Risk Management for Construction

Dr. Robert A. Perkins, PE

Civil and Environmental Engineering

University of Alaska Fairbanks

Class 2

• Construction and Risks

• Work Breakdown Structure

• Estimating and Risks

General Risk Allocation, Fisk

Contracting Strategy

• Contract type– Lump sum, cost reimbursable

• Procurement method– Sole source, prequalification, public bid

• Project Delivery System– Design-bid-build– Design-build– CMAR

Design Build for Public Owner

• Start with “Design criteria”

• “Bridging Design”

• Contractor submits preliminary design– 35%

• Changes– Sure

• Less than DBB– Probably

DB vs. DBB

• DB faster, see next

• Quality about the same

• Cost?

• Changes– Are they different?– Literature varies, some indicated DB had

more changes and they cost more

Projects Analyzed

No. of DBNo. of DBB

Housing 2 4

Barracks/Dormitory

2 5

Industrial 5 4

Utilidor 3 4

Other 2 3

34 DB and DBB Combined

Average Cost $ 15.9 Million

Cost growth and changes for DB versus DBB projects

Construction-Contract Cost Growth (%)

Average No. of Changes per Contract

Average Growth Cost per Contract ($)

DBB 6.6% 25 1,069,882

DB 3.1% 14 480,046

p value 1.7% 1.5% 4.6%

Owner’s project manager’s point of view

• Controllable changes– design errors– lack of site access (perhaps due to permitting

problems)– deficiencies in owner-furnished materials or

equipment.

• Uncontrollable changes– changes requested by the using group– differing site conditions

A comparison of the number and costs of changes for each of three

change typesEngineering

ChangesUser Changes Differing Site

Conditions

No./avgcontract

$/avgcontract

No./avgcontract

$/avgcontract

No./avgcontract

$/avgcontract

DBB15 482,513 1 5,033 5 226,020

DB4 195,714 5 71,514 3 221,524

p0.1% 5.1% 0.4% 2.4% 27.1% 49%

Conclusions re D-B

• Certainly are design-related changes– Much less than DBB

• More user-requested changes in D-B

• Worthwhile to examine these as a source of cost growth distinct from design errors

What the hell is CMAR?

• Owner employs the A/E.

• CM is selected based on qualifications

• The CM provides “preconstruction services:” evaluating costs, estimating, providing value analysis, scheduling, and constructability advice

• Owner and CM negotiate a price

• “Guaranteed Maximum Price” (GMP)

CMAR = nirvana

• Preferred by public owners of complex projects• Used exclusively by higher education

– Minnesota– Arizona– Often by Texas

• Why?– Control the A/E details– QBS– Complex scheduling issues– Avoids disasters– Cheaper?

Culture Change

• Owner, A/E, CM and Subs are separate economic entities

• Clear roles in DBB– Good fences make good neighbors?

• Poll– Employer-type– Number of Public CMAR contracts

CMAR Problems for Public Projects

• Hire CM shortly after A/E

• Subs expertise

• Scope and budget tension

• Teamwork and partnering

• Design Errors

• Design Constraints

When is delayed hiring a severe impact?

• Most A/Es and Subs feel it becomes severe if not done before 35%

• Most Owners and CMs don’t feel it is sever until the 65%

• Opinion?

Agree

Disagree

• A/Es don’t believe CMs have specialty experience in house and are comfortable with negotiating with subs early.

• Owners want to show that they are bringing in the best price.

Tension Regarding Scope and Budget

• CM wants to cut scope and budget to reduce risk

• Has an incentive to bring in high estimates

• Owner wants all the scope possible out of the budget

• A/E does not want design changes

Regarding S-B Tension

• Yes, indeed

• Partnering is often a benefit

• Independent estimator may not reduce tension

• Forcing estimate agreement may increase tension

• Is tension bad?

Other Conclusions

• CM fees– With more experience, fewer wanted CM fees in the

proposal

• Owners did not believe there were fewer design errors in CMAR, while all other parties did.

• CM and subs felt there could be more fast-tracking done, Owners and A/E felt there was enough

• All were comfortable have the CM self-perform some of the work.

