Should Cost Modelling: The Path to Positively Revolutionise Construction Cost Estimation in Australia
5 November, 2024
Introduction
Following the aftermath of the pandemic and in the midst of global supply chain disruptions, skilled labour shortages, geopolitical unrest, etc, there is a growing problem looming over Australia’s construction and infrastructure industries: substantial cost overruns and blowouts. While HJA has already touched on a major cause of delays and cost explosions in a previous article – that being the contracting technique utilised for the project’s delivery (traditional fixed-cost contracts vs collaborative contracting structures) – the focus in this case will be on another leading cause of Australian projects consistently exceeding their budgets: the cost estimation method itself. In Australia particularly, we are experiencing what the Grattan Institute describes as the ‘era of megaprojects’ (primarily a consequence of the large influx of public spending on transport, utilities, energy and other infrastructure projects), which are even more susceptible to cost overruns by nature of their increased size and complexity. In fact, according to a report released back in the latter half of 2020, since 2001, almost half of all publicly-owned road and rail projects with an initial cost estimation of more than AUD$1 billion in today’s dollars (equivalent) experienced a cost overrun, and on average, exceeded their initial proposed cost by 30%. That is, since 2001 it has been found that Australian governments paid an additional AUD$34 billion (or 21%) more on major transport infrastructure projects than what was initially estimated and budgeted for (Moran, 2020). Consequently, there is a clear disparity between estimated costs and actual outturn costs across Australia’s infrastructure and construction sectors (especially for public works). With this in mind, let us move to the primary focus of this article: improving the method of cost estimation used for major Government projects, and how with the advice of HJA’s expert transaction management practitioners, industry professionals can significantly reduce delays, re-designs and re-costings across a project’s life, together driving down total costs and greatly improving efficiency.
Traditional Cost Estimation: The Bottom-Up/‘Design Pricing’ Approach
The traditional cost estimation method used across Australia to deliver major projects can aptly be described as ‘bottom-up cost estimation’, based on a pricing analysis of the proposed design, typically completed by the Contractor (with the help of industry experts). In this way, the goal of this particular method is to establish how much the project will cost as a direct outcome of the design and based on the estimator’s experience (which tends to turn into a ‘scope-based competition’ between prospective Contractors, where the lowest cost estimates are viewed as more favourable by project Owners). Often, once the initial bottom-up cost estimate is obtained, a ‘value engineering exercise’ is then conducted to ensure that the cost estimate aligns with/matches the Owner’s (in many cases, a Government client) pre-determined development budget. This is an iterative, reactive process which necessitates a cycle of re-design procedures and reactionary cost estimate revisions, leading to significant time and cost overruns. Ultimately, the bottom-up, ‘design pricing’ approach presents significant barriers to improved productivity and efficiency, as well as notably reduces Value for Money in that the nature of scope-based competition generally produces cost estimates that tend to be unrealistic/unattainable representations of good value. Furthermore, many argue that this approach fails to utilise the expertise of the wider supply chain while also placing overly onerous expectations on Contractors (particularly in terms of the cost estimation process). It is further claimed that ‘design pricing’ information is backward-looking, frequently delivered too late or distorted to some degree, and therefore cannot be used inform effective project planning and control (ICCPM, 2014). So, does an alternative cost estimation tool exist that can improve productivity, efficiency and ultimately, lower actual outturn costs? HJA strongly believes the answer is yes, and one must look no further than Should Cost Modelling.
