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Lessons Learned for Construction Project Owners - Manage the Risks

June 16, 2017

Capital expansion projects pose significant risks to unsuspecting project owners. As a construction project owner, your business and core competency is typically in an area that is completely different than construction. Yet, your career and the future of your company may ride on completing your capital expansion project on time, with sufficient quality and within budget. With your entire future riding on a multimillion and sometimes billion dollar plus construction project, you have trusted your future to outside architects, engineers and contractors to provide tangible project results in an area that you are unfamiliar. You may have hired a project management firm who is going to take care of your project. You receive very nice looking project reports that let you know there no problems. And, you are comforted in believing your project is very straightforward and everything is going to be just fine.

 

One day you wake up and find that your project will not be done on time. A mountain of change orders appears on your desk. Costs charged to the job are going to exceed available funding. Worse yet, the project is not going to fulfill your business needs and your maintenance department will be required to pick up the pieces.

 

Hopefully, this scenario is not something you will experience. You may be thinking that all of these problems are not likely or, at least, won’t happen at once. You are probably right. But, please don’t think for a minute that you may not be surprised. Here are a few examples of the kinds of surprises project owners have experienced:

 

"Depending on the nature of your project arrangements and risks, you may benefit from implementation of appropriate controls. . ."

 

You may think that addressing your construction project exposures can be a daunting task. You are right. However, there is hope. If you put in the right controls, you have a chance to succeed. Depending on the nature of your project arrangements and risks, you may benefit from implementation of appropriate controls in the following areas: a) The time to begin developing your project control structure is before your project begins. b) Your project management, cost engineering and finance personnel should be experienced and trained. c) Knowledge of your organization and ability to transition the project to facility owners will be important. d) Flexibility will be required to match your needs with efficiencies needed to achieve budget goals. e) Firms should be selected as needed to supplement your staff in providing both project management as well as project oversight, controls and audit services.

 

For example, a project owner saved more than $60 million on a subsequent phase of a project by building the right control structure before construction began. Project controls you should consider are listed in Exhibit 1 below.

 

Exhibit 1—Overall Project Controls

  • Processes, guidelines, procedures and management systems should be defined ahead of time.

  • Appropriate contractor selection methods should be applied.

  • Management should approve a project scope that matches the design requirements.

  • Independent assessment of project design and related cost should be performed where appropriate.

  • Value engineering processes should be performed to match facility design with your operational and maintenance needs.

  • A master project schedule, with defined milestones that match project requirements, should be used.

  • Project budgeting process should be implemented at the same level of detail as your project cost accounting.

  • Processes should be implemented for evaluation of contractor proposed cost support reasonableness
    and relevance.

  • Architecture, engineering and document control processes should be implemented.

  • Project management systems should be user friendly and provide needed information.

  • Site conditions should be independently assessed.

"The contract is the guide that determines the success or failure of your project. Selection of the contract type will be one of your key decisions."

 

Your safety program, bonding and insurance plan should be defined. Bonding and insurance levels should match management’s risk appetite. On larger programs, benefits can often be achieved through use of an owner controlled insurance program. This type of program replaces traditional contractor supplied insurance with insurance that you provide. Organizations often choose this type of program to gain better coverage of construction risk and/or to achieve perceived insurance cost savings.

 

The contract is the guide that determines the success or failure of your project. Selection of the contract type will be one of your key decisions. Some of the factors that will influence your selected method of contracting will include your knowledge of project requirements, project timing and internal capability to manage the project. You will want your construction controls to be defined and built into your contract language. For example, control requirements for competitive bidding, change orders, project reporting, cost accounting, billing, audit rights, work approvals, documentation requirements, insurance, substantial completion, performance incentives and work acceptance should all be clearly defined in the contract. Contractors should be held responsible for site inspections before submitting bids and conditions found during contract performance. Appropriate management and legal contract approvals should be obtained before starting work.

 

Your ability to monitor and control your project will depend on the effectiveness of your financial budgetary management processes and reporting. We often find inaccurate and incomplete project reporting processes. Project owners are better able to monitor project progress when the information indicated in Exhibit 2 below is readily available.

 

Exhibit 2 —Financial Budgetary Management and Reporting Information

  • A summary of commitments, spending and forecast will help you measure variance to budget.

  • Project spending should be compared to the project schedule and earned value.

  • Project budgets and forecasted spending should be compared to available funding.

  • Visibility of compliance with funding source requirements is often required.

  • A summary comparison of project and owner accounting records is necessary to achieve reliable management reporting.

  • Reporting of change order causes, dates and amounts to ensure senior management approval of changes.

  • The results of cost and billing reviews should be summarized for management.

  • Documentation should be maintained on test results, quality inspections and change approval for proper coding.

"Your ability to identify responsibility for change orders will be one of your greatest
challenges."

 

Exhibit 3—Key Change Order Process Controls

  • This process should require appropriate change order review, approval process, documentation, independent assessment of change design and related cost. Areas of particular concern include site conditions, clarity of appropriate requirements, owner communications, subcontractor scheduling and coordination.

  • Walking the site regularly will help you understand issues that surface as construction progresses.

  • You should require full explanations and support to assess the impact of changes and compare them to the original scope.

  • Capability to isolate change order cost and challenge unnecessary charges will likely produce substantial savings.

Construction audits often identify excessive labor, materials, rental equipment and overhead charges that exceed 5% of the overall project cost. Cost controls are of particular significance when your contracts are cost plus fee or when change orders surface. You will want engineering and financial reviews of both invoices as well as audits of contractor records can produce substantial savings. These reviews should cover the areas identified in Exhibit 4 as follows.

 

Exhibit 4—Areas and Documentation Covered by Construction Cost Reviews

  • Payroll charges should be reviewed for supporting cost accounting records, human resource documentation of pay rates, insurance cost support, time sheets and approvals for work performed.

  • Materials charges should be supported by assessment of materials need, approved purchase orders, documentation of materials receipt, quality inspections and inventory counts.

  • Computer aided auditing tools should be used to prevent and/or detect duplicate payments.

  • Support for rental equipment charges should include lease versus buy analysis, comparison of rental rates to market, cost support records, approval and verification of rental equipment use.

  • Overhead charges should be audited to ensure exclusion of home-office and other charges that should already be covered by contractor fees.

  • Support for charges as well as the basis of overhead allocation require should be verified as well.

Once final payment is made to the contractor, your financial leverage in addressing subsequent design or construction issues that may surface is greatly diminished. Therefore, close-out processes should be completely defined and applied as projects near completion. Use of a close-out check list is highly recommended. Some of the items to be included in this check list area as indicted in Exhibit 5 below.

 

Exhibit 5—Key Project Close-Out Items

  • Project owners should verify that final work completion, inspections, punchlist item clearance and permitting have been accomplished by both regulatory agencies and your own inspectors (safety, quality, operational etc.).

  • Obtain "as built" drawings, wiring schematics, warranty, handbooks, training and other information needed for facility operation and maintenance.

  • Achieve final resolution on any outstanding issues (worker compensation, claims, disputes etc.).

  • Conduct a final payment audit and ensure financial terms compliance.

  • Proper disposition of owner owned equipment and materials should be verified.

  • Obtain lien release in exchange for final payment.

  • Perform analysis of project performance and opportunities for improvement on other projects.

"The actions you take to mitigate construction project risks will be well worth the effort."

 

 

 

 

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