Construction You Need Risk-Based Cost Estimating Contracting - - PowerPoint PPT Presentation

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Construction You Need Risk-Based Cost Estimating Contracting - - PowerPoint PPT Presentation

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Construction You Need Risk-Based Cost Estimating Contracting Practices Session, June 8, 2015 John Reilly Alfred Moergeli Philip Sander sander@riskcon.at john@johnreilly.us alfred.moergeli@moergeli.com 1101 Worchester Road moergeli

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Construction – You Need Risk-Based Cost Estimating

Contracting Practices Session, June 8, 2015

Philip Sander

sander@riskcon.at

Alfred Moergeli

alfred.moergeli@moergeli.com

  • Technikerstr. 32

6020 Innsbruck Austria

www.riskcon.at

moergeli consulting, llc (mcllc) 11921 Ferdinand Street, P.O. Box 2852

  • St. Francisville, 70775 LA

www.moergeli.com

John Reilly

john@johnreilly.us

1101 Worchester Road Framingham Massachusetts 10701 USA

  • www. johnreilly.us
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Slide 2 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Presentation Will Cover

Dealing with uncertainty Components of cost estimates Value at Risk (Level) Types of cost estimates

a)

Deterministic

b)

Bandwith, square-root approach

c)

Risk based (probabilistic) Comparison of cost methods Benefits, risk-based approach

a)

Better, more complete information

b)

Explicit definition of risks Summary

a)

Contractor’s advantage / Strategies

b)

Owner’s advantage / Strategies Example, RIAAT process Questions

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Slide 3 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Dealing With Uncertainty

  • Every cost estimate is uncertain.
  • Underestimating construction costs can lead to

problems for owners in the planning and design phase

  • Underestimating construction costs – e.g. by contractors

in the bidding phase - can lead to loss of profit, disputes, claims, and litigation

  • A better understanding of potential costs helps:
  • Owners to budget and get authorization for projects
  • leading to a reduced chance of “cost overruns”
  • Contractors to determine base cost and margin plus:
  • Strategies to secure the work - in low-bid environment
  • Strategies to maximize profit, avoid loss and recover

costs of changes

  • Consider low probability / high impact “black swan” events
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Slide 4 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Risk and Uncertainty

  • Risk is the combination of the probability of an event and its

consequences (if positive = opportunity)

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Slide 5 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Components of Cost Estimates

  • Components of cost which need to be sufficiently addressed in

an estimate include:

  • Base cost – the cost that will result if

“all goes according to plan”

  • Risk costs
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Slide 6 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 0% 1% 2% 3% 4% 5% 6% 7%

1,000 2,500 5,000 7,500 10,000 Value at Risk Relative Frequency

Distribution Function (Impact in kUSD)

Value at Risk (VaR)

= A certain amount, within a distribution, that will not be exceeded according to the corresponding probability.

VaR 70 here means that a $5M budget

would not be exceeded in 70%

  • f all simulated scenarios

(there remains a 30% probability that the $5M budget will be exceeded)

Value at Risk (VaR)

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Slide 7 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Cost Estimates Must Also Address

  • Escalation – costs resulting from inflation (with variability)
  • driven by economic factors.
  • Effect of competition and market factors
  • Other uncertain costs – e.g. from events external

to the project team’s control, including:

  • “Unanticipated” events
  • Management changes / lack of continuity
  • Politically related changes, and
  • “Black Swan” events

Transition to Alfred

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Slide 8 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

  • 1. Deterministic:

Aggregated unit quantities multiplied by unit prices. Usually with some degree of conservatism built in. Plus an added reserve or contingency

  • 2. Bandwidth:

Range approach with minimum, most likely, and maximum cost. The total cost is obtained by simply adding these parameters for all line items.

  • 3. Square Root:

Delivers one single figure which is the sum of all base costs plus the square root of the sum of the squares of the risk contingencies.

  • 4. Probabilistic:

Range approach which characterizes cost information with probability distributions

Types of Cost Estimates

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Slide 9 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Cost Estimating Methods in Comparison:

Tunnel Excavation Category (Base Cost only)

  • 1. Deterministic Approach

Most likely quantity x most likely price

306.95 USD

Price [USD] Cost Item Distribution min ml max unit Distribution min ml max ml Shotcrete 10 cm - Top Heading Triangular 13.83 15.37 17.68 m² Triangular 9.696 12.12 15.756 186.28 Steel Mesh AQ50, outer layer- Top Heading Triangular 13.83 15.37 16.91 m² Triangular 0.976 1.22 1.586 18.75 Swellex 3.0 m - Top Heading Triangular 1.73 1.82 2.00 pc Triangular 20.712 25.89 33.657 47.12 Shotcrete 5 cm - Bench Triangular 5.18 5.76 6.62 m² Triangular 5.992 7.49 9.737 43.14 Swellex 3.0 m - Bench Triangular 0.43 0.45 0.50 pc Triangular 20.712 25.89 33.657 11.65 306.95 Unit Price [USD] Quantity

  • 2. Bandwidth Approach
  • 3. Square Root Approach

( )

∑ ∑

+ − min min max

2

CostItem

= 375.67 USD

∑

) min * (min P Q CostItem

∑

) * ( mlP mlQ CostItem

∑

) max * (max P Q CostItem

223.36 USD 306.95 USD 453.86 USD

  • 4. Probabilistic Approach
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Slide 10 www.riskcon.at www.moergeli.com

Risk-Based, Probabilistic Cost Estimating Methods

www.johnreilly.us

Min.