A Brighter Alternative: Should Cost Modelling, The Top-Down Approach
Should Cost analysis was first popularised and implemented for use in infrastructure projects in the United Kingdom, coinciding with the release of the UK Construction Playbook and its accompanying documentation (Should Cost Modelling Development Guidance Booklet and the Should Cost Modelling Guidance Note). With a number of HJA’s experts having worked in the UK during the early stages of Should Cost’s implementation, in addition to HJA recently advising some major Australian infrastructure clients with regards to the utilisation of Should Cost Analysis, we are exceptionally well-versed in the area, offering many valuable insights. The driving principle behind Should Cost Modelling is to accurately forecast what a programme or project ‘should cost’ over the course of its entire life, which includes both the build phase costs (encompassing Owner/Client costs arising from the initial design) as well as the operations phase costs (relates to the expected design life and any ongoing costs arising from effective project delivery) (United Kingdom Cabinet Office, 2021). Importantly, this acknowledges the costs of additional market factors that go beyond initial project design alone such as profit and risk, and provides a more comprehensive analysis of whole-of-life costs including uncertainty and opportunities relating to schedule, ideal delivery model, sustainability and maximising Value for Money, instead of considering just the ‘initial purchase price’. Should Cost Modelling seeks to maximise value by identifying desired performance and functionality cost-criteria through collaboration between engineers, Contractors, Owners and the wider supply chain, in order to further establish ‘success factors’ relating to resource allocation and budgets. Critically, these factors and cost criterion are then used to INFORM the delivery mode and project design, as an alternative to cost intelligence gathered in RESPONSE TO the design outcomes (the ‘bottom-up’ approach) (United Kingdom Cabinet Office, 2021). As a result, the goal of Should Cost Modelling is to create a financial/analytical model that provides ‘real-time cost information’ throughout the entire design development process, which aims to circumvent a primary issue with the bottom-up method: where limited cost intelligence leads to unrealistic budgets and cost/time overruns arising from delays and frequent programme re-designs.
Within Should Cost analysis, cost information and the model itself are typically informed by:
Historical ‘actual cost’ data (which encapsulates risk) and other relevant benchmark data;
Requires access to actual cost datasets from previous or current projects (internal or external – that is, Client/Owner data OR third-party/market/competitor data), which is then used to establish benchmarks for program baselines and commercial thresholds. Benchmarking refers to the collection and analysis of information from past or similar-ongoing programmes and projects to be used as comparators in the process of creating ‘data reference points’. This establishes ‘recognised benchmark costs’ (in other words, valid price comparisons) at each major stage of a large-scale infrastructure project, which can then be modelled to forecast and inform whole-of-life costs
Targeted, integrated ‘bottom-up’ estimates.
When sourcing internal and external cost records/data proves difficult, the initial cost estimation can be partially informed by targeted, specific bottom up estimating, only when necessary.
A primary benefit of the Should Cost Modelling approach is that it allows for the establishment of meaningful and realistic ‘program baselines’ based on historical actual cost/benchmark data. This is a ‘top-down’ process whereby the total whole-of-life cost of the project outcome is considered, extending far beyond initial design costs to encapsulate Owner/Client, supply-chain input and ongoing operations costs (along with the potential costs of any likely additional outcomes/adjustments). The program baselines represent a translation of the Should Cost Model forecasts into what is known as an ‘affordability envelope’ for the project, which is essentially a cost threshold within which the required outcomes of the project should be delivered. In this way, the baselines set clear expectations with regards to Value for Money and success criteria, and are therefore used to create the project’s commercial delivery strategy and Business Plan (such as whether the works should be split by work type or geography, whether a phased/staged delivery approach should be adopted, and the most effective contracting strategy). These affordability baselines are also used to inform the project design, and by nature of Should Cost Modelling, may be adjusted as the design process unfolds in light of additional data being collected/outcomes being revised or improved. The baselines can further be implemented to incentivise partners and engage with the capabilities of the wider supply-chain. For example, commercial agreements that allow partners to earn a return if they deliver the project outcomes within the modelled affordability envelope (determined by the historic baselines) can and should be created. This aligns exceptionally well with the emerging national trend of collaborative contracting, which is frequently being implemented by Government-Owners in the delivery of major public works across Australia.
