Cost Estimating & Value Management – Best Value & Liability

By Stuart Sokoloff, PE

Introduction

Each of the many issues discussed could each stand alone as the subject of a detailed paper. Therefore, issues are presented as a basis of future evaluations as they are not rigorous.

There are often claims of cost “savings” achieved by a Value Engineering Study. This article discusses the significance and limitations of cost estimates prepared during the VE study. Throughout this paper the term ‘Design Estimator’ refers to the estimator for the entity providing the design, and ‘Value Estimator’ refers to the estimator participating in the value study. Also, the terms Value Management (VM) and Value Engineering (VE) are used interchangeably. Discussions of ‘Risk’ apply to ‘negative risk’, whereas as ‘positive’ risk is just good luck.

Cost Estimating & Best Value

The name used to designate the future cost of a construction project speaks volumes: “Construction Estimate”. The estimate is an evaluation of cost during preparation of the design and includes the quantity and unit cost of items. The Design Estimator and Value Estimator each base their estimates on in-progress design documents, as opposed to the Contractor who bases its bid estimate on final, and not in-progress, contract documents.

‘Best Value’ is defined as Performance (Function) divided by Cost:

V=P(F)/$ (resources)

Therefore, cost is one of two inherent elements to identify ‘Best Value’ as the goal of the Value Engineering Study. In effect, the VE Study is bifurcated into a technical evaluation of the performance (Function) of various elements and the cost associated with each of these elements.

The Cost of any Construction Project

‘Actual’ costs are actual monetary expenditures whether current or future. Estimated costs quantify anticipated future expenditures which may or may not be realized. The most significant aspect of an in-progress design estimate prepared by either the Design Estimator or the Value Estimator is to indicate/guesstimate the budget associated with a project’s scope of work so the Owner can provide adequate funding.

The cost of any project from a budget perspective is The Lowest Responsive Bid Submitted by A Viable Contractor. Construction costs associated with unforeseen conditions, delays and contract extras (scope creep) are future issues and cannot be known during the in-progress design or bidding efforts.

The Contractor is not concerned with Life Cycle/Future Costs beyond the relatively short post construction warranty period, but rather with initial construction costs for most types of procurement such as Design-Bid-Build & Design-Build. The exception is for Design-Build-Operate & Maintain projects (DBOM) where Life Cycle costing is of major concern. Life Cycle (operating) costs can be greater than initial construction cost.

There is a distinction between projects whose costs are under estimated and projects that exceed their estimated budgets (cost over-run). The possible causes could include:

• Estimate is too low (inaccurate quantities or prices)
• Difficult to construct designs
• Owner control of the design
• Poor construction management
• Scope creep
• Aggressive/unrealistic schedules
• Unanticipated increase in the cost of materials
• Unforeseen conditions

Examples of projects whose actual costs have significantly exceeded their budgets include:

• Boston Central Artery (Boston)
• MBTA Green Line (Boston)
• East Side Access (New York City)
• Silver Line Dulles Extension (Virginia)
• California High Speed Rail (California)
• Veterans Affairs Hospital (Colorado)

Contractor Bid Cost Estimates

The contractor’s estimate is based upon a fully developed design as presented by the contract documents (drawings, specifications, general and special conditions). The contractor then evaluates anticipated quantities (take-offs); the cost to purchase, deliver and install the item; the equipment needed; and any other issues that impact upon intended operations. The contractor’s estimate with reflect risk allowances transferred to the contractor.

Duration/Manpower of a Contractor’s Estimate

The contractor performs the above analysis for each item (permanent or temporary) to complete the work. For a $100 million project a contractor would typically have two or three take-off engineers determining quantities and two construction estimators analyzing the project over 3-4 weeks to prepare the bid estimate. Alternatively, contractors usually maintain their own historical cost database of similar projects.