Estimating and Risks

• Many risks are evaluated by considering variation in estimates

• We will spend some time on estimating

• Owner’s

• Contractor’s

• Change Order

Project stages and WBS

• Estimate type will vary with project stage

• Uncertainty/risk associated with an estimate will vary with stage and type

• Owners and contractors often estimate differently

WBS

• The tasks needed to complete the project

• Tie WBS to risks

High Level WBS

• Planning

• Pre-design

• Design

• Procurement

• Construction

• M&O

Mid-level Pre-design

• Survey

• Soils

• ROW

• Environmental

• Public

• Other

More Detail - Soils

• Review Records

• Schedule Drilling

• Drill

• Analysis

• Report

Finer Detail - Drill

• Costs– Labor– Equipment– Subcontract

• Schedule– Permits and approvals– Section A– Section B– Section C

And more

• Labor– Bare– Benefits

• Vacation

– Supervision

Nomenclature - sometimes

• Program

• Project

• Phase

• Task

• Sub-task

• Work Packages

• Etc.

Project Selection Estimates

• Usually based on conceptual design

• Estimate of costs

• Estimate of benefits

Cost Estimating

• Economic analysis is future based.

• Costs and benefits in the future require estimating.

• Estimated costs are not known with certainty.

• The more accurate the estimate, the more reliable the decision.

General Types of Estimates

• Rough - gut level, inaccurate -30% to +60%. AKA rough order of magnitude ROM

• Semi detailed - based on historical records, reasonably sophisticated and accurate -15% to +20%.

• Detailed - based on detailed specifications and cost models accuracy -3% to +5%.

Estimates and Risk

• Purpose/Type– Planning– Owner’s Costs

• Percentage vs. size

– Design Stages• 10, 35, 65, 95%

– Contractor’s Bid– Change Order

• Contractor• Owner

Estimating ModelsModel Explanation

Per Unit Uses a “per unit” factor.

$/sq ft, Benefits/employee

Segmenting Divide problem into items, estimate each & sum.

Cost Indexes Index number based on history.

Power Sizing Scaling previous known costs up or down.

Triangulation Looking at costs from several perspectives.

Learning Curve

Tracking cost improvements.

US CPI

Power Sizing

• Scales known costs for smaller or larger item• For motors, 5-20 HP, X=0.69• Bridges

x

BofSize

AofSize

BequipofCost

AequipofCost

.

.

Learning Curve

• Time required to complete a repetitive task decreases with number of tasks completed

• Often, when output doubles, the time required decreases by a fixed percentage

• Say 85%, 0.85

• Standard tables or historical for industry

• Tn = time for nth unit

• T1 = time for first unit

• n = number of units produced

• R = log learning rate/log 2

rnTn

T 1

Cost Risks

Costs

• For estimates, some costs can be considered

• Fixed– Davis-Bacon

• Variable– Fuel cost

Some terms

• Common in estimating and contract negotiations

Fixed, Variable and Total Costs

Example 2-1Bus Rental 80.00$ Event Tickets 12.50$ Gas Expense 75.00$ Refreshments 7.50$ Other Fuels 20.00$ Bus Driver 50.00$ Total FC 225.00$ Total VC 20.00$

People Fixed cost Variable cost Total cost0 225.00$ -$ 225.00$ 5 225.00$ 100.00$ 325.00$ 10 225.00$ 200.00$ 425.00$ 15 225.00$ 300.00$ 525.00$ 20 225.00$ 400.00$ 625.00$

Fixed Costs Variable Costs

Total costs

$-

$200.00

$400.00

$600.00

$800.00

0 5 10 15 20

Volume

Co

st (

$) Total cost

Fixed cost

Profit and Loss Terms

• Breakeven: total revenue = total costs– Just getting along

• Profit region: total revenue > total costs– Putting money in the bank

• Loss region: total revenue < total costs– Going into debt

Breakeven ChartsExample 2-2

Ticket priceBus Rental 80.00$ Event Tickets 12.50$ 35.00$ Gas Expense 75.00$ Refreshments 7.50$ Other Fuels 20.00$ Bus Driver 50.00$ Total FC 225.00$ Total VC 20.00$

People Fixed cost Variable cost Total cost Revenue Profit Region0 225.00$ -$ 225.00$ -$ (225.00)$ Loss5 225.00$ 100.00$ 325.00$ 175.00$ (150.00)$ Loss

