Taking Costs out of Projects - Avoiding Project Cost Overruns
Tips on how to reduce projects costs and avoid overruns
Dave Rochford BSc, MA, FCMA
Introduction
How many times do you hear about project costs overrunning and exceeding their budgets? No
doubt far too many compared with the number of times you can remember a project coming in well
within budget.
Keeping costs within the project budget and getting value for money and return on investment is
even more important in these times of economic hardship and market competitiveness but how
many companies address this openly passionately and proactively with well tried tools and methods.
Putting your head in the sand is not the answer!
This paper explains the typical causes of project cost overruns and provides some insights on the use
of various techniques and tips for managing and reducing costs.
According to Wikipedia Cost overrun is defined as excess of actual cost over budget. Cost overrun is
also sometimes called "cost escalation," "cost increase," or "budget overrun." It is simply calculated
in one of two ways: either as a percentage, namely actual cost minus budgeted cost, as a percentage
of budgeted cost, or as a ratio, viz. actual cost divided by budgeted cost. For example, if the budget
for a project was £100 million and the actual cost was £150 million then the cost overrun may be
expressed as 50 percent or by the ratio 1.5.
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Background
Cost overrun is reportedly very common in infrastructure, building, and technology projects. One of
the most comprehensive studies [1] of cost overrun that exists entitled Megaprojects and Risk by
Bent Flyvbjerg in 2003, found that 9 out of 10 projects surveyed overran, and that overruns of 50
to 100 percent were common. For IT projects in particular, an industry study [2] by the Standish
Group in 2004 found that the average cost overrun was 43 percent, and that 71 percent of projects
were over budget, over time, and under scoped.
Spectacular examples of cost overruns have been well documented. For example, the Sydney Opera
House had a 1,400 percent overrun and the Concorde supersonic aeroplane experienced a 1,100
percent overrun.
Cost Overruns
So what causes projects to incur cost overruns? The fishbone diagram below highlights many of the
factors that contribute to increased costs and overruns.
Unclear or
poorly
defined
and
agreed
scope
Dimensions of
project
not understood
Excessive lags
and buffers
Requirements
not prioritised
Complexity
Time
Scope
Inaccurate
task duration
estimates
Critical path
not
identified or
controlled
Dependencies not
identified or
evaluated
Dependencies
Risks and
Issues not
Addressed
Environment
Unforeseen
costs
Unjustified
Business
Case
Costs
Criteria for
approval
unclear
Deliverables
not tied to
Objectives
Quality
Planning
Little use of
planning
tools
Poor Project
Management
Systems
Lack of consistent
processes and
documentation
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Vested
interest
groups
People set
own
priorities
Skills & Resources
Skills and
Resources
not available
Culture
Aversion
to risk
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Some obvious causes of cost overruns are listed below:









project and requirements not clearly defined , agreed and prioritised e.g. as evidenced by
“wish lists”
inappropriate choice of design
inadequate data and hidden or unforeseen problems and costs
scope creep
absence of controls over spend e.g. accountability for spend not matched with
responsibility, costs not monitored or reviewed, lack of any change control
skills and resources not available when needed or not managed effectively
timescales extended
insufficient checking of work, waste and rework
lack of project direction and weak and inexperienced project management
Less obvious ones are...













