© 2002 hulett & associates, llc will your project overrun? do a cost risk analysis presented by...
TRANSCRIPT
© 2002 Hulett & Associates,
LLC
Will YOUR Project Overrun?Do a Cost Risk Analysis
Presented by
David T. Hulett, Ph.D.
Hulett & Associates, LLCLos Angeles, CA 90049
(310) 476-7699 / [email protected]
© 2002 Hulett & Associates,
LLC
Cost Overrun Risk
• Estimate at Completion (EAC)
• Sources of Overrun Risk
• Steps in Cost Risk Analysis
• Collecting Risk Analysis Data
© 2002 Hulett & Associates,
LLC
Estimate at Completion (EAC)
• Basis of estimates -- at the cost element level– Historical data– Engineering estimates– Bids from contractors and suppliers– Labor productivity rates– Pricing Experience– Parametric– Industry database
• Each of these produces a single-point estimate for the cost elements
© 2002 Hulett & Associates,
LLC
Traditional Project Estimate At Completion (EAC) Methodology• We usually:
– Estimate the cost by cost breakdown element– Add up the elements’ costs– Present the total as the total project cost– Cross our fingers
• But, is this what the project “will cost?”– Only if everything goes according to plan
© 2002 Hulett & Associates,
LLC
Real Projects
Do projects usually go according to plan? NO!
Do projects sometimes overrun their budgets? YES!
Do we always have the right contingency? NO!
© 2002 Hulett & Associates,
LLC
Is the Traditional EAC Accurate?
• The traditional single-point EAC is precise– It can be audited for summation accuracy
• But it may be wrong– Cost estimates are often overrun
Traditional cost estimates are “precisely wrong”
© 2002 Hulett & Associates,
LLC
Why Conduct a Cost Risk Analysis?
• We do not know what the estimate means -- e.g. – How much risk is there of overrun?– What is the overrun exposure?– How does it relate to ultimate cost at completion?
Cost Risk Analysis answers these questions
© 2002 Hulett & Associates,
LLC
Cost Risk Analysis -- A New Opportunity
• Opportunity to improve the accuracy of the estimate
We can determine the contingency needed
to reduce the risk to an acceptable level
• Opportunity to improve our risk management
We can determine where the risk is in a complex project
© 2002 Hulett & Associates,
LLC
Steps in a Cost Risk Analysis
• Develop cost analysis model (e.g. WBS)• Identify risky cost elements• Determine the two dimensions of risk by element
• Likelihood of occurring and impact if it does
• Explore correlation between elements of cost• Insert model and data into simulation software• Simulate the model• Calculate risk of overrun, contingencies• Prioritize risky cost elements for risk management
© 2002 Hulett & Associates,
LLC
Example -- Risk Analysis Model of Project Cost
• What is the likelihood this project will cost $29,200,000?
Cost Category Value for EAC($000)
Project Design 1,500Equipment 5,000Foundation, Structure 7,000Piping, Elect. HVAC 1,000Labor 8,700Indirects 6,000
Total Project Cost 29,200
Project Cost Risk Analysis
© 2002 Hulett & Associates,
LLC
Interview to Quantify Cost Risk by Element• Identify “experts” in the project area
– Probably area or team leaders– May have estimated the cost and have considered risk
• Sometimes experts are biased– Project Manager who is committed– Subcontractor looking for relief
• Interview them for risk information– Optimistic extreme scenario– Pessimistic extreme possible costs– Most likely possible cost
© 2002 Hulett & Associates,
LLC
Pessimistic Scenario -- High Range
• Worst -case scenario -- the 99% case– What happens if everything goes wrong?– Include failure and need to do it over if possible– Can several things go wrong simultaneously?
• Criterion -- at least a 1% chance of occurring– Has it ever happened? At least once?– Are you uncomfortable with this specification?– Not yet unbelievable never-never land
© 2002 Hulett & Associates,
LLC
Optimistic Scenario -- Low Range
• Lower costs than included in the estimate– Estimates usually include contingency for some things going wrong “most
likely
• Optimistic scenario -- the 1% case– Even expected problems do not materialize– “Murphy” takes a holiday– Equipment works fine– Labor productivity is uncommonly high– Material, equipment comes in as advertised
© 2002 Hulett & Associates,
LLC
Most Likely Scenario
• Sometimes the EAC is not the “most likely” cost• Too Low to:
– Get the contract (contractor) or please the boss– Keep the bankers and other stakeholders happy
• Too High to:– Provide cushion– Include contingency in estimate -- not bare bones
• Explore this possibility before ending the interview
© 2002 Hulett & Associates,
LLC
Triangular Probability Distribution
– Relative likelihood determined by the height of the triangle– Impact determined by X-Axis– Easy to use, commonly used
Relative Likelihood of Occurring
Possible Element Costs
Low Most Likely High
ThreatsOpportunities
© 2002 Hulett & Associates,
LLC
Some Analysis Usingthe Triangular Distribution