10 225.00$ 200.00$ 425.00$ 350.00$ (75.00)$ Loss15 225.00$ 300.00$ 525.00$ 525.00$ -$ Breakeven20 225.00$ 400.00$ 625.00$ 700.00$ 75.00$ Profit25 225.00$ 500.00$ 725.00$ 875.00$ 150.00$ Profit30 225.00$ 600.00$ 825.00$ 1,050.00$ 225.00$ Profit35 225.00$ 700.00$ 925.00$ 1,225.00$ 300.00$ Profit40 225.00$ 800.00$ 1,025.00$ 1,400.00$ 375.00$ Profit

Fixed Costs Variable Costs

Profit-loss breakeven chart

$-

$500.00

$1,000.00

$1,500.00

0 5 10 15 20 25 30 35 40

Volume

Co

st

($)

Total cost

Fixed cost

Revenue

Past (Sunk) Costs and Future (Opportunity) Costs

• Sunk cost - money spent due to a past decision. We cannot do anything about these costs.– Purchase price paid for a car two years ago.

• Opportunity cost - a benefit that is foregone by engaging a resource in a chosen activity instead of engaging that same resource in some forgone activity. We make a choice or decision.– Buying lunch instead of gas.

• A distributor of electric pumps bought a lot of pumps three years ago. Technology advanced and the pumps are less desirable to customers. The pumps are steadily getting less valuable.

Which amount is the value at present?

Price when purchased 7,000.00$ Storage costs 1,000.00$ List price when purchased 9,500.00$ Current list price of new pumps 12,000.00$ Amount offered for pumps 2 years ago 5,000.00$ Current price that the pumps could be sold for 3,000.00$

Expense Types

• Recurring expense - anticipated and occur at regular intervals.– Purchasing food, paying rent.

• Non-recurring expense - one-of-a-kind event that occurs at an irregular interval.– Illness, accident, death.

Sometimes we attempt to plan for large non-recurring costs by buying insurance. Paying the periodic insurance premium turns this expense into a recurring cost.

Incremental Costs

• An incremental cost is the difference between the costs of two alternatives.

IncrementalCost Items A B (B-A)Purchase price 10,000.00$ 17,500.00$ 7,500.00$ Installation costs 3,500.00$ 5,000.00$ 1,500.00$ Annual maintenance costs 2,500.00$ 750.00$ (1,750.00)$ Annual utility expenses 1,200.00$ 2,000.00$ 800.00$ Disposal costs after useful life 700.00$ 500.00$ (200.00)$

Model Costs

Example 2-4

Cash vs. Book Costs• Cash costs - movement of money from

one owner to another - also known as a cash flow.– Payment this month on an auto loan.

• Book cost - cost of a past transaction that is recorded in a book.– Down payment recorded in your checkbook

from last years automobile purchase.

• Book Value

Life-cycle Costs

• Life-cycle - all the time from conception to death of a product (process).

• Life-cycle costs - sum total of all the costs incurred during the life cycle.

• Life-cycle costing - designing with an understanding of all the costs associated with a product during it’s life-cycle.

Estimates vary

• Many types

• By project contracting plan– Traditional– Design-construct– Turnkey– Fast-track– Owner’s forces

• By contract type– Lump sum (AKA hard dollar)– Cost plus– Cost reimbursable (fixed fee)– Unit price

• Contractor’s Organization– No sub-contractors– All sub-contractors 

• Labor Force– Union (closed shop)– Non-union (open shop)– Mixed– (Double-breasted)– Local vs. Expat (expatriate)

• Who’s doing the estimate?– Owner– A/E– Contractor– Subcontractor– Government– Consultant

When (what phase)

• Concept• A/E

Components

• 15%, 35%, 65%, 95%• Is the budget fixed?• Cast in concrete

• Contactor’s Bid• Post bid negotiations• Usually non-government• Changes

Non-construction Estimates

Owners estimate of owners expensesContract administration

Insurance

Lost or interrupted work

Permits and fees

Housing and travel

DOT?

A/E estimate of A/E’s expenses

(Contract type)HoursOther expenses

Sub-consultantsSoils

TravelConstruction phase?

InspectionTesting

Engineering Design Estimates

• Selecting materials

Insulation thickness

Heat loss

Fuel expense• Design life• Economic analysis• Careful with “free money”

Never call it that

Contractor’s Estimate

• Project costs– Those that would not occur without the project

• Overhead/Home office/Indirect– Would occur as long as contractor has some

work – stays in business

Types of estimate

• Guess

• Educated guess

• SWAGWith or without lanyap

• Historical, similar project

• Historical, unit prices

• Estimating guides

• Crew size and production rate

WBS, Contractor’s Estimate

• Estimate by tasks• Crews and duration, schedule

– Equipment

• Job Overhead– Job duration, schedule

• HOOH and Profit– Contingency

• Break down into unit prices– More contingency to risky tasks?

