Tag: Cost Estimating

Can Value Engineering Really Achieve Major Savings?

Value Engineering has become the core activity for may cost engineers / quantity surveyors / commercial managers on major construction projects around the world, while at the same time being viewed as a silver bullet by clients when projects are over budget.  However, can value engineering really be used as a tool to rectify “financially distressed” projects?

First, it is important to remember the purpose and definition of value engineering (as promoted by SAVE™ and similar organisations), which is to identify better ways of achieving the same result.  The focus is therefore on maximizing or improving value rather than simply reducing cost.  Many people have lost sight of this fundamental concept of value engineering:

VALUE  ≠  COST

So, how are these two terms really defined?

The “cost” of a development or component is the capital expenditure incurred in securing the physical achievement of that asset.  It is also all the direct expenditure incurred in operating and owning that asset throughout its lifetime (such as utility costs, repairs, and maintenance).

The “value” of the same item includes not only all the direct “costs” incurred, but also the income and benefit that item can generate for the owner over its whole life.

Therefore, whilst costs can include all expenditure over the whole life period, there is no consideration of the benefits (“income”) generated.  This makes decisions potentially clouded by a focus on the outflows of money rather than taking a more complete look at the consequences of ownership.  Despite everyone agreeing that decisions should be taken in an informed and rational manner, it has become inevitable that capital expenditure decisions now dominate the construction industry.

Consequently, visual elements within a construction project are typically the first to be targeted, for example, architectural finishes and landscaping.  This approach actually results in a more significant value reduction than the simple cost savings indicate.

In the case of residential properties, many prospective buyers are strongly influenced by the visual appearance of the completed building and its surroundings (including amenities).  If corners are cut, there is an immediate perception of lower “quality”.  Where multi-unit developments are concerned attracting buyers is important, since as interest / demand increases so do the ultimate sale price.  Buyers are also keen to secure properties, which require limited or no additional investment (for further fitting out / landscaping works), therefore “move ready” assets are very attractive to many investors.

There is a current trend within the commercial property market globally for small to medium sized firms to be particularly attracted to partially fitted out floor space (raised floors and suspended ceilings pre-installed), rather than the more traditional shell and core tenancy spaces.  Global leasing data (irrespective of market location) validates the conclusion that providing space in this partially fitted out format attracts a premium rental rate, and also attracts tenants who are prepared to commit to longer occupancy periods.  When the additional capital investment involved is compared with the enhanced returns, (“value”) generated the overall resultant financial benefit repays the extra cost in a very quickly.

When can Value Engineering Really Make a Difference?

Whilst value engineering can be carried out at any point in the project life cycle, the earlier in the design process it is performed the better the results tend to be.  As the project evolves, the design team become reluctant to embrace changes, which might involve them in additional non-recoverable expense.  Equally, the cost impact of the changes proposed at these later stages will involve other factors beyond the simple capital cost (often; abortive work and consequential impacts).

This means that there is a zone at the beginning of a project where value engineering can make the largest impact with the least consequences, this is known as the “value zone” and is illustrated below.

value-zone

Setting Expectations

A common question from many clients before undertaking any value engineering exercise is “how much should be the target for the savings we can achieve?”  There is obviously no specific answer to this question since it depends upon the project and status of the design, but the expectations established at the start have to be realistic.

The financial issues on a project cannot be solved by a single value engineering exercise, nor can significant savings be achieved without major design changes.  Therefore, it is important to consider what can actually be achieved.  To establish a reasonable target a detailed review of the project design and latest cost estimate has to be carried out.  This review should consider the following key issues:

  • Scope / potential for brief / functional area reductions
  • Practicality to implement alternative building services systems / technology
  • Ability to consider alternative structural systems
  • Areas of uncertainty in the estimate pricing
  • Aspects of the design which are less developed

Designers, suppliers, and contractors can all assist in this review by providing the evaluation team with expert knowledge and technical information.  Building Service systems are a key aspect where manufacturers and suppliers can provide significant support.  The best of these businesses are able to offer alternative solutions to standard problems, (many of which involve higher capital investment but substantial long-term benefits) based upon the selection of different items from their existing product range.  This ability to think and work outside the “easy” or “regular” solution is what distinguishes the good from the best suppliers.  Successful value engineering studies always require the active involvement of these firms and design teams should actively seek out these experts wherever possible.