absence of a robust business case
little or no evaluation of cost drivers or understanding of direct and indirect project costs
insufficient use of planning tools and techniques e.g. little or no evaluation of the critical
path and the impact of change in a critical activity on the plan
poor estimation or forecasting especially of demand and revenue
lack of option appraisal on costs, quality and time and the evaluation and impact of lower
cost alternatives
absence of a quality plan and lack of agreement on quality as evidenced by the setting of
deliverables, review mechanisms and acceptance criteria
inbuilt complexity and time delays e.g. over-engineering or inappropriate use of time
buffers during or at the end of the project plan
poorly integrated plans and imbalance between people processes and systems - resulting in
additional costs later to correct the imbalance and avoid failure
inadequate account of safety, legal, regulatory and environmental factors
lack of agreements /contracts where there are dependencies on third parties, or contracts
with third parties not aligned to internal project objectives, costs and benefits
risk averse culture or just simply issues and risks not adequately considered and dealt with
political pressure, vested interest groups, or simply fear of lack of approval
poor communication and decision making
By way of example, the Sydney Opera House overran primarily because construction was pushed
ahead before technical design problems were solved leading to significant rework and rebuild.
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Pressure was then placed on costs and payments resulting in the resignation of the key architect and
further delays.
Concorde overran primarily because it was politically led with contractors working to government,
with duplicate assembly lines then established in France and the UK and high-cost high-fuel
consumption aeroplanes purchased only by the respective state airlines.
Whilst culture and politics may be difficult to deal with and may be beyond the capability of a single
project manager, programme and project managers can nonetheless draw on various project
management methods and tools to assist them to manage and reduce costs.
The relationship between cost drivers and project management tools is displayed in the table below.
Cost Table
Cost Drivers
Scope
Timescales
Complexity
Dependencies
Programme Management Tools & Techniques
Factors
Size, scale, functions,
Nos of people, systems,
processes, functions,
locations, geography,
budgets
Seasonality, holidays,
working hours, shifts,
rotas, skills,
availability, downtime,
corporate priorities and
decisions, locations
Functions, technology,
systems, processes,
degree and No. of
changes,
dependencies, skill
requirements
No and duration of
sequential tasks and
dependencies
Systems
Definition,
documenation,
understanding and
ownership, degree of
standardisation,
adherence
Degree of fit for
purpose, integration,
data integrity, extent of
standardisation, change
Skills and Resources
Availability, amount,
location, organisation
structure, matrix teams
and management
Processes
Stakeholder Management
Quality, Health & Safety
Governance
Culture
Senior management,
key internal and
external customers,
unions, government,
third parties
Regulations, Processes
and Procedures,
Standards, Audit
Reporting and meeting
structures, contol and
approval processes,
levels of responsibility,
project management
methodolgy and
practice
Management
style,
performance
management,
incentives, values,
attitudes, customer
responsiveness
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Project
Brief /
Initiation
Document
Business
Case and
Option
Appraisal
Critical
Path &
PERT
diagrams
Requs and RACIs
Specs
Resource Earned
Planning & Value
Time Mgt Analysis
RAID-VS
· · · · · · · ·
· · ·
·
Quality
Reviews
Change
Mgt
Reporting
& KPIs
·
· · · · ·
· · · · · · · ·
·
· · ·
· ·
·
· ·
· ·
· ·
· · · · ·
· ·
· ·
· · · · ·
·
· · · · ·
· · ·
· · · · · · · · · · ·
· · · · · · · · · · ·
· · · · ·
· · · · ·
·
· ·
·
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Clearly the table suggests that above tools and techniques can have a significant impact on many
potential cost drivers.
“The first step in reducing project costs overrun is to acknowledge that a substantial risk of overrun
exists”. Techniques and supporting measures need to be put in place to manage and reduce the risk.
These include:

initial care and attention to project initiation and set up

a sound robust business case and realistic estimates and forecasts of costs and revenue

a good understanding and analysis of cost drivers and direct and indirect costs

analysis of critical path

continual measurement of earned value.
Details on some of the above techniques and how to use them are set out below.
Project Set Up and Initiation
Project set up is key to success. Getting it right from the start will help avoid unforeseen problems
and knock on effects later.
Use of accepted project management methodologies and tools such as Prince 2 or PBOK along with
a good degree of common sense will go some way to getting the project setup properly.
Key factors are:

A clear project brief with defined objectives and scope plus assigned and agreed ownership
of clearly defined deliverables and built in review mechanisms for review and sign off

Detailed tasked and integrated project plan with discrete manageable stages including
sensitivity analysis and evaluation especially of the critical path, supported by a detailed
agreed resource plan including unavailability e.g. holidays, and

Clearly defined individual team and stakeholder responsibilities and accountabilities

