Everything to Know about Cost Overrun Risks

The meaning of Cost Overrun, causes and how to mitigate Cost Overrun risks in construction.

What is Cost Overrun?

Cost overruns in construction are common. 'Cost overrun' or 'budget overrun' refers to a situation where the actual costs or projected total cost, exceeds the original Capital Project budget. This can occur due to poor budgeting, scope creep, unforeseen circumstances, design changes, or general mismanagement. Such overruns can impact the financial stability of a project, requiring use of contingency or worst case leading to disputes among stakeholders.

What does Cost Overruns mean?

'Cost Overruns' means that the Capital Project has, or is projecting that, actual costs on a project exceeds the planned budget. Cost overrun can be for a single subcontract package, work breakdown element or for the entire project, so its important to clarify the context of the Cost Overrun before passing judgement.

Cost Overruns Example

An example of cost overruns is when a construction project encounters unexpected foundational issues requiring additional excavation and structural support, which were not accounted for in the initial estimates. This leads to increased material and labor costs that surpass the budgeted amounts.

Budgeted at an initial cost of $7 million, the Sydney Opera House ended up costing more than $100 million and took more than a decade to construct. That is a Cost Overrun of 1,400 percent! 😱

The History of Cost Overruns

Cost overruns have been a common issue in the construction industry, often cited in both public and private sector projects. Historically, many large-scale projects have experienced significant budget overruns due to complexities and challenges not identified during the planning and design phases.

Causes of Cost Overruns

Cost overruns can be caused by several factors:

Poor Management: Malpractice of Project Managers who still use crazy spreadsheets with formula errors remains a cause of Cost Overruns.
Poor Risk Management: Lack of Risk Management best practice is a cause of Cost Overruns. Without risk identification, quantification and risk mitigation, you leave the capital project exposed to real cost increases eventuating in overall cost overruns.
Scope Creep: Gradual changes or expansions in project scope that increase costs.
Inaccurate Estimates: Initial project cost estimates that fail to accurately account for the real costs of materials, labor, or difficulties.
Project Delays: Delays that extend the project duration, increasing labor and resource costs.
Regulatory Changes: New regulations or requirements that necessitate additional work or materials.
Market Volatility: Fluctuations in material costs or labor rates.

Likelihood of Cost Overruns

The likelihood of experiencing cost overruns is relatively high in the construction industry, particularly in complex or long-term projects. The reality is that there are so many causes of this risk that make's it hard to fully mitigate or treat the risk. However, effective project management and rigorous budget control are essential to minimize these risks. Project Owners, General Contractors and Project Managers should expect risks to be realised and allow for them.

Consequence / Impact of Cost Overruns

The impact of cost overruns can be substantial, potentially leading to financial losses, the need for additional funding, project scope reduction, or even project abandonment of the entire project. Cost overruns can damage relationships, kill reputations and infuriate clients and other stakeholders due to mistrust or dissatisfaction. Primarily though, the main impact of Cost Overruns is requiring more money to complete the project.

Cost Overruns Clauses in Construction Contracts

Depending on your appetite for cost and risk, there are many types of construction contracts to choose from the address the responsibility of this risk differently. Within the contract's themselves there are generally no call-out clauses specifically for 'Cost Overruns' in standard form construction contracts, but there are mechanisms that control cost, time and changes to scope. They are:

Change Orders / Variations: Detailed processes for managing changes in the project scope, including how changes must be documented, approved, and implemented.
Scope Definition: Clear, detailed descriptions of project scope and deliverables to establish firm boundaries.
Stakeholder Roles and Responsibilities: Defined roles for all stakeholders in decision-making processes related to scope changes.
Limitations and Exclusions: Specific limitations or exclusions that define what is not included in the project scope to prevent unwarranted expansions.

Mitigations and Treatments for Cost Overruns Risk

Effective mitigation and treatment strategies for cost overruns include:

Budget, Risk & Contract Automation: Rather than run the risk of errors with spreadsheets, get a software tool to automate budget management, risk management and contract management to guarantee best practice management of costs.
Risk Management and Identification: Engage early with Risk Management practices. Identify potential risks that have cost related impacts, and do your best to elimiate, mitigate or accept them.
Integrated Cost Risk control: To avoid silo'd information for Risk and Budget, use a technology that has Risks integrated with Cost tracking.
Thorough Planning and Analysis: Ensuring detailed project planning and risk analysis to anticipate potential cost overruns.
Regular Budget Reviews: Conducting regular reviews and updates of the project budget as work progresses.
Change Order Management: Implementing strict controls on change orders to manage scope creep and their impact on the project budget.
Contingency Budgeting: Allocating a contingency budget to cover unexpected costs without impacting the overall project budget.

Risk Management and Reporting of Cost Overrun Risks

As we've seen above, there are alot of considerations when it comes to Risk Management. Implementing Risk Management and Reporting controls will make managing this risk easy, and ensure success of your Capital Project.

Risk Management Plan: Download a free Risk Management Plan Template and put a Risk Management process in place.
Risk Register: Download a manual Risk Register Template or use an automated Risk Register solution to track all risks, causes, consquences and mitigations.
Reporting: Create automated Risk Reports, Project Status Reports or Dashboards for communicating with stakeholders. If you need a free Report Template, you can find some examples here.