Despite the vast number of variables in the design of any project, it is typical that savings of between 15 – 20% of capital costs, are possible during the early stages of the design process, with between 10 – 12% being the most commonly achieved cost reduction range.  As noted at the outset, these savings have to be tempered with the potential loss of revenue / other benefits any cost reductions might consequentially generate.  As a rule, the higher the achieved capital cost savings, the greater the overall compromise in other areas, which will result.

Final Thought

Value Engineering is not a silver bullet; it is simply an additional tool within the toolbox of the construction industry professional.  If used at the appropriate time the process can generate savings and reduce budget over-runs, but it will often be at the expense of either functionality or aesthetics.

If you want to read more about a structured process (called the “funnel” approach) designed specifically to reduce project costs without destroying value, please look at our Practical Guide to Performing Effective Value Engineering.

The Do’s and Don’ts of Using Construction Cost Price Books

It is the season for releasing updated editions of major construction cost price books around the world and as these new books arrive in the mail or updated databases are made available on-line it is important to remember how these documents should be used and interpreted.  In the fast-paced construction world, industry practitioners often rely on published cost data to prepare feasibility or initial construction cost estimates.  In doing so, little thought is usually given to the consequences of these actions or the validity of the professional advice being provided.

Just because the construction cost price book has been prepared and published, by a reputable source does not mean the contents are reliable or a substitute for professional estimating services.  This article will consider how these pricing books are really compiled and consequently their benefits and drawbacks.

Sources of Cost Data

So, where does the cost data for a construction cost price book originate?  Despite the claims by most publishers, construction cost data can come from only a limited number of sources and each generates slightly different information.  Therefore, both the users and compilers need to understand exactly what the basis of the data is.

Tender Price Information – In many ways, this is the best cost information, since it represents the market price secured in a competitive bidding environment.  However, modern construction projects have a wide variety of unique features, which means very few tenders are identical (putting aside the different physical nature of the construction work itself) resulting in a whole host of factors which could directly influence the pricing structure.  Illustrations of this point would be:

  • Contractual Terms and Conditions
  • Procurement Route
  • Level of Competition
  • Local Market Conditions
  • Project Desirability
  • Nature of Project Participants
  • Construction Duration
  • Perceived Project Risks

Each one of the above factors will have an impact on how bidders consider and present their pricing.  Therefore, whilst tender prices are perhaps the best source of construction cost information, it is essential for the details of the identified projects to be understood by whoever is going to use the data.  Simply accepting and using information provided can create significant validity risks.

Another factor affecting the use of tender price information is the quantum of suitable data available.  Most construction cost price books provide generic rates, either for project types (roads, schools, offices, etc.) or for individual components (reinforced concrete, reinforcement, blockwork, copper pipe, etc.), this means the authors need to ensure they have a large enough sample size to produce a representative data set.

Here again there are two significant issues; firstly the number of available tenders of a similar type (comparing all school tenders, irrespective of the project type is not going to be appropriate), may not exist, and secondly when the tenders were actually issued / received (often there is a significant time gap between tenders being received and the data being made available to third parties).  The consequence of these situations is often that the valid sample size available for the price book compiler is very small (sometimes only 1 or 2 tenders in any specific category).

A further consideration is that most independent cost data compilers rely on tender information provided by third parties, where the validity of the data is hard if not impossible to interrogate, therefore has to be accepted on face value.  Where the cost data compiler is an industry firm, the reliability of the data should be better, but in these cases, volume of suitable data will become an even greater issue.

