COST ADVICE / WHOLE LIFE COSTS: NRM 3

There are a number of definitions for whole life costing, but one currently adopted is: ‘the systematic consideration of all relevant costs and revenues associ-ated with the acquisition and ownership of an asset.’

When giving cost advice to the client, the project manager should take whole life costs or lifecycle costs into account, which includes a considera-tion of the following cost factors (see also Figure 2.6). The client should be made aware that long-term lifecycle costs, as well as capital costs, should be considered when decisions are taken.

• Initial or procurement costs, including design, construction or installa-tion, purchase or leasing, fees and charges.

• Future cost of operation, maintenance and repairs, including manage-ment costs such as cleaning, energy, etc.

• Future replacement costs including loss of revenue due to non-availability.

• Future alteration and adaptation costs including loss of revenue due to non-availability.

• Future demolition / recycling costs.

Common terms used to describe the consideration of all the costs associated with a built asset throughout its lifespan are:

• costs-in-use,

• lifecycle costs,

• whole life costs, and

• through life costs.

Although whole life costing can be carried out at any stage of the project and not just during the procurement process, its greatest potential for effective-ness is during procurement because:

• almost all options are open to consideration at this time,

• the ability to influence cost decreases continually as the project pro-gresses, from 100 per cent at project sanction to 20 per cent or less by the time construction starts, and

Figure 2.6 Whole life costs

• the decision to own a building normally commits the user to most of the total cost of ownership and consequently there is a very slim chance of changing the total cost of ownership once the building is delivered.

Typically, between 75 per cent and 95 per cent of the cost of running, maintaining and repairing a building is determined during the procure-ment stage.

Criticisms of whole life costing

Whole life costing is not an exact science, as in addition to the difficulties inherent in future cost planning, there are larger issues at stake. It is not just a case of asking ‘how much will this building cost me for the next 50 years?’, but whether a particular building will be required at all in 50 years time – especially as the current business horizon for many organisations is closer to three years. Also, whole life costing requires a different way of thinking about cash, assets and cash flow. The traditional capital cost focus has to be altered and costs thought of in terms of capital and revenue coming from the same ‘pot’. Many organisations are simply not geared up for this adjustment.

Perhaps the most crucial reason for this is the difficulty in obtaining the appropriate level of information and data. The Building Maintenance Cost Information Service (BMI) define an element for occupancy cost as

‘expenditure on an item which fulfils a specific function irrespective of the use of the form of the building’. The system is dependent on practitioners submitting relevant data for the benefit of others. The increased complexity of construc-tion means that it is far more difficult to predict the whole life cost of built assets. Moreover, if the malfunction of components results in decreased yield or underperformance of the building, then this is of concern to the end-user / owner. There is no comprehensive risk analysis of building components available for practitioners, only a wide range of predictions of estimated life spans and notes on preventive maintenance, which are too simplistic. There is a need for costs to be tied to risk including the consequences of component failure. After all, the performance of a material or component can be affected by such diverse factors as:

• Quality of initial workmanship when installed on site and subsequent maintenance.

• Maintenance regime / wear and tear. Buildings that are allowed to fall into disrepair prior to any routine maintenance being carried out will have a different lifecycle profile to buildings that are regularly main-tained from the outset.

• Intelligence of the design and the suitability of the material / compo-nent for its usage. There is no guarantee that the selection of so-called high-quality materials will result in low lifecycle costs.

Other commonly voiced criticisms of whole life cost include:

• Expenditure on running costs is 100 per cent allowable revenue expense against liability for tax and as such is very valuable. There is also a lack of taxation incentive in the form of tax breaks, etc. for owners to install energy efficient systems. (See later section on capital allowances.)

• In the short term, and taking into account the effects of discounting, the impact on future expenditure is much less significant in the devel-opment appraisal.

Another difficulty is the need to be able to forecast, a long way ahead, many factors such as lifecycles, future operating and maintenance costs, and dis-count and inflation rates. whole life cost, by definition, deals with the future and the future is unknown. Increasingly obsolescence is being taken into account during procurement, a factor that it is impossible to control since it is influenced by such things as fashion, technological advances and innova-tion. An increasing challenge is to procure built assets with the flexibility to cope with changes. Thus, the treatment of uncertainty in information and data is crucial as uncertainty is endemic to whole life cost. Another major difficulty is that the whole life cost technique is expensive in terms of the time required. This becomes even clearer when there is a requirement to undertake a whole life cost exercise within an integrated real-time environ-ment at the design stage of projects.

In addition, changes in the nature of development and other factors have emerged to convince the industry that whole life costs are important.

Whole life cost procurement: critical success factors

• Effective risk assessment – what if this alternative form of construction is used?

• Timing – begin to assess whole life cost as early as possible in the pro-curement process.

• Disposal strategy – is the asset to be owner-occupied, sold or let?

• Opportunity cost – downtime.

