Risk Management for Construction Dr. Robert A. Perkins, PE Civil and Environmental Engineering University of Alaska Fairbanks
Jan 20, 2016
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
19
78
19
79
19
80
19
81
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%