Average (expected) cost = (low + most likely + high) / 3(70 + 100 + 180) / 3 = 350 / 3 = 116.7
RelativeLikelihoodofOccurring
Possible Element Costs
70 100 180
Expected Cost = 116.7
© 2002 Hulett & Associates,
LLC
Uniform Probability Distributions
• Uniform distribution, little information early in project, cannot determine “most likely” cost
Expected cost(high + low)/2
RelativeLikelihoodofOccurring
Possible Element Costs
© 2002 Hulett & Associates,
LLC
Beta Distribution
• Beta distribution– Flexible, hard to use (shape parameters)– Expected cost approximated as (H - L) / 6
0.00 24.17 48.33 72.50 96.67
Beta
0.00 8.67 17.33 26.00 34.67
Beta
© 2002 Hulett & Associates,
LLC
Normal Distribution
• Normal distribution– Symmetrical– Many automatically think of the Normal distribution
70.00 85.00 100.00 115.00 130.00
Normal
© 2002 Hulett & Associates,
LLC
Construction Project Interview and Display Low and High Ranges
Cost Category Value for EAC Low Most Likely High($000) ($000)
Project Design 1,500 1,200 1,500 2,000Equipment 5,000 4,500 5,000 6,000Foundation, Structure 7,000 6,200 7,200 8,600Piping, Elect. HVAC 1,000 800 1,000 1,600Labor 8,700 4,500 5,000 5,900Indirects 6,000 5,000 6,000 6,700
Total Project Cost 29,200
Project Cost Risk Analysis
© 2002 Hulett & Associates,
LLC
Assumptions and Results Highlighted
Cost Category Value for EAC Low High
Project Design 1,500 1,200 2,000Equipment 5,000 4,500 6,000Foundation, Structure 7,000 6,200 8,600Piping, Elect. HVAC 1,000 800 1,600Labor 8,700 7,500 12,500Indirects 6,000 5,400 6,700
Total Project Cost 29,200
Project Cost Risk Analysis
($000)
Assumptions -- Input Distributions
Result Distribution
© 2002 Hulett & Associates,
LLC
The EAC is Not the Average Cost. It is Not Even the Most Likely Cost!
Frequency Chart
Mean = 30,733.000
.008
.015
.023
.030
0
37.75
75.5
113.2
151
27,000 29,250 31,500 33,750 36,000
5,000 Trials 0 Outliers
Forecast: Total Project Cost
EAC = $29,200
Average Cost is Not the EAC
© 2002 Hulett & Associates,
LLC
Cumulative Distribution
Cumulative Chart
Certainty is 10.24% from -Infinity to 29,200
Mean = 30,733.000
.250
.500
.750
1.000
0
5000
27,000 29,250 31,500 33,750 36,000
5,000 Trials 0 Outliers
Forecast: Total Project Cost
$29,200 is only 10% likely
© 2002 Hulett & Associates,
LLC
Cumulative Distribution Table
EAC of $29,200is just over 10%
Need a contingency of $2,615 for 80%
likelihood
Forecast:Total Project CostPercentile Value
0% 27,29610% 29,17220% 29,62030% 29,98940% 30,30550% 30,63360% 31,01070% 31,37780% 31,81590% 32,461100% 35,143
© 2002 Hulett & Associates,
LLC
Contingency Percentages on Baseline Project Cost Estimate
Percentile Value Contingency0% 27,296 -7%10% 29,172 0%20% 29,620 1%30% 29,989 3%40% 30,305 4%50% 30,633 5%60% 31,010 6%70% 31,377 7%80% 31,815 9%90% 32,461 11%100% 35,143 20%
Forecast: Total Project Cost
© 2002 Hulett & Associates,
LLC
How do You Identify the Most Risky Cost Elements? • Which cost elements contribute most to overrun risk?• One measure of total project risk
– Difference between the EAC and the average cost from the simulation
• The Method of Moments (MOM) rule is that:The average total project cost is the sum of the
average cost from the elements’ distributions• For the triangular distribution (only) remember:
Average = (low + most likely + high) / 3
© 2002 Hulett & Associates,
LLC
Which Elements Contribute Most to the Difference?
Frequency Chart
Mean = 30,733.000
.007
.013
.020
.026
0
33
66
99
132
24,000 27,500 31,000 34,500 38,000
5,000 Trials 0 Outliers
Forecast: Total Project Cost
Explain the Contingency at the Mean
© 2002 Hulett & Associates,
LLC
Compute the Average Project EAC Assuming Triangular Distribution
Cost Category Value for EAC Low High AverageProject Design 1,500 1,200 2,000 1,567Equipment 5,000 4,500 6,000 5,167Foundation, Structure 7,000 6,200 8,600 7,267Piping, Elect. HVAC 1,000 800 1,600 1,133Labor 8,700 7,500 12,500 9,567Indirects 6,000 5,400 6,700 6,033
Total Project Cost 29,200 30,733
Project Cost Risk Analysis
© 2002 Hulett & Associates,
LLC
Calculate the (Average - EAC) and Sort on It to Help Focus Risk Management
Cost Category Value for EAC Average Average - EACLabor 8,700 9,567 867Foundation, Structure 7,000 7,267 267Equipment 5,000 5,167 167Piping, Elect. HVAC 1,000 1,133 133Project Design 1,500 1,567 67Indirects 6,000 6,033 33
Total Project Cost 29,200 30,733 1,533
Identifying High-Risk Elements Using Method of Moments
© 2002 Hulett & Associates,
LLC
Will YOUR Project Overrun?Do a Cost Risk Analysis -- Summary
• The EAC is not even the most likely cost• A cost risk analysis can improve the accuracy of the estimate,
provide a contingency amount, and identify the high-risk elements
• Correlation is important in developing cost risk estimates• Data collection is the main part of the risk analysis
– There are several steps that have proved effective– It is important to recognize several important biases