How to Effectively Develop and Implement a Should Cost Model
The below step-by-step process to develop a continuously evolving Should Cost Model is a very broad overview that merely scratches the surface with regards to the insights HJA has to offer in this area. For much further detail, practical advice and direct implementation assistance, please contact HJA to get in touch with one of our Should Cost experts.
Step 1. Begin by identifying the key outcome goals, deliverables and all major stakeholders.
Frame how the SCM will be developed by establishing the primary ‘customer outcomes’ along with the relevant metrics and measurements. Ensure that the key stakeholders are accurately determined, and that roles and responsibilities are clearly set.
Step 2. Building on the foundations created in step 1, start capturing and identifying the wide range of cost components for the project that will be included in the model. This could encapsulate:
Design and build costs
Operation and maintenance costs throughout the design life of the project
Costs with regards to wider business aspects such as overheads, indexation/price adjustments, management fees and profit
Broader socioeconomic factors such as social value and environmental impact
Economic benefits (which includes cost savings as well as non-monetary benefits such as carbon abatement potential and other positive externalities)
Step 3. The cost (and benefit) components to be included in the model provides clear guidance on the type of input data that is required. Focusing on data sourcing, quality and availability at the planning stages of model development is crucial.
Common sources of Should Cost input data are:
Client/Owner Data – cost data that has been generated in the past by the Owner itself in the delivery of previous projects or programmes.
Market Data – data that is available from business partners and across the wider supply chain more generally.
Comparable Company Data – cost data retrieved from similar major-infrastructure project Owners, typically within the same industrial sector.
Private Data – historical cost data that may be purchased from third-party cost benchmarking firms or cost consultants.
Step 4. The next step is to actually create the model, which requires specifying the modelling techniques and statistical tools to be used.
For Should Cost analysis, as identified previously, the ‘top-down’ approach (statistical, parametric analysis based on past/comparable data) is to be employed as the primary modelling technique, ensuring that risk and uncertainty is adequately accounted for.
The appropriate modelling tools should be determined subject to the volume of data, and may include Microsoft Excel or more specialist software such as statistical database programmes (Stata, Python, R).
Step 5. Building on the previous step, sensitivity analysis and scenario testing should then be conducted.
The initial ‘top-down’ forecast generated by the Should Cost Model must be reviewed, engaged with and actively improved on a regular basis through the use of sensitivity analysis. Testing different cost component and project design scenarios, along with relevant variable sensitivities (changes in the amount of material required for a certain part of the works for example) should be run to address uncertainty and risk, as well as develop an acute understanding of key cost drivers.
Step 6. The final step is to develop a Quality Assurance Plan to ensure the model is evolving and continuously improving as the project’s design process is finalised and delivery commences.
This involves establishing check-in dates and meetings to:
Monitor the model’s performance (that is, the cost intelligence it provides) by ensuring it lines up with the project’s design and delivery strategy, and consistently provides achievable/realistic project baselines (affordability envelopes).
Continuously enhance the model by further developing and sourcing cost information (data).
Engage the wider market and supply chain with regards to specific cost components, past performance and opportunities for improvement.
Any and all additional data and cost information should be actively included in the existing model to enhance, mature and evolve it as time progresses (ensures adaptability).
Executive Summary/Conclusion
In summary, the utilisation of Should Cost analysis involves a significant change in mindset: there needs be a move away from the traditional post-design, bottom-up cost estimation method towards the emerging Should Cost Modelling technique. A Should Cost Model is a continuous ‘design and development steering’ tool that informs more realistic Client budgets by providing a clear understanding of the whole-of-life costs and risks associated with a wide variety of project structures/options. Should Cost Modelling adjusts for uncertainty, adapts to ongoing change throughout the design process, as well as encourages interactive collaboration between partners, systematic data collection and sharing, and increased efficiency/productivity across the project’s delivery. Although, as is often seen, companies can be opposed to change, and in practice, implementing Should Cost analysis can be difficult as infrastructure Clients may feel as though their traditional bottom-up cost estimation team is being criticised or dismissed. Thus, it is important to prepare for and mitigate the negative fallout of this possibility.
