Why Do Mega Projects Continue to Experience Cost Blowouts?
Recent Australian mega-projects have experienced significant cost overruns for a variety of reasons, with one of the most prevalent being unsuitable procurement methods.
Of particular interest here is fixed-price lump sum contracts that fail to accommodate project complexities and risks, highlighting the need for probabilistic cost estimation approaches better suited to large, evolving projects.
Mega Project Cost Blowouts
Several high-profile mega-projects have seen large cost blow-outs recently, seeing the costs double. A particular ongoing project was procured on a fixed price, lump sum contract. The project encountered several delays, primarily ground conditions that summarily saw works cease until a settlement agreement was reached.
Another mega-project encountered major setbacks, such as a contractor collapse, rising costs, and delays, prompting a switch to a cost-plus-margin contract, seeing the estimated total cost price double the fixed-price estimate.
Why the Huge Variance?
Several reasons are cited, including rising material costs and the shortage of construction personnel. However, the key issues are that the form of procurement did not suit the project, and the pricing was incorrect.
The Lump Sum Contract
Using a lump-sum D&C contract, where the project cost is agreed upfront, often sets mega project teams at cross purposes. Though appealing to financiers, this approach encourages intense price competition, as the lowest bid is generally the winning bid.
The bigger the project, the greater the number of stakeholders, which requires more interfaces and coordination. Owners and stakeholders require contractors to work collaboratively, but when engaged under a lump sum contract, each contractor tries to avoid coordination tasks outside their defined scope, since extra effort reduces their profit.
For the contractor awarded the contract, the next phase often involves seeking methods to adjust the price and minimise responsibility for potential issues. The concept of “cost certainty” in a fixed-price contract paradoxically increases the possibility of cost overruns, as contractors aim to maintain their margins, while owners and other stakeholders try to allocate more risk to the contractors.
The owner and contractor have a conflict of interest. Risk should be allocated to the party best able to manage the risk. In design and construct lump-sum contracts, contractors are frequently assigned the responsibility of managing risks that are beyond their control. If the contractor prices the assigned risk, its tendered price will be uncompetitive.
This pricing strategy is unsuitable for mega-projects, particularly when design development is still in its initial phases and project scope remains subject to significant changes. Only one in ten mega-projects are delivered in budget. To achieve optimal outcomes on projects of this magnitude, it is essential to examine and implement the latest best practices supported by emerging evidence.
Deterministic and Probabilistic Cost Estimation
Deterministic methods in quantity surveying estimate construction costs by measuring quantities, applying rates, and calculating overheads. These methods are based on fixed inputs and outputs, which may not always represent actual project conditions. They are best suited to mature designs in lump sum contracts, as they may not fully account for the uncertainties encountered in Design & Construct projects.
In contrast, the probabilistic method of cost estimation uses historical data to consider uncertainty and provide a range of possible outcomes. Instead of a single value, this approach evaluates the likelihood of various cost and program scenarios, supporting informed decision-making.
The probabilistic methodology is better suited to Design & Construct mega-projects.
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