiency resulting from rescheduling
  • Loss of labor efficiency resulting from longer work hours
  • Loss of efficiency caused by disruption of the orderly existing processes and procedures
  • Inefficiency from tearing out completed work and the associated lowering of morale
  • Loss of efficiency during rescheduling of manpower
  • Inefficiency incurred from resubmittal of shop drawings, sample materials, etc.
  • Additional costs resulting from inability to transfer manpower expertise to other work

Each remaining item in this plan would be costed at the productivity and rate in effect at the time the work is to be accomplished and the cost incurred. The same scope of work under the original plan would also be separately costed at the productivity and rates in effect at the originally scheduled time. The net difference from the totals of these two estimates yields the cost of impact.

Whatever the method used, those impacts determined valid must be included and costed by the most accurate method available. The estimator should avoid including questionable impact costs in the initial government estimate unless each has been found to be justifiable.

Support for Negotiations

Interior of Reagan Building, Washington, DC

Interior of Reagan Building, Washington, DC

Once the government estimate for the modification has been completed, approved, and delivered to the Contracting Officer or his authorized representative, the estimator should continue to support the negotiations. This support is entirely dependent upon the desires of the negotiator. The estimator must become thoroughly familiar with negotiating requirements and techniques before the estimator participates as part of a negotiating team.

Whenever feasible, the estimator should review the contractor's proposal and furnish the negotiator with the resulting analysis. The estimator must review many of the costs presented in the contractor's proposal breakdown for accuracy, reasonableness, and allowability. Of those costs found allowable (see FAR 31.2), each must further be reviewed for applicability for that portion relevant to the particular project. The government should expect to pay for all reasonable costs anticipated to be incurred by the contractor.

Revision of the Government Estimate

As a result of an error, different conditions, or additional information, the government estimate may require revision. It is permissible for government estimates for modifications to be revised either by supplementary sheets or by actually changing the contents of the original estimate pages. The method used will be determined by the extent of the revision and the format utilized. Whichever the method, all revisions to the estimate must be clearly indicated, dated, justified, and approved by the appropriate authority. The appropriate authority is usually considered to be the original estimate approving individual or the individual having authority to approve the modification itself. See Record of Negotiation (XLS 150 KB) for more detail.

Note that earned value analysis is a useful tool to determine at any given point in time the financial status of the project and to forecast the likely outcome.

Contractual Claims

Every construction contract contains provisions for dealing with "claims" for additional costs or time extensions as a result of the failure of one party to the contract to perform one of its obligations. These typically are time-related and arise when the general contractor forms the opinion that some act or lack of action has caused him a delay on the project. This is a very complex subject and contracts vary in how claims are dealt with, however in essence the delay claimed must be on the critical path, must be notified in writing within a given time period of the delay occurring, and must be the result of the owner or someone acting for the owner (e.g. the architect) failing to fulfill a contractual obligation for the claim to succeed. A claim can be rejected or at least diluted if the contractor is also behind in other areas which are causing a delay in the project (called a concurrent delay) and there are myriad other issues which come into play. It is often necessary to bring in a claims and scheduling expert to sort through all the paperwork and establish the root causes of a delay and the true cost, if any, to the general contractor.

Additional Resources

Associations

Publications

  • Architect's Essentials of Cost Management by Michael Dell'Isola. New York, NY: John Wiley & Sons, Inc., 2002.
  • Construction Change Orders: Impact, Avoidance, and Documentation by James J. O'Brien. New York, NY: McGraw-Hill, 2002.
  • Construction Claims: Prevention and Resolution, 3rd Edition by Robert A. Rubin, Virginia Fairweather, Sammie D. Guy. New York, NY: John Wiley & Sons, Inc., 1999.
  • Construction Contracts: Law and Management by J. R. Murdoch, Will Hughes, John Murdoch. New York, NY: Spon Press, 2000.
  • Smith, Currie & Hancock's LLP's Common Sense Construction Law: A Practical Guide for the Construction Professional, 2nd Edition by Robert B. Ansley, Thomas J. Kelleher, Anthony D. Lehman. New York, NY: John Wiley & Sons, Inc., 2004.