Sponsored: Infrastructure projects: Being on the lookout for cost overruns


Sponsored: Infrastructure projects: Being on the lookout for cost overruns
A render of the exquisitely designed Riverbank Apartments living room. PHOTO| COURTESY

“48 percent of projects were over budget and 87 percent of projects have a time overrun.” – Deloitte East Africa [1]

It’s all fine and dandy when you have a great business case for your infrastructure project and you go ahead and hit the ground running. In most cases, as best practices demand, one will have an approved budget from which costs will be paid out.

This budget is based on the business case that gave life to the project or in the case of non-profit organization or government agencies the budgetary or grant allocations.

“The report, which looked at Africa construction trends in the past year, said 87 per cent of all Kenyan public projects suffered time delays while 48 per cent overshot their budgets creating a loophole for corruption to thrive.” – Daily Nation [2]

It has nowadays become common place to find infrastructure project exceeding the existing allocations and the developers having to seek additional funding to successfully close on the projects. This without a doubt negatively impacts the return objectives of undertaking the infrastructure projects originally envisioned.

There will be some common themes in the proposed remedies such as continuous review of the business case at every stage (a theme championed by Prince 2 project management approach) and the use of either management reserves (a reserve used to address unknown unknowns) or contingency reserves (a reserve used to address known unknowns) anchored on the PMI approach to project management.

This article is meant to be easy to understand and has a clear aim of getting the conversation on cost overruns among property developers and real estate stakeholders going.

This may not be an exhaustive list of all factors that contribute to cost overruns but certainly includes some of the most common ones.

THE USUAL SUSPECTS

a. Delays in project commencement

If the time taken between crafting of the business case and the time works commence on the ground is significantly long, it usually has a negative impact on the anticipated project budget and intended project return as set out in the business case.

Inflation is normally the biggest driver of these changes. Cost of materials, labour and many other major components go up over time. For instance, price changes in crude oil prices creates a significant impact on the prices of infrastructure projects such as road since there is a close correlation of crude oil prices with bitumen prices.

Transportation costs are also affected due to price changes in refined petroleum products.

When project commencement is significantly delayed it is always important to review the existing prices/rates and determine their applicability to the present scenario. Where vast differences are noticeable, then the business case should always be updated to give the developer/funder a very clear perspective of what to expect.

Best practice demands that, the business case, funding, design and implementation is done within reasonable timelines that will not significantly alter the validity of the envisioned costs that made the project feasible in the first place. But since this is not always the case, and substantial time has passed, it’s always best practice to revise the business case and adapt it to the prevailing market conditions.

b. Delays in Project Implementation

Certain aspects of a project i.e scope, time, quality and costs have an interlinked relationship such that a variation in one aspect has a knock-on effect on at least one other aspect of the project.

Delays in project implementation usually have a cost implication, ranging from extension of preliminary costs, exposure to possible penalties from end clients/users, additional financing charges such as interest on debt etc

To remedy these scenarios interventions such as fixed price contracts, penalty clauses e.t.c can to be put in place such as

c. Changes in Legislation and/or Policy.

This happens to cut across all sectors of the economy and infrastructure projects are no exception. The government policy making organs, may from time to time, either through set cyclical periods or through ad hoc sessions, review and adjust existing rates, tighten or loosen the compliance measures put in place, add to or deduct players and/or stages from the compliance process.

These changes may negatively impact project costs. To mitigate against the impact of these kinds of change in legislation/policy is to have a contingency reserve in the budget to cater for the cyclical changes as they are predictable when they happen. For the

d. Changes in wages (Minimum Wage)/Consulting Costs

Periodically, in some economies, there will be a review in the minimum wages and from time to time, professional bodies may also review the fees charged for services rendered. For most jurisdictions the period of effecting these changes can be determined but the nature and extent of the change is almost impossible to determine.

To mitigate against the impact of these kinds of change provisions in the budget (contingency reserves) may come in handy that allow you to accommodate these changes. From a developer’s perspective, a fixed price contract with the contractor substantially eliminates the headache.

e. Few Market Players and Inadequate Competition

In some specialist practices, where you have very few players, the industry can take on cartel like behavior where specific players dictate the prices. Ordinarily, in a competitive market, costs estimates given by the costing expert should track the market, or even yield a saving attributable to competition amongst many industry players, but where you have few players, prices tend to go higher as the players aim to maximize their profits.

Interesting enough in instances where you have many industry players and many ongoing projects such that for a majority most of their spare capacity is taken up, prices tend to also go up. This is because for the contractors to take up additional works, they must beef up their capacity and this tends to come at an extra cost.

