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by Jono Bonifant on 24 July, 2023
Effective project cost management is essential for the success of construction projects.
However, despite meticulous planning and budgeting, cost overruns remain a constant challenge in the industry.
With large-scale projects often exceeding budgets by up to 80%, construction professionals face significant pressure to mitigate financial risks and deliver projects on time and within budget.
In this article, we dive into expert strategies and best practices to prevent cost overruns in your construction projects. Let’s get started.
What is cost overrun in construction
Cost overrun in construction refers to the situation where the actual costs of a project exceed the initially budgeted estimates.
It is essentially the financial discrepancy between what was planned and what is actually spent during the construction process. In the most basic terms - it's when you go over budget.
Cost overruns can wreak havoc on the financial health and timeline of a project, making it crucial for project managers and QSs to understand their causes and implement effective strategies to mitigate them.
Common causes of cost overrun in construction projects
Cost overruns can be attributed to various factors throughout the project lifecycle which can significantly disrupt construction projects, often resulting in delays, strained budgets and frustrated stakeholders.
Let’s explore some of the primary culprits behind these budgetary challenges:
1. Cost Escalation
Cost escalation refers to the increase in project costs beyond the original budget. It can be caused by various factors such as inflation, changes in material prices, increased labour costs or unexpected market conditions.
To shield your projects from cost escalation, consider the following proactive measures:
- Have a cost escalation clause in the contract: Negotiate a cost escalation clause in your contract that outlines how adjustments to the contract price will be calculated in response to changes in material prices, labour costs or other relevant factors. This clause can provide a mechanism for fair and transparent adjustments to the contract price, protecting you from unfair budget overruns.
“The principle that neither party (client or contractor) should profit from escalation is one to be adopted in any contract negotiations involving escalation costs.” -Downer
- Secure early procurement: Mitigate the risk of cost escalation by engaging with the market or supply chain early on in the project timeline. By procuring materials and services ahead of time, you can lock in prices and minimise the impact of potential price fluctuations.
- Allocate contingency reserves: Anticipate unforeseen cost increases by setting aside contingency reserves within the project budget. These reserves act as a safety net, allowing you to address unexpected expenses without derailing the project’s financial health.
- Monitor project costs: Utilise project cost management software to track expenses in real-time and identify any deviations from the budget. With live data insights, you can analyse cost trends, pinpoint areas of overspending and take proactive measures to stop budget creep before it blows out.
2. Scope Creep
Scope creep refers to the gradual expansion of project scope beyond its original boundaries. It often occurs when additional requirements, features or changes are introduced during the course of the project.
When the project scope expands without proper control, it can result in increased labour, equipment and material costs, as well as delays in project completion.
Combat this problem with strategic approaches:
- Clearly define project scope: Document specific requirements, timelines and deliverables agreed upon with the client to establish a baseline for evaluating changes.
- Implement a change management process: Establish a structured process for evaluating, approving and implementing scope changes, considering their impact on the timeline, budget and resources.
3. Inaccurate Estimates
Accurate estimates are the foundation of successful projects. When estimates fall short of the actual costs, it can lead to significant financial challenges and project delays.
To ensure your estimates are as precise as possible, consider implementing the following strategies:
- Use historical data and cost codes: Tap into past project data and utilise construction cost codes to inform your current estimates. Analyse similar projects you’ve completed in the past to identify patterns and trends in costs. Historical data, when categorised using cost codes, can provide valuable insights into material costs, labour rates and other factors that may affect your estimates.
- Embrace estimating software: Invest in estimating software to streamline your estimation process and improve accuracy. Estimating software allows you to create detailed estimates quickly by automating calculations and integrating with a wealth of databases.
- Collaborate with experts: Don’t underestimate the value of input from experienced professionals in your field. Consult with subcontractors, suppliers, and other industry experts to get their insights on cost factors and potential challenges specific to your project. Their expertise can help you identify potential cost-saving opportunities and ensure your estimates are realistic and comprehensive.
4. Poor Risk Management
Construction projects are rife with uncertainties, from adverse weather conditions to subcontractor performance issues. To mitigate the impact of these risks, adopt proactive risk management strategies:
- Evaluate project risks: Take a proactive approach by identifying and assessing potential risks. Factors such as inflation in material prices, delays with permits and potential labour shortages should be thoroughly evaluated.
- Prepare backup plans: Anticipate the unexpected by developing contingency plans and alternative approaches. From establishing backup supplier relationships to exploring alternative construction methods, proactive planning can help mitigate the impact of unforeseen challenges.
What to do when costs have overrun
Project cost overruns are an unfortunate reality in the construction industry, and when they occur, it’s essential to take swift action to mitigate their impact.