All Four Cost Estimating Methods in Comparison: Visualized

Ml. Max .

223

Bandwidth Approach

307 454 286

VaR5

321

VaR50

362

VaR95 Probabilistic Approach Deterministic Approach Square Root Approach

307 376 A B C D A B B B C D D D

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Slide 11 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Pro’s & Con’s of the Methods

Estimating Method Pro Con

  • 1. Deterministic

One single figure Well-known & accepted Quick Can be performed “manually” No probability information - single value No VaR information More often than not on the unsafe side (high, unknown probability of cost

  • verruns)
  • 2. Bandwidth

Three values

  • minimum, most likely and

maximum, ranged Quick Can be performed “manually” No probability data, range values only No VaR information More often than not on the unsafe side (high, unknown probability of cost

  • verruns)

Range maximum and minimum very unlikely

  • 3. Square Root

One single value Quick Can be performed “manually” No probability information for single value Bandwidth information is lost No VaR information Range limits are extreme values and very unlikely

  • 4. Probabilistic

Full probability information Needs probabilistic thinking & understanding Needs (a little bit) more time Needs software support

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Slide 12 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Tornado Diagram - Risks/Opportunities

Transition to John

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Slide 13 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Benefits of Risk-based Cost Estimating

  • Risk-based methods give more detailed and specific

information of risk and potential cost impacts – with the following possibilities in the planning & bidding phases:

  • Allows strategies to protect public funds and interests
  • Allows the owner to develop better and more equitable

contract documents and provisions for risk

  • Allows a better understanding, by owner and contractor,

who will “own” risks – leads to contractual clarity

  • Allows the contractor to assess risk in bidding vs. the

competition – to better evaluate chances of securing the work at a specific price – and to make an informed “go-no go” bid determination

  • Allows the contractor to determine a risk management

strategy for construction in order to best obtain a profit

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Slide 14 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Concerns – “Low-Bid” Environment

  • A concern has been expressed that if an improved risk

identification process is used the contractor’s estimate will include higher potential costs, which will mean that their bid will be higher and they are likely not to be successful

  • This is a valid concern – however, we would argue that more

detailed and realistic information about potential risk events is an advantage if:

  • Appropriate bidding and construction management

strategies are used by the owner and contractor and

  • These strategies are compatible and consistent
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Slide 15 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Risk & Risk Registers

  • If the owner includes a sufficiently comprehensive risk register

in the bid documents, and the potential contractor prepares their own detailed risk register, they will better understand the risk environment and can also judge if the owner’s risk register is accurate.

  • There are several possibilities in this regard:
  • If the potential contractor thinks that the owner has

estimated the consequence or probability of some risks too high, they may see a bidding advantage compared to other bidders.

  • If the owner has estimated the consequence or probability
  • f some risks too low, it may mean that the potential

contractor, using a reasonable assessment of risk, may submit too high a bid and may not win the project over

  • ther bidders who have a lower appreciation of risk.
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Slide 16 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Summary - Owner’s Strategies

  • Planning & Design:
  • A risk-based approach gives a better understanding during

design of potential costs and mitigation strategies which help manage the design to meet available budget

  • Risk definition and characterization allows better contract

documents with a more equitable sharing of risks

  • Sharing of risk registers with contractors can “level the

playing field” – more realistic bids with less “contingency”

  • Owner’s definition of specific risks can clarify who owns the

risk as reflected in the owner’s risk management plan

  • Owner’s definition of specific risks can help avoid

“unanticipated” events that can lead to disputes, claims and litigation.

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Slide 17 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Summary – Contractor’s Strategies

Risk-based cost estimating for construction allows:

  • A better understanding of potential cost to inform the

contractor’s bidding strategy re potential profitability

  • Whether to bid
  • What level to bid
  • What potential profit/loss may be possible
  • A better understanding of potential risks will allow:
  • Understanding who “owns” each risk
  • More specific risk management plans in construction
  • More specific risk mitigation and claims avoidance

procedures

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Slide 18 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

How can you do this?

  • A concern is that the risk-based approach is complex
  • Requires experienced practitioners
  • Requires sophisticated software
  • Some systems are proprietary
  • Has a significant learning curve
  • But, benefits outweigh the investment
  • For owners and contractors
  • Example of current software (RIAAT) follows

Transition to Philip

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Slide 19 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

RIAAT Approach, Software

Video: https://www.youtube.com/watch?v=Y_dHxxRZFBA Website: http://riaat.riskcon.at

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Slide 20 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Where is your project on this curve? How do you know?

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Slide 21 www.riskcon.at www.moergeli.com Construction – You Need Risk-Based Cost Estimating www.johnreilly.us

Thank you for your attention…… Questions?

Philip Sander

sander@riskcon.at

Alfred Moergeli

alfred.moergeli@moergeli.com

  • Technikerstr. 32

6020 Innsbruck Austria

www.riskcon.at

John Reilly

john@johnreilly.us

1101 Worchester Road Framingham Massachusetts 10701 USA

  • www. johnreilly.us

moergeli consulting, llc (mcllc) 11921 Ferdinand Street, P.O. Box 2852

  • St. Francisville, 70775 LA

www.moergeli.com