16-03-2012, 04:17 PM
Measuring and Managing Cost Escalation
Agenda
• Escalation-What is it?
• Escalation-Can we manage it?
• Discussion
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
• The Immediate Issues
– Major natural disasters
– Material cost increases
– Bid market disruption
– High volume of construction work
– Regulatory climate
• Upcoming Issues
– Continued high demand for construction
– Shortage of labor
– Global economy
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Major Natural Disasters
• The reality:
– Approximately 250,000 homes destroyed by
Katrina, Rita & Wilma
– Roughly another 250,000 homes seriously
damaged
– Typical annual damage is 50 – 75,000 lost or
damaged
– Annual new housing construction is roughly
2,000,000
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Major Natural Disasters
• The reality:
– Approximately $40bn in non-residential damage
– Typical annual damage is $bn10 – $bn15
– Annual non-residential market is roughly $bn400
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Major Natural Disasters
• The reality:
– Total damage is 10 – 15% of annual construction
market
– Given duration of reconstruction, likely impact is
in the 3 – 5% range
– Significant, but not overwhelming
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Major Natural Disasters
• The reality:
– Materials
• Likely to be sporadic shortages
• Likely to be transient price spikes
• Government intervention has skewed the market – so
have rumors
• There is a lot of uncertainty in price & availability
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Major Natural Disasters
• The reality:
– Labor
• Wages are lower than many parts of the
country
• Much of the labor is opportunist/non
construction
• The area has not drained the national pool of
construction workers
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Material Cost Increase
• The reality:
Material Cost Increase
• The Reality:
•World steel prices rose by 100% in 2004- $330/TN - $600/TN
•Prices have leveled off at about $600/TN
•US steel prices are higher than world steel prices by about $100/TN
•Steel was $500/TN 10 years ago
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Steel Cost Increase
• The reality in construction:
– Buildings use 20 - 30# of steel/GSF
• At $400/TN, that is about $4.00/GSF
• At $700/TN, that is about $7.00/GSF
– Steel is everywhere in the building
• Structure
• Miscellaneous metals
• Studs
• Doors & Frames
• Ductwork, Pipework & Conduit
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Escalation
Material Cost Increase
• The reality:
– Other strategic materials have seen
significant increase
• Wood - PVC pipe
• Cement - Asphalt Oil
• Copper
– Pressure on strategic materials is likely to
continue for some time
– Commodity prices are likely to be volatile
for some time
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Cost of Construction
Material Cost Increase
• The reality:
– Asphalt oil
• Tons of oil/SF of roof
– Oil
• barrels of oil/SF of building
– Copper
• Tons of copper/SF of building
– Diesel oil
• Gallons of diesel/hour of operation
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Cost of Construction
Material Cost Increase
The Reality:
When you are in the woods with a friend and
you are attacked by a bear . . .
Remember . . .
You don’t have to run faster than the
bear . . .
Just faster than your friend .
Bidders do not bid on cost, they bid against
the competition
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Market Disruption
• Volatility is a bigger issue than price
increase.
– Bidders can not lock in prices at bid time
– Delivery schedules are extended
– Bidders pay premiums to expedite supplies
– Bidders double & triple book orders compounding
shortage
– Most contracts concentrate volatility risk at the
lowest level (Vendor/Subcontractor)
– Contractors are nervous
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
$0
$2,000
$4,000
$6,000
$8,000
$10,000
$12,000
$14,000
$16,000
Vendor Subcontractor Owner
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
STEEL PRICING
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Vendor Subcontractor Owner
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
PUTTING THE RISK IN THE WRONG PLACE
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Construction Volume
• The reality:
– Construction activity nationally has been fairly
strong for several years
– some regions have been extremely strong for
many years.
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Construction Volume
• The reality:
– Competition for construction workers is very
high, especially for skilled workers and
superintendents
– Limited supply of qualified contractors & subcontractors
– Quality & performance suffer
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Cost of Construction
Regulatory Climate
• The reality:
– Natural disasters are likely to increase the
regulatory burden
– High volume of construction delays approvals
– Regulations tend to increase over time
• Gulf coast hurricane & flooding codes
• Earthquakes
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Escalation Summary
• Big Issues
– Busy Contractors
– High degree of uncertainty/risk
• Not so Big Issues
– Natural Disasters
– Material & Labor increases
• Escalation impact is selective &
variable
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Measuring Escalation
• Market volatility
– Significant market fluctuations not covered by
most indices
• Code changes
– Code & practice changes not covered by most
indices
• Tighter budgets
– Less room to accommodate missed inflation
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
1. Recognize reality
– Materials prices are not going back
– Bidders have plenty of options, & may not be
very interested in your projects
– Material prices are going to be volatile for some
years
– Most contracts transfer the price risk to the
subcontractor
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
2. Face reality
• There is a limit to available accuracy
• Uncertainty is here to stay
• We have to be smarter in what we do
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
3. Speak reality
• We have to communicate the truth to project
teams
• Speak early, speak often
• Stop hiding behind
q China
q Katrina
q Oil
q US Exchange rate
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
4. Tackle reality
• Material price volatility
• Contractor capacity
• Labor availability
• Core escalation
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
Reduce the impact of material volatility
• Pre-purchase materials
• Use fluctuation clauses
• ‘Cost plus’ with target cost
• Dedicated float for material procurement
• Break contract into smaller packages
• Delay bidding non-essential packages
• Reduce bid award period to accommodate
shorter price locks
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
Reduce the impact of contractor capacity
• Be nice – prompt pay, resolve change orders
• Good documentation
• Eliminate/reduce complexity
• Build long term relationships
• Framework agreements/Indefinite Quantity
Contracts
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
Reduce the impact of labor capacity
• Offsite fabrication
• Standardization
• Improve worksite environments
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
What can be done?
Reduce the impact of core escalation
• Accelerate schedules
• 4D/5D design software (BIM)
• Standardize
• Eliminate/reduce indecision masquerading as
flexibility
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Realign some of the A/E’s risk
– Limit the redesign clause
– Recognize inflation during design
– Actively manage design & cost
Absorb some of the Program risk
– Develop program-wide contingencies/risk
management protocols
– Redefine success
– Be willing to fail (occasionally)
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Making Changes - This takes:
– Nerve
– Freedom of action at project level
– Some budget/contingency flexibility
– Committed leadership
– More work from project team
– New contract forms
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Business as usual
• Transfers risk to the architect – redesign
clauses
• Transfers risk to the contractor – hard
money bids
• Transfers risks to project staff –
performance expectations
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Business as usual
• Consequences
– Everyone who buys the risk will charge a
premium
– You may still not get the performance you
bought
Northwest Construction Consumer Council ANNUAL CONFERENCE 2006
Northwest Construction Consumer Council ANNUAL CONFERENCE 2005
Managing Escalation
Conclusion:
• There are several inflationary factors at play
• Virtually no published index will pick these
factors up
• Inflation will be higher and less predictable
• Quick & innovative responses are needed if
the quality of construction is to be
maintained.