Finally, irrespective of the data compiler, many project owners remain reluctant to release the commercially sensitive contract / tender price information from their projects, which further reduces the available data pool.

Quotations / Supply Prices – Some price books heavily focus on providing cost data relating to a wide range of material, labour or plant / equipment items.  These rates are sourced, either from tender prices (as above) or through the solicitation of market quotations / price lists.  Although the information collected is traceable and largely consistent (since the format, structure, and conditions relating to the quotation received can be determined by the originator) these rates do not truly reflect the local market conditions.

In most countries around the world, or within large cities for that matter, supply prices will vary depending upon the exact location of the project.  In the USA for example, there are often significant State-by-State variances, linked to taxation, transportation, supply availability, or climatic conditions.  In Africa, prices in major urban centres will be dramatically different to those found in settings that are more rural.  Some of these issues are addressed through regional factor adjustments (discussed below) but fundamentally, the user of the price book needs to know what is the base point used by the cost data compiler.  The difficulty still remains that there needs be a large enough sample size to make the cost data credible, which means they often use a wide catchment area.

When quotations / supply prices are used as the basis of a cost price book, it is important that the author use the same sources for each edition of the book; this ensures consistency in the pricing.  If different sources are used each time, the cost data is going to be highly unreliable, unless the sample size is statistically significant (so that anomalies can be removed from the data set before averaging takes place).

Regulated / Controlled Prices – In certain markets around the world, the Government or State may impose a capped or regulated price for particular key commodities or services.  This price regulation may come from a government monopoly position in that aspect or it may relate to a key item, which could be subject to market price manipulation if not controlled.  In each case, clearly stating these controls in the price book is critical.  The primary reason is that when the controlled prices are separately adjusted by regional / locational factors (to suit the actual location of the project being priced), the price controls in one location may not apply in the new location, meaning further adjustment to the pricing will be necessary.

Labour Rates – Published labour rates often come in two formats, the pure labour costs (i.e. the amount an individual worker costs) or labour content within a particular rate.  The second aspect (labour content within a particular rate) can be a complete topic by itself, but in simple terms, they are usually a theoretical value based upon the perfect worker performing the specific task in the most efficient manner (therefore exceedingly rare in practice).

Pure labour costs may seem to be a simply obtainable value, especially where there are union controlled, or government dictated minimum wages.  However, this is not the case.  Firstly, it is important to understand the basis of the rates being quoted is the amount the worker receives, “take home”, or are they the cost to the company employing the worker.  The two are significantly different values.  Secondly, the definition of the worker category has to be understood.  It is frequently the case that a particular role requires workers of specific skill level, qualification, years’ experience, or trade certification, ensuring that all the rates compared are for exactly the same type of worker is vital.  Finally, the working conditions of the different labour rates has to be considered, they should all be based upon the same working hours (without overtime), similar shift patterns (day productivity is usually better than night working), and operating conditions (whether below ground or at high level).

In each of the above situations, the number of factors potentially influencing the rate outcome is significant and if the cost price book does not clearly set out the assumptions and methodology adopted, the users of the data can be extremely exposed.

Compilation Process

Once the actual data has been sourced and gathered perhaps the hardest part begins.  Whilst it may seem obvious to average the complete dataset to produce single value, or perhaps apply more complex statistical analysis processes, the result would not be acceptable.  In a perfect world a range of values would be provided in the pricing book (to show the potential spread of outcomes possible), but typically a single value is all that is provided.

The optimum approach to producing a single value is to review the data available for each item in turn.  Where there are outlying rates (i.e. particular rates, which stand out from the remaining data as being too high or low), these rates should be either excluded from the calculation or queried with the original data provider to revalidate the information recorded.  The rest of the data should then be averaged to produce the single mean value.  The fact that this process has to be repeated for every item in the pricing book often means it is not carried out, or there simply is not adequate data available in the first place for every item to determine if the rates provided are consistent.