This is difficult to remedy as it requires intervention at a macro level. A good way to resolve this in a free market, is reduce the barriers of entry into the market for players who address the envisioned gaps. Competition is a good driver for better quality and lower prices.

f. Never Ending Design Process

A never-ending design process leaves the project susceptible to introduction of new ideas that may end up pushing the project costs upwards. This often happens where a design freeze point has not been agreed on by the relevant players.

Peculiarly, this is a process that cuts both ways in the sense that it could lead to cost cutting measures or on the flip side “gold plating”, where costs end up going higher without being functionally beneficial to the project but take on a form appeal.

g. Overdesign and Over-provisioning.

In most cases, designers/consultants like to give allowance or tolerances to accommodate unaccounted for factors or for future proofing purposes. This is ordinarily acceptable; however, you may find that the redundancy measures put in place, may end up being done in the extreme and this often causes huge cost overruns.

To remedy this, it’s always advisable to engage a third party, of equal or greater standing and experience, to conduct a peer review. Peer reviews assist in thoroughly interrogating the designs and giving an alternate perspective to the solution provided and this may greatly cut down on costs.

h. Necessary/Compulsory Acquisition of Land

This in most instances affects government driven projects, but nevertheless affects private developers where say, they need to improve value of the land through better access and this can only be achieved through acquiring adjacent property.

In instances where one must acquire land through compulsory acquisition (government) or a willing buyer, willing seller scenario (private sector) the infrastructure costs may go up as the acquiring party is at the mercy of the selling party, and where government compulsory acquisition is applicable, the process can be prone to abuse and corruption. This is generally resolved with a contingency reserve as this is easy to envision.

i. Works for Public Benefit

For private developers, there may be certain works that are undertaken that may not have been initially envisioned but need to be done for the benefit of the general populace and the developer will have no claim to these works/assets. These works serve to facilitate, the overall experience of the intended consumer. Key examples in these situations are road improvement works, doing footbridges and bus stops, doing street lighting and drainage works, landscaping works etc.

Ordinarily these works are carried out by the relevant government authority, but if they do not have these works in their priority list and do not envision carrying out these works soon, the developers may end up picking the tab on this one. these works can be accommodated in the contingency reserves.

2. THOSE THAT SNEAK UP ON YOU

a. Forex Fluctuation
This is a difficult one to tell with reasonable certainty especially where you are importing plant and equipment (in most instances for Utility Projects – Power, Water, Gas, ICT e.t.c). This is primarily because of changes in the markets where the procuring currency performs poorly against the quoted currency.

There are contractual remedies set out to mitigate and/or reduce these impact for developers, but these mitigation measures can only be to a certain extent. Management reserves serve to remedy these kinds of unknowns.

b. Existing Ground Conditions

In some instances, you may find that the assumptions you made with respect to sub surface works are incorrect. This forces you to carry out additional works that may not have been captured in the business case.

For larger projects this can be remedied by conducting comprehensive geotechnical, hydrogeological surveys et al, that comprehensively inform on the works that require to be carried out. This will ordinarily be budgeted for as they are a huge expense. But for lower budget projects, this may not be the case.

In other instances (though not common in this market) addressing archeology issues and sites of historical importance may force changes to the project that may adversely affect the project budgets.

This can be mitigated by ensuring thorough risk management is carried out and continuous stakeholder engagement is done. Management reserves come in handy where the risk was an unknown unknown. If the costs escalation is too high, the business case must be reviewed to assess viability going forward. Where compensation by authorities is applicable, this can be of reprieve to the developer behind the infrastructure costs.

c. Mis-Interpretation of Applicable taxes.

Where an expert on matters taxation is not consulted during the procurement budgeting process (procurement of consultants, contractors, materials etc) then there is the risk of misinterpretation looms large and may lead to errors of commission or omission.

An apt example within the local context is, professional fees attract a VAT charge if the professionals are VAT registered in the country and if they are not (foreign consultants) their fees attract a Withholding tax charge. The former in most instances is taken care of but the latter slips through the cracks quite often.

There are possibly several other contributors to cost overruns and the conversations on the same need to keep on going as they efficiently and effectively facilitate the growth of the real estate industry.

Article Written by:
Michael Thiriku, – PMP, Prince 2
Centum Real Estate

Citations:
https://www.trademarkea.com/news/13pc-of-infrastructure-projects-in-kenya-are-completed-on-time-deloitte-report/

https://www.nation.co.ke/lifestyle/smartcompany/Project-delays-costing-billions–warns-Deloitte/1226-4575072-bwvoesz/index.html

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