In-Progress Design & VE Estimates

Most VE Studies take place between 10% (scoping) and 50% design completion with the majority between 30-35%. At this early stage of the design, major design concepts have been developed but are not complete, and some items are yet to be addressed such that many item quantities are not yet determined and uncertainty remains. The design estimate is an in-progress/incomplete evaluation of cost for the items of work anticipated which typically carries allowances and contingencies to address unknowns.

The Design Estimator addresses all items of work whereas the Value Estimator is only concerned with those major cost items identified as value target during the VE Study. On the other hand, the VE Estimator could have multiple Alternative Ideas for a single item to cost.

Estimate Accuracy: Contingency, Probability & Risk

From a cost perspective, the incompleteness/uncertainty/risk of the in-progress design is addressed by applying allowances and a contingency factor. The contingency factor is typically as high as 25% or more at an early stage of design and is eventually decreased as the concept design is further developed, and even abandoned at 100% design completion. As an example, a $100 million estimate is increased to $125 million because the Design Estimator is constrained to work off incomplete drawings.

Risk can be defined as the chance of occurrence of an event (negative or positive), although positive risk is really ‘good luck’. There are probabilistic methods to address negative risk in lieu of applying a contingency factor. These mathematical methods address uncertainty in costing that is quantified as a probability distribution over a range of costs constrained by confidence limits (i.e. Bounds). Probability applications can either be applied project wide or to individual items. Project wide application might include weather impacts, labor disruptions, an increase in the cost of materials, etc. Specific item applications might include an ‘uh-oh’: a mistake or an event such as: the front of the building is in the back; the bridge is in the wrong place; the concrete is below strength; we ran out of backfill, etc.

It is unlikely that either the Design Estimator or the Value Estimator will have the knowledge or experience to apply such an approach. Almost certainly there is insufficient time during a VE Study as usually structured to perform such a rigorous analysis.

If the Value Engineer does perform such a rigorous and probabilistic analysis and decides to change a unit cost(s), then the VE Estimator and the entire VE Team will have adopted liability for its accuracy and any future negative outcomes that may come to pass.

Cost Avoidance

There are indeed VE alternative ideas that offer verifiable cost avoidance while maintaining project performance. The writer prefers the term ‘cost avoidance’ as opposed to ‘cost savings’ or ‘cost reduction’ since the actual cost associated with most items during the VE Study is guesstimated.

Examples of quantifiable cost avoidance alternative ideas in achieving best value include:

• Highway realignments to avoid right of way acquisition or other obstacles
• Alternative super-structure type (example: simple multiple span bridge versus a cable stay bridge)
• Alternative foundation types (example: structure on grade versus piling)
• Scope reduction (if Performance is not compromised)
• Reduce the size of over-designed elements, etc.

Estimate Comparison: Design Estimator, Value Estimator & Contractor

Contractors perform specific estimating calculations or use their own cost database based on a 100% complete design. The Design Estimator will typically not perform specific cost calculations, and even if so attempted, he could not know what specific equipment will be used by a contractor, whether the contractor owns or will rent equipment, time to perform each task, or other specifics.

If the Design Estimator or the VE Estimator rely upon available reference publications such as RS Means, etc. these generic/nationwide costs are modified by cost factor adjustments for specific geographic locations, and do not account for any special conditions for a project.

If the Design Estimator or VE Estimator rely upon historical unit costs provided by the owner, these are merely unit bid prices submitted by contractors on previous projects which may or may not have relevance to the specific project at hand. In addition, these submitted item bid prices often do NOT reflect the actual cost to a contractor, as all contractors “unbalance/front load” their bids. Items completed early in a construction project are bid at a higher than actual unit price to get an early payback, and items that are completed near the end of a project have their prices decreased. Contractors will additionally unbalance the unit cost bid amount for items whose quantities will either over-run or under run, such that items whose quantities are envisioned to over-run will be bid at a higher than actual unit price. Unbalancing unit bid prices as above further obfuscates the accuracy of database unit costs.

VE Cost Estimates: Time Limitations

Some clients allow the estimator time to perform a “verification/reconciliation” of the design estimate while others allow little or no time at all for this effort. A pre-study estimate reconciliation is an excellent strategy for a “double check” that would tend to identify blatant errors in the design estimate such as obvious quantity busts, arithmetic errors or unit cost prices anomalies.