Timing of Release

Once all the data has been sourced, compiled, analysed, and averaged, it is time for publication.  The construction price book hitting the market now is unfortunately unlikely to be representative of the market today (or in the future for that matter); it reflects the market at the time when the data was sourced.  Irrespective of the publisher, most price books contain cost data, which is at least 6 months old.  Therefore, a 2016 price book published in September probably contains tender price information for projects released to the market in late 2015 or early 2016.  In most developed construction markets, this is acceptable since prices do not fluctuate significantly during the course of any given year.  However, if there have been major geo-political or economic events, which have influenced exchange rates, material supplies, or government regulations, it is possible the cost data is outdated even before it is published.

Some online systems claim to have “real time” updates on price movements.  Whilst this may be technically true to the extent that as new information becomes available the database is updated, it is the timing of the cost data, which is important.  Most tender price information will only (or should only) be released once the evaluation process has been completed and a successful award taken place (which usually takes a minimum of at least 1 month from tender submission).  Therefore, before any analysis by the cost data compiler can take place at least a month will have elapsed from a tender submission.  Then the review and validation process will take a further period before publication can be approved (if the review does not take place the validity of previous data will be called into question).  This lag, between submission and publication will depend upon the processes adopted by the price book compiler but in all cases, it will result in cost data, which is based upon historic information.  It is therefore the obligation of the data publisher to identify clearly the periods used for the source data.

Regional Factors

As a user of a construction cost price book, it is often inevitable that the project being considered for pricing is not exactly in the location where the price book is based.  This means that some sort of adjustment to the information available has to be made to make it appropriate for use.  Many publishers assist in this process by usefully providing regional or locational factors, which can be applied to all the prices depending upon the final project location.  These factors are typically a percentage (either positive or negative) adjustment to be applied to the published rates.

Although this may seem a quick and simple solution to the problem at hand, the factors provided have to be treated with the same level of caution as all the other information.  The general principle behind the location factor is to provide a general guide as to how prices vary from one location to another.  Often they are historical averages or simply reflect different legislation patterns.  However, the basis must be understood and spelt out in the price book.

As a rule, not every rate or price across all items will fluctuate in the same magnitude from location to location.  Whilst as an overall average, the adjustment may be appropriate; if a particular project has, a greater proportion of a particular component than would be the norm, then examining the locational pricing trends of that aspect becomes more important than relying upon just the blended average.

Therefore, it is important to consider not only the physical location of the project, but also the nature of the work being proposed.  In geographically large countries, such as China or USA, regional factors become even more suspect as prices will vary significantly from one side of the country to the other.  In these situations using published information from the actual market, being considered is more important than relying on generic national data with adjustment factors.

Conclusions

Despite the above concerns, there is a role for construction cost price books, but they have to be handled with great care.  Price books provide a valuable source of generic cost information, which allow professionals to gain a rapid understanding of price trends as well as reference point for validating their own estimating.

Provided the users clearly read the basis and methodology provided by the publishers, (assuming this is actually available) then the composition of the cost data can be established.  In the case of projects, which are less sensitive to individual market price fluctuations, such as major infrastructure, or civil engineering projects price books are much more reliable.  For these projects, the use of a price book can be of significant value to the estimator since it will provide base cost data.  This information can then be adjusted to reflect any project specific factors or conditions.

In terms of headline benefits, construction cost price books offer a wealth of market data for those people not actively involved in the construction industry or do not have access to actual project commercial data.  However, they must always be viewed as being a guide rather than definitive information and they certainly cannot be regarded as a substitute for obtaining professional advice.

Ultimately, it is always advisable to carry out a cost estimate based upon actual design information, project specific market data (i.e. quotations), and if possible historical cost data for similar projects in that location.  There are numerous methods, which can be adopted when preparing a construction cost estimate, the Practical Guide to Estimating provides information, guidance, and advice on how to approach, prepare, and present a construction cost estimate depending upon the level of information available.  This guide also includes more information on the use of cost data from both price books as well as in-house databases.