• Maintenance strategy / frequency – does one exist?

• Suitability – matching a client’s corporate or individual strategy to procurement.

RISK

A widely accepted definition of risk is: ‘an uncertain event or set of circum-stances that should it occur, will have an effect on the achievement of project objectives’.

It is the role of the project manager to deal with the project risks on behalf of the client and to ensure the client’s interests are protected when involved in administering, managing, communicating and co-ordinating risk within the project. Each of the consultants in the development/ design team and the organisations in the construction team will be focused on managing their risks on the project. The project manager should take a strategic view on behalf of the client.

One of the most important factors that the project manager has to be able to manage is the potential for risk to impact adversely on project outturns.

Risk has the potential to impact on the development throughout a project’s lifecycle, from the decision to invest, to procurement, to construction, to running and maintenance costs. Areas with a potential for risk are:

• inadequacy of the business case,

• environmental impact,

• disputes and claims,

• economics (macro business cycle),

• late contractor involvement in the design process,

• complex contract structures,

• degree of innovation,

• poor contractor capabilities,

• poor management team, and

• poor project intelligence.

The client’s and the project team’s risk viewpoint may vary markedly on the importance of the above.

Who carries the risk?

Construction projects have a great deal of risk. Traditionally the following responsibilities apply.

• The project manager is responsible for the identification, analysis and co-ordination of a risk management strategy to ensure that develop-ment and project risks are minimised and mitigated against.

• The investor / client / owner is responsible for the investment / finance risk.

• The design team consultants are responsible for the design risk.

• The contractor and specialist contractors are responsible for the con-struction risk, which includes the health and safety of the workforce.

• Suppliers and manufacturers are responsible for the performance risk of their components and materials.

• The client / owner is responsible for operating and maintenance risk.

• The insurance industry carries the risk of failure by any of the parties through negligence, accident or force majeure.

• Government agencies are responsible for ensuring their codes and regu-lations set the minimum acceptable standards.

• Maintenance teams and facilities managers take the risk of ensuring that the project works in use.

Risk accountability

For each risk it is necessary to consider who is accountable should that risk occur. This person is normally called the risk owner and will be a senior manager or board member. The team must also decide on who can best take responsibility for the action to manage the risk, either on his / her own or in collaboration with others. This person is normally called the action owner. Individuals rather than organisations should be nominated in each case as the latter is too ambiguous. The risk manager should allocate new ‘action owners’ in the event that individuals leave the project team.

Next the team needs to consider what the action owner can undertake to implement one of the strategies outlined above. This will be the manage-ment action. Finally, the team needs to decide the date by when the action should be completed and when it should be reviewed. The risk manager should ensure that the team nominates specific dates rather than vague terms such as ‘ongoing’ or ‘next progress meeting’. Poorly defined dates may lead to unmanaged risk escalations and slippage, threatening the successful delivery of the project.

It is the job of the project manager to chase up the action owners in order to ensure that risks are being managed.

In defining the action that the action owner should take, it is necessary to keep things in proportion, assess the resources needed to undertake the

action and compare these with the impact should the risk occur. There is little point in expending more resources to manage a risk than would be required were its impact to occur.

The form of contract / procurement strategy will also play a large part in the allocation of risk. Many contracts contain provision for risk management to be more transparent.

The questions that should be addressed by the project manager are:

• What are the risks?

• What will their impact be?

• What is the likelihood of the risks occurring?

The processes involved with risk management are:

• risk analysis, and

• risk management.

How to deal with risk

• Avoidance – be pro-active and take evasive action to stop the risk from happening.

• Contingency – take the decision to let the risk happen and make plans to absorb the action. This can take the form of:

° Strategic contingency, i.e. having a plan B. In the event of the risk occurring, implement a pre-planned alternative.

° Cost contingency: have a reserve of uncommitted cash to cover the financial consequences should the risk occur. Usually allowed for as a percentage of the total cost. it should be transparent.

° Time contingency: allow for some time in the programme should subcontractors or materials do not turn up on schedule.

° Take out insurance.

• Mitigation – action to reduce the probability of the risk occuring or, if it does occur, to minimise its impact.

• Transfer – agree at the start of the contract who will manage the risk and transfer risk to those who are best able to manage it.

• Take no action – take a positive decision to ignore risk on the basis that the chance of risk impacting on the project is minimal, as is the potential cost set against the high cost of trying to manage risk.

It is never too early to start considering risk. The management of risk should be a continuous process, not just to be considered at the start of a project and

then forgotten; it must be constantly re-visited throughout the duration of the project.

The success of project risk management is dependent on the effective implementation of the risk responses. The objectives of the risk monitoring and control processes are to:

• review on a monthly basis the current risk profile and identify changes in the risk probabilities and impacts,

• monitor on a monthly basis the implementation of risk responses and implement any necessary changes,

• update the risk register on a quarterly basis with any new risks and asso-ciated responses based on changes in project scope, project progress and changing risk generators, and

• review on a quarterly basis the level of project risk management matu-rity of each project in the programme.