Processes defined for identifying, recording and managing risks, issues, assumptions,
dependencies and decisions (often referred to as a RAID Log) and changes.
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Finally it’s important that leadership, stakeholder and risk management issues are factored into
projects early and discussed openly at project board and steering group meetings. Projects should
be run on the principle of “no surprises” supported by an open supportive culture, thus avoiding the
practice of issues typically being discussed behind closed doors.
Business cases – costs and revenue
Business cases drive projects. They should be seen as a living breathing model for delivering
continuous benefit. However they are often seen as “1 off” exercises to get funding and then
forgotten.
Fundamentally the business case must be detailed, timed, easily understood with clearly defined
itemised costs and benefits and a ROI signed off and monitored by at least Finance.
In building up the business case it is also important to establish realistic estimates of costs based
ideally on past experience or validated from various sources.
Identifying Costs
In identifying costs it is useful to distinguish between direct and indirect costs
•
Project Indirect Costs -Costs that cannot be associated with any particular
work package or project activity and tends to be fixed e.g. management,
administration and interest
•
Direct Costs -Normal costs that can be assigned directly to a specific work
package or project activity e.g. labour, materials, equipment, and
subcontractors
Once direct and indirect costs and key drivers have been identified it is then useful to prepare a cost
duration graph to inform project timeline decisions and run sensitivity analysis to inform which
critical activities and costs should be focused on.
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Note reducing project duration may reduce indirect costs but may increase direct costs by having to
put more resources on the project.
In assessing and reviewing costs it is useful to:

Identify lowest cost activities which could reduce project duration and cost

Assess options and lower cost alternatives e.g. internal v external resources, insourcing v
outsourcing,

Explore different delivery options and processes e.g. run cross functional end to end process
workshops to drive requirements, run training internally

Compute the cost benefit of reducing project time and cost

Perform impact assessment on risks and issues and build in a contingency factor. A project's
budgeted costs should always include cost contingency funds to cover risks (other than
scope changes imposed on the project).
In summary focus should be on what drives and adds value to desired project output (a lean
principle) so benefits should also not be ignored and often can alleviate cost increases by tying them
to benefit delivery.
Hence cutting the budget is not the answer as it could reduce all the value in the project!
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Estimating Demand/ Revenue
It is important to establish agreed baselines of performance from which improvements and benefits
can be measured. As mentioned above they should also be tied to costs where possible to inform
decisions on project scope and priorities.
Spending time on benefit assessment can improve the viability of the project and identify further
potential benefits as well as quick wins which help deliver early benefit and commitment. But as
evidenced below calculating benefits and forecasting demand/ revenue isn’t as straight forward as it
seems.
The cost overrun for the Channel tunnel between the UK and France was 80 percent for construction
costs and 140 percent for financing costs. This coupled with a significant shortfall in revenue
projections resulted in near collapse and significant long term refinancing. Traffic forecasts were in
the early years of the project wildly optimistic. This was explained by the need to preserve
shareholders and banks confidence when the cost overruns became apparent. After the tunnel was
completed the forecasts became more conservative. Unfortunately, this is not untypical.
For example the UK Dept of Transport is reasonably satisfied if the original forecast of traffic flow for
the year after opening a section of a new road is within 20% of actual flow for that year. In a study
carried out by the Dept 22 of 41 road schemes were within this limit; the other 19 had differences
from forecast from -50 to +150 percent.
In summary Flyvbjerg in his book on Megaprojects and Risks argues that traffic and revenue
forecasting cannot be relied on and can have serious consequences on viability. He suggests that
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there is a need for more institutional checks and balances, the use of performance specification,
penalties for forecasting and estimating errors and the use of risk capital to deliver a stronger
commitment to produce more accurate forecasts.
Critical Path Analysis
Critical Path Analysis (CPA) is a project management tool that:

Sets out all the individual activities that make up a larger project

Shows the order in which activities have to be undertaken

Shows which activities can only take place once other activities have been completed

Shows which activities can be undertaken simultaneously, thereby reducing the overall time
taken to complete the whole project

