Cost Estimating and Profitability in Construction
by Jeffrey C Kadlowec, Registered Architect
Cost estimation is critical to the success of any construction project. Inaccurate estimating can lead to poor job performance or project failure due to budget shortfalls and schedule overruns. Most formal research has been focused on the various methods of cost estimations without investigating the performance factors of those estimates (Fazil 2021). By studying cost estimating methods and how they impact to project outcome, we can better predict the profitability of future work.
Historical data and macroeconomic indicators are widely used in construction cost estimating. These range from rough approximations based on size, scope and complexity to detailed itemization of projected costs of materials, labor and overhead. Construction projects that are complex and large-scale require continuous revision to original estimates (Yazıcıoğlu 2020). Fluctuations in the market and economic uncertainty increase the financial risks for all stakeholders. Integrating this data through decision tree model will increase the efficiency and accuracy of cost estimations and improve decision-making processes.
Determining the cost of a project is crucial to planning, design and construction. Failure to provide adequate funding may constrain the development, cause production delays, and reduce overall quality. It can also negatively impact operational safety, building maintenance and equipment serviceability (Lopez del Puerto 2016). Feasibility studies, conceptual design, and preliminary engineering completed during the preconstruction services phase will help determine the required budget. Given the investment of capital and resources, evaluation of costs for preconstruction and construction phases should be used guide decisions to proceed.
Cost estimates are essential to control to time and budget of construction projects. They must be completed at each stage of the design process and through the building phase. The level of accuracy increases at each stage as the project scope becomes more definitive. Initial estimates based on order of magnitude will vary from -30% to +50%, through design and documentation at -15% to +30%, and onto bidding at -5% to +15% (Dandan 2019). Contingency funds to address inherent risks caused by the dynamic nature of work and complexity of the design should factored into these figures.
Change orders will likely happen throughout the construction phase of most projects at an additional cost. Uncertain conditions and events make it difficult to estimate this requirement in advance. Incorporating a minimum contingency fee into the project budget will ensure these costs are met (Noeman 2023). This portion of the budget will cover possible overtime, contractor errors, missing scope and market variances without contract amendments. Any unutilized funds can later be credit back to the client, enhance the project or awarded as profit.
Labor productivity is a major factor affecting the profitable of a construction company. Work must be performed efficiently, effectively and free of errors. The level of education, degree of skill and motivation of workers will affect production rates (Ozola 2023). Project management must address a wide variety of internal issues related to employees and their work environment with a focus on overall performance. External factors regarding completion in the sector, migration of workers, policies and regulations, technological developments, and economic conditions also need to be considered. The goal of these companies ultimately remains creating value through the production of high quality construction projects.
The construction industry experiences the highest rate of insolvency of any business sector. Poor financial management is the leading cause of failure of these companies attributed to primarily to insufficient cash flow (Hasan 2022). General contractors go out of business not from a lack of work, but by running out of money. Payment delays create financial deficits to suppliers, sub-contractors, and workers. Overruns to project cost and duration require additional financing. Changes to material, labor and equipment costs impact cash flow. Inaccurate schedules, estimating errors, and uncertainty can further reduce profit margins. Owner and contractors must focus effort towards control and mitigation of these risk factors to remain profitable.
References
Dandan, Tala Hassan; Sweis, Ghaleb; Sukkari, Lilana Salem & Sweis, Rateb Jalil. (2019). Factors Affecting the Accuracy of Cost Estimate During Various Design Stages. Journal of Engineering Design and Technology. DOI: 10.1108/JEDT-08-2019-0202.
Fazil, Mohammand Waffy; Lee, Chia Kuang & Tamyez, Puteri Fazline Muhamad. (2021). Cost Estimation Performance in the Construction Projects: A Systematic Review and Future Directions. International Journal of Industrial Management. 11(1): 217-235. doi.org/10.15282/ijim.11.1.2021.6131.
Hasan, Musaab Faith & Mahoman, Sawsan Rasheed. (2022). Factors Affecting Time and Cost Trade-off in Multiple Construction Projects. Archives of Civil Engineering. LXVIII(2): 549-561. DOI: 10.24425/ace.2022.140658.
Lopez del Puerto, Carla; Costa Agosto, Luis & Gransberg, Douglas. (2016). A Case for Incorporating Preconstruction Cost Estimating in Construction Engineering and Management Programs. ASEE 123rd Annual Conference & Exposition.
Noeman, Aws. (2023). Methodology of Estimating Construction Projects Contingency. IOP Conference Series: Earth and Environmental Science. DOI: 10.1088/1755-1315/1129/1/01204.
Ozola, Antra. (2023). Factors Affecting Labour Productivity in the Construction Sector. Rural Environment Education Personality. Vol 16. DOI: 10.22616/REEP.2023.16.006.
Yazıcıoğlu, E & Kanoğlu, A. (2020). Cost Estimating in Construction Projects: The Relationship Between Cost and Macro Economic Indicators. Instanbul Technical University.
Choosing an experienced, well established general contractor is key to a successful construction project. In my early days as a foodservice consultant, senior co-workers would tell me how terrible GC’s were. I believed it until i started doing contract work. Quickly learned that poor drawings and miscoordination with the project engineers led to confusion on site and change orders. Now, I have great admiration and fascinated that they can get projects done. Too many shortcuts and lack of role understanding in my opinion.
I finally came to the realization that most of the problems I’ve encountered over the years were caused by trying to salvage projects brought to me by low-bid contractors from underfunded clients. As I move forward into the realm of commercial real estate development, I must begin thinking less like an architect/engineer and more as an investment banker. Thanks for the comment. Stay tuned for plenty more essays and research papers this year.