Here are some key steps to consider when costs have overrun:
1. Identify the root causes
Begin by identifying the root causes of the cost overrun. Conduct a thorough analysis to understand what factors contributed to the deviation from the original budget.
This may involve reviewing project documentation, conducting interviews with project stakeholders and analysing project data.
By pinpointing the underlying issues, you can develop targeted strategies to address them effectively.
2. Look for cost savings in other areas
Explore opportunities to reduce costs in other areas of the project to offset the overrun. This could involve renegotiating contracts with suppliers or subcontractors to secure more favourable terms and pricing.
Additionally, consider redesigning specific project components or substituting materials to address supply constraints or inflationary risks.
By assessing redesign and exploring alternative materials, you may uncover opportunities to achieve cost savings without compromising project quality or efficiency.
3. Renegotiate the price with the client
If a cost overrun has occurred because of a genuine oversight or misunderstanding in the initial project scope, it could be worth renegotiating the contract with the client.
For example, it might happen that human error meant you only quoted for 80% of the project’s requirements, overlooking a crucial aspect that significantly impacted costs.
By openly discussing the oversight with your client and presenting a revised cost breakdown with justification, you may be able to renegotiate the price to better align with the actual scope and costs incurred.
Remember, most clients prioritise project completion with quality outcomes over seeing their contractors go bankrupt.
4. Determine scope creep and create variations
Once scope creep has been identified, work with the client to create variations to formalise the changes in the project scope.
Variations outline any additions, substitutions, or omissions from the original scope of work and provide clarity on the associated costs and timelines.
By creating variations, you ensure that you’re properly reimbursed for any additional changes to the project scope.
5. Learn from the experience
You should reflect on the cost overrun as a valuable learning opportunity. Use the experience to refine your future projects by identifying areas for improvement in your estimating processes, project management practices and risk management strategies.
Consider implementing additional checks and balances to ensure more accurate estimates and better contingency planning in future projects.
By learning from past mistakes and continuously improving your project management, you can mitigate the risk of future cost overruns.
Cost overrun examples
Cost overruns in construction projects can stem from various sources, often arising from unexpected circumstances or miscalculations during the planning phase. Here are some illustrative examples:
- Underestimation of scope: Imagine tendering for the construction of a five-story building but, due to human error, only estimating costs for a four-story structure. This discrepancy means crucial aspects like materials, labour and other resources for the additional floor weren’t factored into the initial budget, leading to significant cost overruns.
- Unforeseen site conditions: Suppose a construction project begins without a comprehensive site survey, only to encounter unforeseen geological challenges such as unstable soil conditions or hidden underground utilities. Dealing with these unanticipated obstacles can require costly remediation efforts and adjustments to the project plan, leading to budget overruns.
- Design changes: Changes in project design or client requirements mid-construction can also contribute to cost overruns. For instance, if a client decides to modify architectural features or upgrade materials after construction has commenced, it can lead to additional expenses in labour, materials and project management.
These examples underscore the importance of thorough planning, diligent risk assessment and effective project management to mitigate the risk of cost overruns in construction projects.
How to avoid cost overruns on construction projects
In today’s digital world, there is a modern solution that will help you effectively manage and mitigate the causes of cost overruns. Trust us, it’s a game-changer:
Implement construction cost management software
Inefficient manual processes and paper workflows have long plagued the construction industry. McKinsey & Co. report that the construction industry is the second least digitalised among all major sectors.
With such a heavy reliance on paper workflows, communication and information sharing is delayed.
The problem? Owners and contractors are often working from two different versions of reality. For example, 61% of business owners say they have to make decisions with outdated data due to slow manual processes.
On the other hand, construction cost management software provides a centralised hub where all project stakeholders can collaborate, track expenses and make informed decisions based on real-time data.
It offers several benefits that contribute to cost control and project success, including:
- Streamlined budget management: Easily create detailed budgets, track costs and monitor expenses in real-time. Identify potential cost overruns early and take proactive measures.
- Automated cost tracking: Eliminate manual data entry and reduce human error. The software automatically captures expenses and updates financial records, providing accurate project cost information.
- Real-time reporting and analytics: Generate real-time reports and analytics to gain valuable insights into project finances. Monitor cost trends, compare actual costs to budgeted amounts and make data-driven decisions to keep the project on track.
How to prevent cost overrun with Lentune
At Lentune, we help construction companies streamline the way they handle project finances. Our project cost management and automation tools help you to save money, improve cash flow and increase productivity. We’d love to show you how it works!
In a live demo, we can answer any questions and show you how Lentune construction software could grow your business.