The advantages over bottom-up methods are clear, especially as it relates to Government-funded infrastructure: Should Cost Modelling provides a far more comprehensive understanding of different delivery models and design options, which reduces the need for re-designing and re-programming (less delays and overruns); adopts a whole-of-life cost perspective that goes well beyond ‘design pricing’ techniques, allowing for more realistic representations of good value and total outturn costs; commercially incentivises project-best-practice from the private sector and wider supply chain; clearly defines commercial thresholds and affordability envelopes that will evolve as the project design develops; and ultimately, ensures that whole-of-life cost analysis is the key determinant of the project’s scope, design and procurement strategy (and not reactive to these aspects after-the-fact). This in turn guarantees that Government Owners do not succumb to the ‘low-cost bid bias’, or tendency to simply favour the lowest-cost, yet highly limited design pricing bid during the tendering process, which is frequently a clear underestimation of total project costs. Combined with less than optimal contract structures, this is very often what leads to projects being bogged down in lengthy cost recovery disputes and contributes to the cultivation of a ‘blame-game’ culture across the construction industry.
While project cost blowouts have essentially become the norm in Australia, especially with regards to publicly-funded infrastructure, this doesn’t have to be the ongoing reality. HJA’s Should Cost experts possess the key to revolutionising the cost estimation process, which translates to more accurate budgeting, less delays and ultimately, delivering on the Government’s assurances to Australian taxpayers. In light of Brisbane 2032, a spiralling housing crisis that calls for a drastic uptake in home building, and a preserving practice of large public spending on major infrastructure works across the nation, the federal and state governments are in desperate need of positive change with regards to improving project productivity and reducing construction costs and delays. HJA has the answer, and emerges as a clear advisory leader in the future of accurate, efficient, Should Cost estimation.
References
Australian Constructors Association (2022). Should Cost - why it unlocks a more effective way to deliver. [online] Constructors.com.au. Available at: https://www.constructors.com.au/should-cost-why-it-unlocks-a-more-effective-way-to-deliver/ [Accessed 28 Oct. 2024].
International Centre for Complex Project Management (ICCPM) (2014). Submission for the Australian Government’s Productivity Commission Public Inquiry into Public Infrastructure. [online] Australian Government: Productivity Commission, pp.6–29. Available at: https://www.pc.gov.au/inquiries/completed/infrastructure/submissions/submissions-test/submission-counter/sub105-infrastructure.pdf [Accessed 28 Oct. 2024].
Moran, G. (2020). $34b and counting: beware cost overruns in an era of megaprojects. [online] Grattan Institute. Available at: https://grattan.edu.au/news/34b-and-counting-beware-cost-overruns-in-an-era-of-megaprojects/ [Accessed 28 Oct. 2024].
United Kingdom Cabinet Office (2021a). SHOULD COST MODELLING DEVELOPMENT GUIDANCE. [online] pp.3–50. Available at: https://assets.publishing.service.gov.uk/media/60a4ef7dd3bf7f28855b901f/SCM_Development_Guidance_V1_May_2021.pdf [Accessed 28 Oct. 2024].
United Kingdom Cabinet Office (2021b). SHOULD COST MODELLING GUIDANCE NOTE. [online] pp.2–22. Available at: https://assets.publishing.service.gov.uk/media/60a3879f8fa8f56a32f91cfd/Should_Cost_Modelling_guidance_note_May_2021.pdf [Accessed 28 Oct. 2024].
United Kingdom Cabinet Office (2022). THE CONSTRUCTION PLAYBOOK: Government Guidance on sourcing and contracting public works projects and programmes. [online] pp.1–84. Available at: https://assets.publishing.service.gov.uk/media/6312222de90e075880923330/14.116_CO_Construction_Playbook_Web.pdf [Accessed 28 Oct. 2024].
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