Cost Items

• Labor

• Supervision, project office

• Installed Materials and Equipment

• Operating Equipment

• Supplies and Consumables

Operating Equipment– Capital cost– Operation costs– Fuel– Permits– Insurance– Operator?– Mechanics?

Steps in contactor’s estimating process

Preliminary• Get resources to bid the job• Decide if you will bid• Get plans, get on bidders list• Engineer’s estimate reasonable• Broad brush estimate, schedule• Subcontracting strategy• Consider your resources

• Call your bonding company• Do you still want to bid?

 Attend the pre-bid meeting!

Estimate

• Manager allocates work• Be sure subs will bid• Take off major installed equipment

Check delivery timesBarge schedules

Schedule for quoteCheck delivery options, FOB

• Take off quantities• Special matters• Pre-bid fly over• Hire consultants• Do your own borings?

Historical unit prices

• Escalate?

• CPI, ENR– Felix work

Fig. 2: AK Highway CCI vs. Anchorage CPI-U for the period 1974 to 1983 (normalized to 1982-84=100)

405060708090

100110120130140150160

19

74

19

75

19

76

19

77

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78

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19

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19

82

19

83

Dates

AK HighwayCCI

AnchorageCPI

Linear(AnchorageCPI)

Linear (AKHighway CCI)

Average Rate of Inflation 1974-1986: 8.0%

Average Rate of inflation 1974-1986: 8.2%

Fig. 5: Alaska HCCI vs. California HCCI

405060708090

100110120130140150160170180190

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Dates

Alaska Highway CCI

California Highway CCI

Linear (Alaska HighwayCCI)

Linear (California HighwayCCI)

Fig. 6: Alaska HCCI vs. ENR Construction Cost Index

405060708090

100110120130140150160170180190

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

Dates

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

Alaska Highway CCI

ENR Construction CostIndex

Estimating guides

Production rate

See next

Unit Price

Read the front!

Factors

Crew size and production rate

Size crew and supervision

Equipment

All methods

• Is production rate average or high?

• Where do you put you operating factor?

• Read the front!

• Check contract for delays, risk

• Liquidated damages

• Experience with owner, location, etc.

Do you still want to bid??!!

• If so, secure bonding and financing

• Prepare bid documents with prices blank

• Check subs and major suppliers again?• When, to the minute, will they give you the

price?• How?•  • Develop plan for bid delivery.• Communications• Time

Post bid

• Protest?

• Negotiations

• Intelligence?

• When is a deal a deal?

Plan for changes

• Pre-job photos and videos

• Documenting changes

• Know the contract

• Document everything

Ethics

• Never lie, cheat, or participate in any dishonest act• Admit your mistakes forthrightly, if they are

mistakes• More often, just state the facts, without blaming

anyone, yourself included• Don’t “trade on the specifications” unless it is in

writing • Nothing unethical about asking for what you have

coming!• Or demanding, if the situation warrants it.

A little on:Risks and Change Orders

Overhead and Profit

Changes are inevitable

• Differing site conditions• User changes• Design errors

– “Contract documents are an imperfect expression of the design professional’s and owner’s intent for the project.”

• Value engineering• Third parties• Deductive

Pricing Changes

– Unit price within limits– Unit price over limits– T&M or Force Account– Gold book method– FARs

Types

– Directed Change, only argue about money– Constructive change

• Owner directs but feels it is included in the original contract

– Cardinal Change, essentially breach by the owner• Owner mandates work outside the scope• Owner directs multiple or drastic changes so

work is materially different.– Cumulative and Impact

• Usually claim

• “A cumulative impact of change orders occurs when “the issuance of an unreasonable number [or unusual kind] of change orders creates a synergistic disruptive impact such that the total disruption caused by the changes exceed the sum of the disruptive impacts caused by the individual changes when looked at independently.”