During the VE Study, usually a 3 or 4 or 5-days, the VE Estimator is the last to provide his expertise since the technical experts generally do not submit their Alternative Ideas for costing until very late in the study. The VE Estimator then has only a limited time to prepare comparative cost estimates for perhaps 20 to 40 or more alternative ideas leaving little time for rigor of evaluation.

VE Liability

The VE Estimator can elect to use the design estimate or perform an independent estimate. Should the VE Estimator’s own costs not be accurate, there can be a significant liability in the eventuality that a project is not financially viable. Likewise, if the VE Estimator claims to ‘validate’, or ‘verify’, the design estimate, then he and the entire VE Team have volunteered for and adopted the liability involved.

Life Cycle Costing

Life cycle costing evaluates the future cost to operate and maintain a facility, structure or piece of equipment (repair, consumables, etc.) over its anticipated operational life including any salvage value. Life cycle costing is an important and sometimes determining evaluation for a VE Study outcome. Life cycle cost is equated to a present worth value for use in the VE Study. Therefore, the best value equation can be refined as:

V=P(F)/($ construct + $ life cycle)

A Life cycle evaluation can be the determining factor in deciding whether to rehabilitate or replace a structure, or decide what type of mechanical equipment is most appropriate to provide best value.

The present worth calculation of future expenditures is by definition problematic. The equation(s) require quantification of future unknowns including: annual future cost (A); the life of an element (n); the interest rate over the assumed life (i); and potentially even the discount rate (d). The discount rate is the interest rate charged to commercial banks (lenders) for loans received from the Federal Reserve Bank.

Best value decisions based on present worth (addressing life cycle costs) entail a degree of risk to both Owner and VE Team, as present worth can never be well known.

VE Risk & Cost

A ‘negative’ risk evaluation (quantitative of qualitative) during the VE Study can identify the potential for and severity of a negative event(s) occurring during the life of a project that will most likely have cost impacts. Once risks are identified during the VE Study, they can ideally be mitigated by the design alternative ideas offered by the VE Team to the owner.

Conclusions

• VE Study Estimates. All quantities, and therefore cost differentials, offered as an outcome of the VE Study are generally based on the designer’s incomplete design and subject to a contingency factor. VE Alternative Ideas are therefore based on a comparison to incomplete early stage in-progress drawings. The cost estimates prepared during the VE Study for each of the many alternative ideas are constrained by the uncertainties of an incomplete design.
• VE Study Alternative Ideas. The VE Study should offer “ideas” to be evaluated by the Engineer and refrain from “recommendations”. Cost comparisons of a VE Idea to the Engineer’s base case can only reflect an order of magnitude difference.
• Cost “Savings” as a Claimed Outcome of the VE Study. Claims of outright cost savings as an outcome of a VE Study are premature and tenuous for most items. The VE estimate is only a relativistic comparative snapshot in time of VE technical alternative ideas to the designer’s in-progress base case.
• Clients/Life Cycle. Clients should be made aware that life cycle costing as a VE tool is a valuable and even necessary effort to guide owners in their decision-making pertaining to project scope and budgeting. However, the limitations should be made known to project participants.
• Cost Risks. A risk analysis, informal or otherwise, should be incorporated into the Standard VE Methodology as a necessary step in determining best value since almost every risk impacts upon scope, project approach, budgeting and expenditures. Early identification of risks will often lead to alternative ideas that will mitigate/manage risk.
• Liability. The VE team should be wary of volunteering for liability by offering to ‘verify’ or ‘validate’ the design cost estimate. A disclaimer included in the VE Report could read: “The costs used are those provided by the engineer. Where the VE team has offered alternate costs, they are provided for information only reflective of the extremely short duration of the VE study and should be evaluated by the owner and its engineer. VE ideas are provided to the owner/engineer for their evaluation. Implementation is exclusively at their discretion.”