Wednesday, October 22, 2008

Cost Overrun

Cost overrun is defined as excess of actual cost over budget. Cost overrun is also sometimes called "cost escalation," "cost increase," or "budget overrun." However, cost escalation and increases do not necessarily result in cost overruns if cost escalation is included in the budget.

Cost overrun is common in infrastructure, building, and technology projects. One of the most comprehensive studies [1] of cost overrun that exists found that 9 out of 10 projects had overrun, overruns of 50 to 100 percent were common, overrun was found in each of 20 nations and five continents covered by the study, and overrun had been constant for the 70 years for which data were available. For IT projects, an industry study by the Standish Group (2004) found that average cost overrun was 43 percent, 71 percent of projects were over budget, over time, and under scope, and total waste was estimated at US$55 billion per year in the US alone.

Spectacular examples of cost overrun are the Sydney Opera House with 1,400 percent, and the Concorde supersonic aeroplane with 1,100 percent. The cost overrun of Boston's Big Dig was 275 percent, or US$11 billion. The cost overrun for the Channel tunnel between the UK and France was 80 percent for construction costs and 140 percent for financing costs.

Three types of explanation of cost overrun exist: technical, psychological, and political-economic. Technical explanations account for cost overrun in terms of imperfect forecasting techniques, inadequate data, etc. Psychological explanations account for overrun in terms of optimism bias with forecasters. Finally, political-economic explanations see overrun as the result of strategic misrepresentation of scope and/or budgets.

All of the explanations above can be considered a form of risk. A project's budgeted costs should always include cost contingency funds to cover risks (other than scope changes imposed on the project). As has been shown in cost engineering research [1], poor risk analysis and contingency estimating practices account for many project cost overruns. Numerous studies have found that the greatest cause of cost growth was poorly defined scope at the time that the budget was established. The cost growth (overrun of budget before cost contingency is added) can be predicted by rating the extent of scope definition, even on complex projects with new technology. [2]

Cost overrun is typically calculated in one of two ways. Either as a percentage, namely actual cost minus budgeted cost, in percent of budgeted cost. Or as a ratio, viz. actual cost divided by budgeted cost. For example, if the budget for building a new bridge was $100 million and the actual cost was $150 million then the cost overrun may be expressed as 50 percent or by the ratio 1.5.

List of projects with large cost overruns
 Big Dig
 Channel Tunnel
 F-22 Raptor
 National Programme for IT
 Panama Canal
 Suez Canal
 Sydney Opera House
 TAURUS (share trading)
 Airbus A380
 Scottish Parliament Building
 Montreal Olympic Stadium
 Rogers Centre (formerly SkyDome)
 Pickering Nuclear Generating Station
 Millennium Dome
 Humber Bridge
 Oresund Bridge
 Hallandsås Tunnel
 Great Belt railway tunnel
 Sydney Olympic Park
 Joetsu Shinkansen high-speed rail line
 Pergau Dam
 V-22 Osprey
 Denver International Airport
 Eastern span replacement of the San Francisco–Oakland Bay Bridge

Cost underestimation
Cost underestimation is defined as the act of assessing the cost of a future venture lower than what actual cost turned out to be once the venture was implemented. Cost underestimation causes cost overrun. The main causes of cost underestimation are optimism bias and strategic misrepresentation.


1. Hackney, John W. (Kenneth H. Humprhies, Editor), Control and Management of Capital Projects, 2nd Edition, AACE International, 1997
2. Merrow, Edward W., Kenneth E. Phillips, and Christopher W. Meyers, Understanding Cost Growth and Performance Shortfalls in Pioneer Process Plants, (R-2569-DOE), Rand Corporation, 1981

Flyvbjerg, Bent, Nils Bruzelius, and Werner Rothengatter, Megaprojects and Risk: An Anatomy of Ambition (Cambridge University Press, 2003).
Flyvbjerg, Bent, Mette K. Skamris Holm, and Søren L. Buhl, 2002, "Underestimating Costs in Public Works Projects: Error or Lie?" Journal of the American Planning Association, vol. 68, no. 3, 279-295.
Standish Group, 2004. CHAOS Report (West Yarmouth, MA: Author)
UK Department for Transport, 2004. Procedures for Dealing with Optimism Bias in Transport Planning: Guidance Document (London).
Lev Virine and Michael Trumper. Project Decisions: The Art and Science, Vienna, VA: Management Concepts, 2008. ISBN 978-1567262179

Source:  Wikipedia, the free encyclopedia.

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