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Understanding Cost Overruns in Major Projects

Delve into the importance of reliable cost estimates in major projects, the impact of overruns, and the reasons behind them, backed by research findings and case studies. Explore solutions to mitigate risks and improve project planning processes.

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Understanding Cost Overruns in Major Projects

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  1. Cohesion Policy evaluation – Cost and time estimates of major projects Warsaw 30 November Hugh Kelly

  2. Importance of reliable estimates • Estimates are critical: • Public policy decisions • Investment decisions • Accountability • Cost overruns and benefit shortfalls: • Lead to an inefficient allocation of resources • Lead to delays and further cost overruns • Destabilize policy, planning, implementation and project operation1 1. See Megaproject Policy and Planning: Problems, Causes and Cures, Flyvberg, Department of Development and Planning, Denmark

  3. Estimates and evaluation • Ex post evaluation • What estimates were used in the ex ante CBA? • How did the outcome compare to estimates? • What were reasons for differences? • How did they impact on the effectiveness of the project?

  4. But major projects can go spectacularly over budget A$102m $5.0bn A$7.2m Sydney Opera House $1.5bn £9.5bn Denver's International Airport $14.6bn £4.7bn $3.7bn Boston’s Central Artery “The Big Dig” Channel Tunnel http://miller-mccune.com/business_economics/bill-of-goods-the-world-s-biggest-boondoggles-601

  5. And the evidence suggests that the problem is not restricted to flagship projects • ERDF 2000-2006 Evaluation (51 projects): • Average cost overrun • Rail +27% • Road +9% • Urban transport +45% • Water +11% • Energy +21% • Flyvberg: 44 Urban rail projects: • Average overrun 45%

  6. Traditional explanations Source: European Commission DG XVI (1998), “Understanding and Monitoring the Cost-Determining Factors of Infrastructure Projects”, A User’s Guide, Brussels

  7. Numerous studies confirm the reasons for over runs Source: ECORYS et al. (2005), “Ex post evaluation of a sample of projects co-financed by the Cohesion Fund (1993-2002)”, Synthesis Report, Rotterdam

  8. Recent review of ERDF projects

  9. Traditional approach to dealing with the risk • Risk management • PPP • Contingency funding • More and more detailed budgets

  10. Traditional solution – better planning and contingency Source: Flyvbjerg, Bent in association with COWI (2004), “Procedures for dealing with Optimism Bias in Transport Planning: Guidance Document”, The British Department for Transport, London, June.

  11. But if we understand the reasons for overrun why do we keep getting it wrong ? £9.3bn £2.3bn Original bid cost Current estimate

  12. Alternative approach: Flyvberg: Delusion and Deception in large Capital Projects1 • Delusions • Planning fallacy • Human optimism • Anchoring and adjustment • Tendency to ‘stick’ to initial estimate • Deception • Principal-Agent Problem • Sources of strategic deception Delusions and Deception in Large Infrastructure Projects, Bent Flyvberg, Massimo Garbuio, Dan Lovallo California Management Review Vol 51 No 2 Winter 2009

  13. Principal agent issues

  14. Sources of Strategic Deception • Actors self interests • Asymmetric information • Different risk preferences • Different time horizons • Diffuse accountability

  15. Different types of risks for different projects

  16. Solutions – (a) risk sharing • Pass risk of over runs to: • Member states • Local Governments • Contractors

  17. Solutions – (b) reference class projects • Select reference class • Assess distribution of outcomes • Make an intuitive prediction of project’s position in the distribution • Assess the reliability of prediction • Correct intuitive estimates

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