Construction Cost Overruns: Common Contractual Causes And How to Prevent Them
Over budget construction projects are an all-too-common problem. In fact, construction cost overruns are considered the industry norm. According to KPMG’s 2015 global construction survey, only 31% of all respondents projects came within 10% of their budgets. And according to McKinsey, large projects typically take 20% longer to finish and are up to 80% over budget.
If construction cost overruns are so common, you ask, should we then just accept them as par for the course? Of course not.
- Over budget projects lead to delays, which forces the project owner to incur even more additional costs.
- Severe disputes can arise among stakeholders, which not only prevent collaborations in the future, but can also damage reputations.
- Construction productivity and financial returns will continue to plummet.
While most of the blame usually is directed towards the project’s general contractor, the reality is that project owners only have themselves to blame. The sad, unfortunate truth is that owners don’t spend enough time (and money) making sure their construction documents are drafted to fully protect their interests.
Owners usually make three common mistakes during the project’s contracting phase that lead to construction cost overruns: (1) failing to make sure the architect issues fully complete construction documents; (2) failing to require contractors to review the drawings and specifications prior to bidding; and (3) simply accepting the lowest bid.
The good news is that there are simple fixes for these issues:
1. Incomplete Design Documents.
While other forms of project delivery, such as design-build and construction manager at risk, are gaining acceptance, the most common delivery method remains design-bid-build.
Under the design-bid-build delivery method, the owner hires an architect to design the project (Design). The architect designs the project and prepares drawings, plans, and specifications outlining what the contractor are to build. The owner then takes the plans and specifications and obtains bids from contractors to build the project (Bid). Finally, the owner selects a contractor to build the project (Build).
Projects go over budget when contractors demand more money from the owner for work that was not clearly shown on the plan and specification that the architect prepared. These payment demands are referred to as “change orders.”
This mistake happens when owners assume that the architect has prepared a 100% complete set of plans and specification that contain every detail necessary for the contractor to build the project.
To the contrary, most owner-architect agreements only require the architect to prepare plans and specifications that show the architect’s general design intent. It is up to the contractor to fill in the blanks by requesting information from the architect during the construction phase of the project.
Problems arise when contractors claim their bid was based on details not shown on the plans and specification. When the detail is revealed during the construction of the project, the owner is then forced to incur additional costs.
In order to address this problem, owners should insist that their owner-architect agreement contains language requiring the architect to produce a 100% fully complete set of drawings that are fully coordinated with any documents prepared by engineers and designs working on the project.
By including such language, owners can look to the architect for compensation for cost overruns incurred because of missing details in the drawing.
Of course, owners already routinely look to the architect for compensation when they are forced to incur additional costs because of incomplete plans; however, by including language requiring the architect to produce a fully complete set of documents, both sides can protect themselves from financial and legal consequences.
2. Failing to Require Contractors to Review Documents Prior to Bidding.
In some cases, contractors fail to fully comprehend and anticipate the work necessary to complete a project. They will then seek additional compensation for work allegedly not shown on the plans and specifications.
To prevent this, owners need to include language in their owner-contractor agreement stating that the contractor has fully reviewed the plans and specifications prior to submitting its bid.
The owner should also require the contractor to affirm that it is fully familiar with the plans and specifications and fully understands the architect’s design intent, and that the contractor’s price includes all of the work necessary to achieve the architect’s implied or express design intent.
3. Automatically Accepting the Lowest Bid.
Whether because of the demands of shareholders, boards of directors, or investors, the owner’s need to complete a project at the lowest possible price is understandable. However, unlike in public contracting, there is no need for the owner to select the lowest bid among the bids it receives. As any experienced owner knows, the lowest bid does not equal the best bid.
Indeed, some unscrupulous contractors are known to purposely underbid a project only to make up the cost through a series of change orders which request additional compensation.
Owners–or even interior designers or architects who are doing the hiring– are much better off going with a trusted contractor rather than simply selecting the lowest bid. Selecting a trusted contractor with a track record of constructing projects like the one the owner wants to build, combined with changes to the contract suggested above, will greatly increase the chances that a contract will be completed within budget and on time.
An earlier version of this post appeared in 2013 in Supplemental Conditions.
McKinsey has reported a staggering increase in construction cost overruns. The biggest culprit? Paper-based processes that don’t support the cross-team collaboration, reliable document management or real-time decision-making. Digitize your firm with Fohlio: Build more accurately, finish projects faster, and stop leaking capital. Get a free demo today!
With Noam Hazan. Click here to watch.