Stop Punishing the Overruns
If you could have 10 minutes of your plant manager’s time, what would you talk about? I know what I would want to discuss, and you may be surprised to hear that it has nothing to do with Front-End Loading (FEL). Nope, I would use that time to talk about why it doesn’t make good business sense to beat up on projects that overrun.
No one likes a project cost overrun, and for many plant managers, punishing overruns may be a favorite pastime. However, do this often enough and the tactic will ultimately backfire. Project managers are savvy folks – if they work at a site where a cost overrun is career limiting, they will wisely set an estimate that is fat enough to ensure an underrun.
The problem is, an underrun does NOT mean that you spent less money than Industry. It just means that you paid less than planned. IPA has data to prove that when a project team sets a soft target, about half of the unneeded funds are usually spent.
For example, let’s say a project manager is developing a project that should cost about $2 million. However, he wants to avoid any chance of overrunning, so he builds a budget of $2.2 million. He is planning to spend 10% more than what Industry would spend for the same scope. That’s a conservative estimate, so he probably won’t need all of that money. In fact, he’ll probably complete the project for a total cost of $2.1 million. He delivers an underrun and his plant manager is happy…but the actual project cost is about 5 percent higher than the industry norm. Set a soft target and you open the door for unnecessary design changes, urban renewal, folks charging extra time to the project…one way or another, the extra funds often get spent.
Unfortunately with small projects, this scenario isn’t limited to a few projects or a few sites, but has become more and more widespread. Over the past 10 years, IPA has evaluated thousands of small projects and we have observed that underruns are becoming more and more common. Currently, about 70 percent of small projects underrun and the average underrun is 8 percent. Sure, an 8 percent underrun on one project doesn’t sound so bad, but routinely underrunning all your projects by that amount ties up funds that could be spent on other capital projects.
In the end, punishing overruns usually means that you will end up spending more capital on projects than you really need to. To truly drive competitive estimating, you have to set p50 targets, in conjunction with achieving a good level of project definition. And p50 targets mean that about half of projects will overrun (and half will underrun, meaning the total capital budget for the site should not be exceeded). So go ahead and investigate projects that overrun and learn from your mistakes, but then move on. Don’t insist that all projects underrun.
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