Risk attitude

The project manager needs to be aware that every organisation / client will have a different perception of risk. Risk-loving, neutral and risk-averse organisations will respond differently to the same risk, but there is no scientific way to measure perception or attitude that can be used in risk analysis. Hence, some risks will be over-compensated, while others will be underestimated.

Risk management

The aim of risk management is to ensure that risks are identified at project inception, their potential impacts allowed for and where possible, the risks or their impacts minimised.

Risk identification

Successful risk management depends on accurate risk identification. Both management practice and engineering techniques should be applied to determine how things might go wrong. When identifying potential risks, it is important to distinguish between the origin of a risk and its impact.

Risk assessment

The purpose of risk assessment is to understand and quantify the likelihood of occurrence and the potential impacts on the project outcome. Various analytical techniques are available, but the key features are:

• Qualitative assessment – to describe and understand each risk and gain an early indication of the more significant risks.

• Quantitative assessment – to quantify the probability of each risk occur-ring and its potential impact in terms of cost, time and performance.

Qualitative assessment

A descriptive written statement of relevant information about a potential risk should be prepared. Issues to be considered should include:

• the stages of the project when the risk could occur,

• the elements of the project that could be affected,

• the factors that could cause the risk to occur,

• any relationship or interdependency with other risks,

• the likelihood of the risk occurring, and

• how it could affect the project.

Quantitative assessment

The likelihood of a risk occurring is given a numerical probability. This is measured on the following scale:

0 = impossible for risk to occur, 0.5 = even chance of risk occurring, and 1 = risk will occur.

Possible consequences of a risk arising are quantified in terms of:

• cost – additional cost above the base estimate for the project outturn,

• time – additional time beyond the base estimate of the completion date for the project, and

• performance – the extent to which the project would fail to meet the user requirements for standards and performance.

Risk monitoring and control

The aim of risk management is to minimise the opportunity for risks to occur and their impact should they occur. There are various options avail-able when evaluating the risk response strategy. Care should be taken when considering the management actions available to ensure that the potential impact of each risk is not outweighed by the direct costs to the project from:

• the cost of reducing the risk,

• the cost of transferring the risk (or the cost of insurance), and

• all management and administrative time, consultants’ fees and other charges associated with managing and dealing with the risk.

For each project, a risk management plan should be prepared and updated regularly to summarise the risk management process to date.

Risk response

A risk response should only be determined after its possible causes and effects have been considered and fully understood. It will take the form of one or more of the following management actions:

• avoidance,

• reduction (including elimination),

• transfer, or

• retention (including sharing).

As a general rule, risks should be allocated to those best placed to manage them.

Risk avoidance

Where risks would have such serious consequences on the project outcome to make them totally unacceptable in the context of the client’s internal rules or the project’s objectives, risk avoidance measures might be instituted.

These might include a review of the project objectives and a re-appraisal of the project, perhaps leading to the replacement of the project, or its cancellation.

Risk reduction

Typical action to reduce risk can take the form of:

• re-design – including re-design arising out of VE studies,

• more detailed design or further site investigation – to improve the infor-mation on which estimates and programmes are based,

• different materials or permanent equipment – to avoid new technology or unproven systems or long delivery items,

• different methods of construction – to avoid inherently risky construc-tion techniques,

• changing the project execution plan– to package the work content dif-ferently, or

• changing the contract strategy – to allocate risk between the project participants in a different way.

Risk reduction measures lead to a more certain project outturn. They usually result in a direct increase in the base estimate, and a correspondingly greater reduction in risk allowance.

Risk transfer

Where accepting a risk would not result in the best value for money, it could be transferred to another party who would be responsible for the consequences should the risk occur. The object of transferring risk is to pass the responsibility to another party better able to control it. Risk transfer is usually from:

• client to design consultant,

• client to contractor,

• contractor to subcontractor,

• client or other parties to an insurer in the form of insurance cover, or

• contractor or subcontractor to a bank or a surety in the form of warran-ties, bonds and guarantees.

Whenever a risk is transferred to another party a premium is usually paid.

This results in a direct increase in the base estimate and a reduction in risk allowance. To provide value for money, risk transfer should only be carried out where the overall potential cost of the risk to the department is reduced by more than the cost of the premium.

Factors that should be considered include:

• Who is best able to control the events which may lead to the risk occurring?

• Who can control the risk if it occurs?

• Is it preferable for the client to be involved in the control of the risk?

• Who should be responsible for a risk if it cannot be controlled?

• If the risk is transferred to a project participant:

° Is the total cost to the client likely to be reduced?

° Will the recipient be able to bear the full consequences if the risk

° Will the recipient be able to bear the full consequences if the risk

In document 0415732395 (Page 120-137)