Five elements are necessary to provide sufficient burden of proof for a cumulative impact claim

– A significantly large number of change or disruptive events

– The changes or events have an impact on productivity (performance time and efficiency)

– The impact flow from the synergy of the number and scope of changes;

– The contractor was unable at the time of pricing of each change or event or directive to foresee the ripple-type effect of the multiplicity of change and events; and

– The contractor did not knowingly waive the right to assert cumulative impact claims when negotiating changes

Foreseeability

• “This change represents full and complete compensation for all direct costs and time required to perform the work set forth herein, plus the overhead and profit as provided for in the Change clause in this contract. The contractor hereby reserves the right to submit a request for equitable adjustment for all costs resulting form the impact of this change on unchanged contract work. “

Risks to Owner

• Direct Change

• Ignore Change– “Just do what the plans say.”

– Interest– Legal (?)– Contractor refusal

• Risks from T&M

Risks in Change Orders

• All risks belong to owner unless transferred to contractor• Base contract did that and is the reference point

• Delays to public• Unit Time Value• For highways this is the Daily Road-User Cost

– No standard computation– Operating costs plus time delay.

Constructive Changes

No control over, four categories:– Disagreement over meaning of contract

» Owner’s interpretation different, contractor must comply or risk default termination

– Defective specifications» Poor or misleading information

– Constructive acceleration» Owner fails to acknowledge excusable delays

– Failure of owner to cooperate» Other contractors not performing

• T&M– Bear all cost and schedule risks– May be OK for small, separable change

• Will not get rid of DSC risk

Risk to Contractor

• See next• Personnel

– Hunting season• Bonding and HOOH• Market conditions• Schedule• Alaska• Unknowns

– Probability increases with complexity and unfamiliarity.

Disruption Inefficiency due to CO

• Increased frequency of planning and replanning• Loss of efficiency due to interruption, interference,

and lack of availably of tools, labor, and materials to meet changed requirements

• Increase project management and supervision involvement

– Shirt collar• Loss of efficiency due to a ripple impact that is a

direct result of change orders, such as stacking of trades, schedule compression, and out-of-sequence work.

• Difficulty in determining equitable adjustment compensation for parties REF 6

• Estimating Changes– Unit price– Force Account– Forward Price

• Acceleration, Delays, Impacts, etc.– Estimating for Forward Pricing– Critical Path– Other Issues

Profit

• Once job/project costs have been estimated, contractor must add “profit”

• The profit line usually contains– Home office overhead (HOOH)– Contingency– Profit

HOOH

• All costs not directly attributable to job

• AKA “indirects”

Contingency

• This is for the project

• Might be imbedded in cost items– “conservative” vs.– “neat”

• Or be in both places

Profit

• Return on Investment

• What is business worth?– Garage sale– Good will

• Would compare ROI with other, similar, businesses– With similar risks

Standards, Variables

• Divide Costs into

• Labor, which includes burden

• Materials

• Equipment

• Subcontracting

• Field Office Expense

Risk – Variable

Labor, which includes burden

High

Materials Low

Equipment Med

Subcontracting Low

Field Office Expense

Med

Contractor Overhead and Profit Allocation

1 15-25% A+B+C+D

2 8% A+B+C+D+E

3 8% A+B+C+D+E Or

35%-40% A+C greater

4 4-6% A+B+C+D+E Or

10% Total Labor greater

5 15% A+B+C+D+E

6 50% Total Labor

7 8-20% A+B+C+D+E Or

40%-100% Total Labor

8 15% A+B+C+D+E

A=Direct Labor, Excluding Field Office Staff; B=Materials Cost; C=Equipment Cost D=Subcontracting; E=Field Office ExpensesTotal Labor includes all direct and indirect labor

Allowable change order markupsCalifornia Major Owners 1992

Labor

Materials Equipment Bond Subs Labor Burden

1 20 15 15 1 15 Actual

Typical 33 15 15 0 5 29

Several 20 15 15 0 0 29/Actual

In general the markup included field staff and small tools and supplies up to $200. Remarkably, the same percentages were uses if the lump sum was negotiated, or if a force account (time and material) method were used.

Corps / GSA

• Old manual• Uses 15% G&A• Variable profit, 3.6% to 13.2% depending on

risks• Risk factors:

– “Degree of risk”– Relative difficulty– Size (smaller, larger)– Period of performance (longer, larger risk)– Subcontracting (more, smaller risk)

• Profit + G&A = 18.6% to 28.2%

DOT Change Order Profit

• Assumed mix of cost types

• AK 24%

• Colorado 41%

• Florida 17.5%

• Indiana 20.7%

• Ohio 25.7%