Shows when certain resources will be needed.
Thus CPA is recognised as a powerful method for assessing:
•
What tasks should be carried out
•
Where parallel activity can be carried out
•
The shortest time to complete a project
•
Resources required
•
Sequence of activities scheduling and timings
•
Task Priorities
•
The most efficient way of shortening project time and hence cost.
In order to construct a CPA, it is necessary to estimate the elapsed time for each activity – that is the
time taken from commencement to completion.
Then the CPA is drawn up a based on dependencies such as:

The availability of labour and other resources

Lead times for delivery of materials and other services

Seasonal factors – such as the weather
Once the CPA is drawn up, it is possible to see the critical path – this is a route through the CPA,
which has no spare time (called ‘float’ or ‘slack’) in any of the activities. In other words, if there is
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any delay to any of the activities on the critical path, the whole project will be delayed. The total
time along this critical path is also the minimum time in which the whole project can be completed.
A simple example of a CPA is shown below where the letters represent tasks and the numbers task
duration, with earliest start and latest finish times shown in the top right and bottom left
respectively of the circles. Critical path is shown in red where the earliest start and latest finish times
are the same.
Earned Value Management
Earned value looks at how much value has been achieved so far. Each task in a project earns value as
planned work is completed. Thus Earned value can be compared to actual cost and budgeted cost to
determine variance against budget and plan. It concentrates on three basic parameters:
•
How much work should have been done to date - Budgeted Planned Work
•
How much money has actually been spent to progress the project to date - Actual Spending
•
What is the value of work that has been accomplished to date - Earned Value
The above terms are defined as:
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Budgeted Planned Spending = Budgeted Cost of Planned Work (often referred to as BCPW)
Actual Spending = Actual Cost of Work Performed
Earned Value = Budgeted Cost of Work Performed. The value in terms of budget of what has been
actually completed at a given point in time (or, % complete X Planned Spending)
Earned Value Analysis can also be used to predict future performance by extrapolating the above
with estimates to complete based on performance to date ( assuming future performance will of
course be the same as that to date– which to be fair is rarely the case).
20 Tips on Managing and Reducing Project Costs
Set out below are tips on managing and reducing project costs:
1. Clearly define and prioritise requirements
2. Identify direct and indirect costs and key cost drivers and dependencies and understand
cost/time relationships
3. Validate forecasts and estimates especially on demand
4. Match costs and benefits and link them to objectives and deliverables
5. Optimise cost / benefit ratios and ensure accountability is matched with responsibility
6. Reduce scope where little added value is evident
7. Consider lower cost alternatives
8. Continually focus on critical path and activities
9. Avoid managing by task due dates
10. Plan task durations so that they are carried out sequentially in order of priority
11. Provide timely task and predecessor task completion updates
12. Proactively obtain information and secure resources to complete tasks
13. Report on task completion and provide alerts and act on issues immediately
14. Use Agile techniques in systems projects, using joint workshops and cross functional teams
of users and developers to deliver iterative solutions
15. Use cross functional teams or hit squads to address issues
16. Use project and resource management software that provides
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 resource availability and task completion alerts/triggers
 escalation filters and root cause analysis
 exception reporting on tasks not started, not progressing and/or escalated
17. Continually measure earned value and alternative ways of meeting project deadlines
18. Regularly produce estimates to complete and review actual costs and revenue to date
against the original business case
19. Enforce tight discipline and adherence to agreed change and risk management approach
20. Engender an open honest “no surprises” culture and reinforcement of objectives.
Conclusions
This article has focused on techniques for managing and reducing project costs. We should not
forget that projects are run and delivered by people so stakeholder analysis, strong governance and
effective communication are equally important.
References:
[1] Megaprojects and risk: an anatomy of ambition, by Bent Flyvbjerg, Nils Bruzelius, Werner
Rothengatter
[2] Standish Group, 2004. CHAOS Report (West Yarmouth, MA: Author)
[3] A study in project failure; Dr John McManus and Dr Trevor Wood-Harper Chartered Institute of IT
[4] Tutor2u.net and BizHelp24 CPA tutorial and example
Google images
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