Professional general contractors recognize the need for precise cost estimates for planning and operational success. For ages, market forces have determined construction costs such as labor, materials, insurance, and fees. This reality is changing, though, as project complexity and technology capabilities increase. In the near future, cost estimates will be shaped by the requirement to both comprehend and quantify risk when undertaking complicated projects.
It is reasonable to state that cost overruns have become typical in the construction sector. According to a KPMG survey, only a 31percent of all construction projects performed in the last 3 years were completed within 10percent of their original budget. There are numerous examples of this pattern. For example, a recent public works project in Florida that began with a $91 million budget quickly ballooned to a far larger undertaking. Costs escalated by 53percent in order for the project’s engineering firm to effectively finish the required work.
Estimators Must Look at Risks Differently
The overall budget for typical projects is based on the multiple cost estimates offered by subcontractors and vendors. The industry standard has been to prequalify these subcontractors in parallel to determine their skills and capacity to do certain kinds of work. But, as the project reaches the bidding stage, there is a divide. General contractors may set bids only on the cost of labor, materials, and overhead (such as insurance and management fees), despite having calculated risks upfront. Extra costs incurred as a result of a subcontractor’s or vendor’s risk profile are kept out of the cost estimate equation when putting up bids in this manner.
This pattern of behavior appears logical, particularly considering how project-scope intense the bidding process can be, with the razor-thin margins and levels of planning that go into each project. But, new technological solutions can make it easier for estimators to account for the cost of subcontractor and vendor risk throughout the bidding process, allowing them to see when the lowest bidder isn’t always the best or even the cheapest alternative. General contractors can select the best potential crew for the project and add risk-adjusted costs into their estimates, rendering them more exact, by evaluating project-specific risks for subcontractors and suppliers.
How Does It Work?
Since they account for both the likelihood of an event occurring and the potential cost implications of those events, risk-adjusted costs quantify uncertainties and result in more correct estimates. The most common example of risk-adjusted cost is when a subcontractor’s prequalification reveals financial difficulties, prompting the general contractor to implement risk mitigation measures like asset waivers or joint checks. These tools are useful, but they add administrative expenses to the subcontractor’s estimate. A general contractor must consider these costs in the budget leveling phase rather than incurring them after setting the budget.
Furthermore, suppose a subcontractor chosen for a project lacks considerable experience with that work area. In that case, the general contractor may need to add expenses for additional field oversight to avoid a quality issue. This cost is quantifiable (general contractors can utilize a known supervision labor rate and hours required) and should be included in the budget when necessary.
Uncertainty can also be measured using risk-adjusted costs. What is the likelihood of an issue arising, and how can a general contractor budget for it so that alternatives may be put in place to ensure the project is completed? What are the possibilities that snow will cause the project to be delayed, and how will this affect the budget? With the advancement of technology, it is possible to envision a future in which general contractors can quickly comprehend the likelihood and impact of certain risks and add risk costs into their quotes.
Why Is Risk-Adjusted Cost the Future?
If a general contractor’s prequalification and bidding management tools align, obtaining risk-adjusted cost estimates based on subcontractor data is now possible. First, the risks associated with a subcontractor are outlined and paired to mitigation strategies within prequalification software. These specifications are then automatically passed on to estimators in their bid management platform, who factor the cost of the mitigation tactic into bid leveling.
Nevertheless, obtaining a more complex risk-adjusted cost estimate based on uncertainty will necessitate a collaborative effort that goes beyond prequalification and bid management tools. Risk-adjusted cost necessitates the integration of numerous tools, including enterprise resource planning, accounting systems, and on-site technology. To accomplish this, prequalification tools must be linked to the various phases of construction. They must collect data from accounting platforms as well as from the field in order to quantify the impact of specific risks.
On the worksite, there is already technology in place that assesses the possibility of specific risks. Looking at weather conditions with timetables, for example, can help predict possible future risks. When this information is fed back into the prequalification system, general contractors might look at a subcontractor’s application from a better perspective. When changing estimates in the future, the estimator will have predictive estimates for the cost of risk.
General contractors may now plan for cost-impacting possibilities early in the project life cycle using smart digital solutions to predict and reveal risk indicators. As the sector adopts more technology and better integration between tools enables connected construction between project phases, a risk-adjusted cost estimating approach will enable general contractors to unearth an even broader range of risk factors, ensuring project success time after time.
Conclusion
Each construction project has a variety of uncertainties, and as projects become more complicated, the uncertainties and risks increase. Many major organizations already use risk-adjusted cost estimating approaches. Still, all general contractors could benefit from better defining and assessing risks earlier in the process to close the gap between budget and actual costs. Contractors might use the identified risk costs as the first benchmark for bids estimation. Because of the low rate of return, the results cannot be considered universally valid and must be backed up by more data. Nonetheless, the findings may aid in determining the amount of risks costs based on factors such as market situations, company-specific risk disposition, and strategic considerations.
